**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

----

 

**FORM10-Q**

 

**Quarterly report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

 

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

 

**Commission file number 000-14742**

 

**CANDELACORPORATION**

(Exact name of registrantas specified in its charter)

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

 

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Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

Yes  ý       No o

 

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

Yes  ý       No o

 

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

 

| **Class**                              | ** ** | **Outstanding at February 7, 2005** | ** ** |
|----------------------------------------|------------|-------------------------------------|------------|
| Common Stock, $.01 par value per share |       | 22,568,776                          |       |

 

 

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**CANDELACORPORATION**

**Index**

 
| Part I.  | Financial Information: |                                                                                                                                                                                                  |
|----------|------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |                   |                                                                                                                                                                                                  |
|     | Item 1.                | Financial Statements                                                                                                                                                                                  |   |
|     |                   |                                                                                                                                                                                                  |   |
|     |                   | Unaudited Consolidated  Balance Sheets as of January 1, 2005 and July 3, 2004                                                                                                                         | 3 |
|     |                   |                                                                                                                                                                                                  |   |
|     |                   | Unaudited  Consolidated Statements of Operations for the three-month periods ended January  1, 2005 and December 27, 2003, and for the six-month periods ended January 1,  2005 and December 27, 2003 | 4 |
|     |                   |                                                                                                                                                                                                  |   |
|     |                   | Unaudited Consolidated  Statements of Cash Flows for the six-month periods ended January 1, 2005 and  December 27, 2003                                                                               | 5 |
|     |                   |                                                                                                                                                                                                  |   |
|     |                   | Notes to  Unaudited Consolidated Financial Statements                                                                                                                                                 | 6-12 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Item  2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                           | 13-18 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Item  3.               | Quantitative  and Qualitative Disclosure about Market Risk                                                                                                                                            | 19 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Item 4.                | Controls and  Procedures                                                                                                                                                                              | 19 |
|     |                   |                                                                                                                                                                                                  |   |
| Part II. | Other Information:     |                                                                                                                                                                                                  |
|     |                   |                                                                                                                                                                                                  |
|     | Item 1.                | Legal proceedings                                                                                                                                                                                     | 20 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Item  4.               | Submission  of Matters to a Vote of Security Holders                                                                                                                                                  | 21 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Item 6.                | Exhibits and Reports on Form 8-K                                                                                                                                                                      | 21 |
|     |                   |                                                                                                                                                                                                  |   |
|     | Signatures             |                                                                                                                                                                                                  |
|     |                   |                                                                                                                                                                                                  |
|     | Index to Exhibits      |                                                                                                                                                                                                  |

 

----

 

**Part I. Financial Information**

 

**Item 1 - Financial Statements**

**CANDELA CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| **(in thousands)**                                | ** ** | **January 1,  2005** | ** **  | **July 3,  2004** | ** ** |
|---------------------------------------------------|------------|----------------------|-------------|-------------------|------------|
| ** **                                        | ** ** | **(unaudited)**      | ** **  | ** **        | ** ** |
| **Assets:**                                       | ** ** | ** **           | ** **  | ** **        | ** ** |
| ** **                                        | ** ** | ** **           | ** **  | ** **        | ** ** |
| Current assets:                                   |       |                 |        |              |       |
| Cash and cash  equivalents                        | ** ** | **$**                | **45,798**  | ** **        | **$**      | **37,139** | ** ** |
| Restricted cash                                   | ** ** | **260**              | ** **  | **257**           | ** ** |
| Accounts  receivable, net                         | ** ** | **30,291**           | ** **  | **34,302**        | ** ** |
| Notes receivable                                  | ** ** | **877**              | ** **  | **1,151**         | ** ** |
| Inventories, net                                  | ** ** | **13,679**           | ** **  | **13,571**        | ** ** |
| Other current  assets                             | ** ** | **1,404**            | ** **  | **2,184**         | ** ** |
| Total current  assets                             | ** ** | **92,309**           | ** **  | **88,604**        | ** ** |
| ** **                                        | ** ** | ** **           | ** **  | ** **        | ** ** |
| Property and  equipment, net                      | ** ** | **3,504**            | ** **  | **3,406**         | ** ** |
| Deferred tax  assets                              | ** ** | **5,661**            | ** **  | **5,914**         | ** ** |
| Prepaid licenses                                  | ** ** | **966**              | ** **  | **1,054**         | ** ** |
| Other assets                                      | ** ** | **3,938**            | ** **  | **1,501**         | ** ** |
| Total assets                                      | ** ** | **$**                | **106,378** | ** **        | **$**      | **100,479** | ** ** |
|                                              |       |                 |        |              |       |
| **Liabilities  and Stockholders’ Equity**    |       |                 |        |              |       |
| Current  liabilities:                             |       |                 |        |              |       |
| Accounts payable                                  | ** ** | **$**                | **6,474**   | ** **        | **$**      | **6,973** | ** ** |
| Accrued payroll  and related expenses             | ** ** | **3,314**            | ** **  | **5,428**         | ** ** |
| Accrued warranty  costs                           | ** ** | **4,779**            | ** **  | **4,946**         | ** ** |
| Income taxes  payable                             | ** ** | **3,468**            | ** **  | **1,844**         | ** ** |
| Other accrued  liabilities                        | ** ** | **3,542**            | ** **  | **3,586**         | ** ** |
| Deferred income  (current portion)                | ** ** | **4,465**            | ** **  | **3,421**         | ** ** |
| Current  liabilities of discontinued operations   | ** ** | **1,249**            | ** **  | **1,019**         | ** ** |
| Total current  liabilities                        | ** ** | **27,291**           | ** **  | **27,217**        | ** ** |
| Other long-term  liabilities                      | ** ** | **4,773**            | ** **  | **3,945**         | ** ** |
| Long-term liabilities  of discontinued operations | ** ** | **649**              | ** **  | **2,548**         | ** ** |
| Total  liabilities                                | ** ** | **32,713**           | ** **  | **33,710**        | ** ** |
| ** **                                        | ** ** | ** **           | ** **  | ** **        | ** ** |
| Stockholders’  equity:                       | ** ** | ** **           | ** **  | ** **        | ** ** |
| Common stock                                      | ** ** | **246**              | ** **  | **246**           | ** ** |
| Treasury stock,  at cost                          | ** ** | **(12,997**          | **)**       | **(12,997**       | **)**      |
| Additional  paid-in capital                       | ** ** | **53,487**           | ** **  | **53,069**        | ** ** |
| Accumulated  earnings                             | ** ** | **31,478**           | ** **  | **26,023**        | ** ** |
| Accumulated  other comprehensive income           | ** ** | **1,451**            | ** **  | **428**           | ** ** |
| Total  stockholders’ equity                  | ** ** | **73,665**           | ** **  | **66,769**        | ** ** |
| Total  liabilities and stockholders’ equity  | ** ** | **$**                | **106,378** | ** **        | **$**      | **100,479** | ** ** |

 

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

 

3

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**CANDELA CORPORATION**

**ConsolidatedStatements of Operations**

(in thousands, except per share data)

(unaudited)

 
| ** **                                                                                                                                                                                           | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **January 1,  2005**            | ** ** | **December 27,  2003**        | ** ** | **January 1,  2005** | ** ** | **December 27,  2003** | ** ** |
| **Revenue**                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products**                                                                                                                                                                       | ** ** | **$**                           | **23,539** | ** **                    | **$**      | **19,906** | ** ** | **$** | **41,882** | ** ** | **$** | **35,260** | ** ** |
| **Product-related  service**                                                                                                                                                                         | ** ** | **4,665**                       | ** ** | **3,992**                     | ** ** | **8,713** | ** ** | **7,324** | ** ** |
| **Total  revenue**                                                                                                                                                                                   | ** ** | **28,204**                      | ** ** | **23,898**                    | ** ** | **50,595** | ** ** | **42,584** | ** ** |
| **Cost of  sales**                                                                                                                                                                                   | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products**                                                                                                                                                                       | ** ** | **9,833**                       | ** ** | **9,527**                     | ** ** | **17,386** | ** ** | **17,156** | ** ** |
| **Product-related  service**                                                                                                                                                                         | ** ** | **4,395**                       | ** ** | **2,124**                     | ** ** | **7,192** | ** ** | **3,869** | ** ** |
| **Total  cost of sales**                                                                                                                                                                             | ** ** | **14,228**                      | ** ** | **11,651**                    | ** ** | **24,578** | ** ** | **21,025** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross  profit**                                                                                                                                                                                    | ** ** | **13,976**                      | ** ** | **12,247**                    | ** ** | **26,017** | ** ** | **21,559** | ** ** |
| **Operating  expenses:**                                                                                                                                                                             | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selling,  general and administrative**                                                                                                                                                             | ** ** | **9,997**                       | ** ** | **7,818**                     | ** ** | **16,657** | ** ** | **13,221** | ** ** |
| **Research  and development**                                                                                                                                                                        | ** ** | **1,621**                       | ** ** | **1,415**                     | ** ** | **2,956** | ** ** | **2,491** | ** ** |
| **Total  operating expenses**                                                                                                                                                                        | ** ** | **11,618**                      | ** ** | **9,233**                     | ** ** | **19,613** | ** ** | **15,712** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income  from operations**                                                                                                                                                                          | ** ** | **2,358**                       | ** ** | **3,014**                     | ** ** | **6,404** | ** ** | **5,847** | ** ** |
| **Other  income (expense):**                                                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest  income**                                                                                                                                                                                 | ** ** | **141**                         | ** ** | **76**                        | ** ** | **237** | ** ** | **155** | ** ** |
| **Interest  expense**                                                                                                                                                                                | ** ** | **—**                      | ** ** | **(4**                        | **)**      | **—** | ** ** | **(8** | **)** |
| **Other  income, net**                                                                                                                                                                               | ** ** | **75**                          | ** ** | **379**                       | ** ** | **118** | ** ** | **412** | ** ** |
| **Total  other income**                                                                                                                                                                              | ** ** | **216**                         | ** ** | **451**                       | ** ** | **355** | ** ** | **559** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income  from continuing operations before income taxes**                                                                                                                                           | ** ** | **2,574**                       | ** ** | **3,465**                     | ** ** | **6,759** | ** ** | **6,406** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Provision  for income taxes**                                                                                                                                                                      | ** ** | **824**                         | ** ** | **1,024**                     | ** ** | **2,163** | ** ** | **2,176** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income  from continuing operations**                                                                                                                                                               | ** ** | **1,750**                       | ** ** | **2,441**                     | ** ** | **4,596** | ** ** | **4,230** | ** ** |
| **Discontinued  operations:**                                                                                                                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loss  from discontinued Skin Care Center operations of $473 less income tax benefit  of $175**                                                                                                     | ** ** | **—**                      | ** ** | **—**                    | ** ** | **—** | ** ** | **(298** | **)** |
| **Gain  (loss) on closure of skin care center including revision of leasehold  obligations of $1,374 and provision of $(3,348) less income tax expense of  $(515) and income tax benefit of $1,253** | ** ** | **859**                         | ** ** | **—**                    | ** ** | **859** | ** ** | **(2,095** | **)** |
| **Net  income**                                                                                                                                                                                      | ** ** | **$**                           | **2,609**  | ** **                    | **$**      | **2,441** | ** ** | **$** | **5,455** | ** ** | **$** | **1,837** | ** ** |
| **Net  income (loss) per share of common stock**                                                                                                                                                     | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income  from continuing operations**                                                                                                                                                               | ** ** | **$**                           | **.08**    | ** **                    | **$**      | **.11** | ** ** | **$** | **.20** | ** ** | **$** | **.20** | ** ** |
| **Gain  (loss) from discontinued operations**                                                                                                                                                        | ** ** | **.04**                         | ** ** | **—**                    | ** ** | **.04** | ** ** | **(.11** | **)** |
| **Net  income**                                                                                                                                                                                      | ** ** | **$**                           | **.12**    | ** **                    | **$**      | **.11** | ** ** | **$** | **.24** | ** ** | **$** | **.09** | ** ** |
| **Diluted:**                                                                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income  from continuing operations**                                                                                                                                                               | ** ** | **$**                           | **.07**    | ** **                    | **$**      | **.11** | ** ** | **$** | **.20** | ** ** | **$** | **.19** | ** ** |
| **Gain  (loss) from discontinued operations**                                                                                                                                                        | ** ** | **.04**                         | ** ** | **—**                    | ** ** | **.04** | ** ** | **(.11** | **)** |
| **Net  income**                                                                                                                                                                                      | ** ** | **$**                           | **.11**    | ** **                    | **$**      | **.11** | ** ** | **$** | **.24** | ** ** | **$** | **.08** | ** ** |
| ** **                                                                                                                                                                                           | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic  weighted average shares outstanding**                                                                                                                                                       | ** ** | **22,363**                      | ** ** | **21,739**                    | ** ** | **22,356** | ** ** | **21,563** | ** ** |
| **Diluted  weighted average shares outstanding**                                                                                                                                                     | ** ** | **23,063**                      | ** ** | **22,576**                    | ** ** | **23,058** | ** ** | **22,380** | ** ** |

 

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

 

4

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**CANDELA CORPORATION**

**ConsolidatedStatements of Cash Flows**

(in thousands)

(unaudited)

 
| ** **                                                                                         | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                         | ** ** | **January 1,  2005**          | ** ** | **December 27,  2003** | ** ** |
| **Cash  flows from operating activities:**                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Net  income**                                                                                    | ** ** | **$**                         | **5,455**  | ** ** | **$** | **1,837** | ** ** |
| **Adjustments  to reconcile net income to net cash provided by (used for) operating  activities:** | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **(Revision  of) provision for disposal of discontinued operations**                               | ** ** | **(1,374**                    | **)**      | **2,095** | ** ** |
| **Depreciation  and amortization**                                                                 | ** ** | **362**                       | ** ** | **253** | ** ** |
| **Provision  for bad debts**                                                                       | ** ** | **300**                       | ** ** | **111** | ** ** |
| **Effect of exchange rate changes on foreign  currency denominated assets and liabilities**        | ** ** | **59**                        | ** ** | **25** | ** ** |
| **Increase  (decrease) in cash from working capital:**                                             | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Accounts  receivable**                                                                           | ** ** | **4,245**                     | ** ** | **(2,220** | **)** |
| **Notes  receivable**                                                                              | ** ** | **(327**                      | **)**      | **348** | ** ** |
| **Inventories**                                                                                    | ** ** | **397**                       | ** ** | **(2,572** | **)** |
| **Other  current assets**                                                                          | ** ** | **(1,865**                    | **)**      | **(613** | **)** |
| **Other  assets**                                                                                  | ** ** | **369**                       | ** ** | **(80** | **)** |
| **Accounts  payable**                                                                              | ** ** | **(975**                      | **)**      | **(501** | **)** |
| **Accrued  payroll and related expenses**                                                          | ** ** | **(2,157**                    | **)**      | **(1,593** | **)** |
| **Deferred  revenue**                                                                              | ** ** | **909**                       | ** ** | **59** | ** ** |
| **Accrued  warranty costs**                                                                        | ** ** | **(218**                      | **)**      | **801** | ** ** |
| **Income  taxes payable**                                                                          | ** ** | **1,787**                     | ** ** | **(717** | **)** |
| **Long  term portion of deferred revenue**                                                         | ** ** | **805**                       | ** ** | **(760** | **)** |
| **Loss  from discontinued operations**                                                             | ** ** | **—**                    | ** ** | **298** | ** ** |
| **Other  accrued liabilities**                                                                     | ** ** | **(122**                      | **)**      | **1,048** | ** ** |
| **Change  in restricted cash**                                                                     | ** ** | **(3**                        | **)**      | **—** | ** ** |
| **Net  cash provided by (used for) operating activities**                                          | ** ** | **7,647**                     | ** ** | **(2,181** | **)** |
| ** **                                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Cash  flows from investing activities:**                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Purchases  of property and equipment**                                                           | ** ** | **(468**                      | **)**      | **(88** | **)** |
| **Net  cash used for investing activities**                                                        | ** ** | **(468**                      | **)**      | **(88** | **)** |
| ** **                                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Cash  flows from financing activities:**                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Proceeds  from the issuance of common stock**                                                    | ** ** | **419**                       | ** ** | **2,434** | ** ** |
| **Net  cash provided by financing activities**                                                     | ** ** | **419**                       | ** ** | **2,434** | ** ** |
| ** **                                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Effect  of exchange rates on cash and cash equivalents**                                         | ** ** | **1,061**                     | ** ** | **362** | ** ** |
| ** **                                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| **Net  increase in cash and cash equivalents**                                                     | ** ** | **8,659**                     | ** ** | **527** | ** ** |
| **Cash  and cash equivalents at beginning of period**                                              | ** ** | **$**                         | **37,139** | ** ** | **$** | **31,870** | ** ** |
| **Cash  and cash equivalents at end of period**                                                    | ** ** | **$**                         | **45,798** | ** ** | **$** | **32,397** | ** ** |

 

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

 

5

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Candela Corporation

Notes to ConsolidatedFinancial Statements

 

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

 

The accompanying unaudited consolidated financialstatements and notes do not include all of the disclosures made in the AnnualReport on Form 10-K of Candela Corporation (the “Company”, or “Candela”) forfiscal year 2004, which should be read in conjunction with these financialstatements.  The financial informationincluded herein is unaudited, with the exception of the consolidated balancesheet as of July 3, 2004, which was derived from the audited consolidatedbalance sheet dated July 3, 2004. However, in the opinion of management, thefinancial statements include all necessary adjustments, consisting of normalrecurring accruals, for a fair presentation of the quarterly results and areprepared and presented in a manner consistent with the Company’s Annual Reporton Form 10-K. The results for the three and six-month periods ended January 1,2005 are not necessarily indicative of the results to be expected for the fullyear.

 

**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, and 44employees have been terminated as of January 1, 2005.

 

During the three-month period ended October 2, 2004,the landlord for the Boston facility secured a sublease for that property.  The Company was not able to determine thefuture economic benefit of the sublease at that time. The sublessee commencedmaking payments to the landlord during December of 2004.  As a result of these and future payments scheduledunder the sublease, the Company revised the estimated future costs associatedwith the Boston facility and, in the quarter ended January 1, 2005, hasreversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublesseepayments of $1,703, net of legal and other fees of approximately $329 and incometaxes of approximately $515, and was recognized in the three-month period endedJanuary 1, 2005.

 

The following table reflects the combinedrestructuring charges incurred in the six month period ended January 1, 2005:

 
| **(in thousands)**                                                | ** ** | **Leasehold  Improvements  and Fixed  Assets** | ** ** | **Facility  Costs** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------|------------|---------------------|------------|-----------|------------|
| **Balance  at July 3, 2004**                                      | ** ** | **$**                                          | **197**    | ** **          | **$**      | **2,809** | ** ** | **$** | **3,006** | ** ** |
| **Reduction  of reserve due to cash payments**                    | ** ** | ** **                                     | ** ** | **337**             | ** ** | **337**   | ** ** |
| **Non-cash  amortization relating to the Scottsdale reserve**     | ** ** | **50**                                         | ** ** | **—**          | ** ** | **50**    | ** ** |
| **Reduction  of reserve due to revision of leasehold obligation** | ** ** | **—**                                     | ** ** | **1,374**           | ** ** | **1,374** | ** ** |
| **Balance  at January 1, 2005**                                   | ** ** | **$**                                          | **147**    | ** **          | **$**      | **1,098** | ** ** | **$** | **1,245** | ** ** |

 

6

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**2.****                   DiscontinuedOperations, continued**

 

AtJanuary 1, 2005, the discontinued segment had a net liability of approximately$1.9 million consisting primarily of the aforementioned reserve of $1.2 millionand deferred gift certificate revenue of $0.8 million partially offset by fixedassets of approximately $0.1 million.  Revenuesfor discontinued operations for the quarter ended September 27, 2003 were approximately $0.4 million. There havebeen no subsequent revenues.

 

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

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement No. 123R, “Share-BasedPayment” (“FAS 123R”). FAS 123R is a revision of FASB Statement No. 123, “Accountingfor Stock-Based Compensation” (“FAS 123”). The Company is required to adopt theprovisions of FAS123R as of the beginning of its first fiscal quarter of 2006,beginning July 3, 2005. This statement establishes standards for and requires therecognition of the cost of employment-related services settled in share-basedpayment. The adoption of the provisions of FAS 123R will have a material impacton the Company’s consolidated financial statements.

 

Currently and until theadoption of FAS 123R, the Company follows the provisions of FAS 123. Theprovisions of FAS 123 allow companies to either expense the estimated fairvalue of stock options or to continue to follow the intrinsic value method setforth in Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB 25”), but disclose the pro forma effects on netincome (loss) had the fair value of the options been expensed. Candela haselected to continue to apply APB 25 in accounting for its stock optionincentive plans.

 

In accordance with APB 25and related interpretations, compensation expense for stock options isrecognized 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 equals or exceeds the fair market valueof Candela common stock at the date of grant, thereby resulting in norecognition of compensation expense by Candela. For awards that generatecompensation expense as defined under APB 25, the Company calculates the amountof compensation expense and recognizes the expense over the vesting period ofthe award.

 

7

----

 

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

 

Had compensation cost forCandela’s stock option plans been determined based on the fair value method setforth in FAS 123, Candela’s net income (loss) and basic and diluted netincome (loss) per common share would have been changed to the pro formaamounts indicated below:

 
| ** **                                                                                                                                         | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **(in thousands, excepts per  share data)**                                                                                                        | ** ** | **January 1,  2005**            | ** ** | **December 27,  2003**        | ** ** | **January 1,  2005** | ** ** | **December 27,  2003** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  income , as reported**                                                                                                                      | ** ** | **$**                           | **2,609**  | ** **                    | **$**      | **2,441** | ** ** | **$** | **5,455** | ** ** | **$** | **1,837** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Add:  stock-based employee compensation expense included in reported net income,  net of related tax effects**                                   | ** ** | **—**                      | ** ** | **—**                    | ** ** | **—** | ** ** | **—** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Deduct:  total stock-based employee compensation expense, determined under fair value  based method for all awards, net of related tax effects** | ** ** | **(138**                        | **)**      | **(401**                      | **)**      | **(289** | **)** | **(775** | **)** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Pro  forma net income**                                                                                                                          | ** ** | **$**                           | **2,471**  | ** **                    | **$**      | **2,040** | ** ** | **$** | **5,166** | ** ** | **$** | **1,062** | ** ** |
| **Net  income per share of common stock**                                                                                                          | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic -  as reported**                                                                                                                           | ** ** | **$**                           | **0.12**   | ** **                    | **$**      | **0.11** | ** ** | **$** | **0.24** | ** ** | **$** | **0.09** | ** ** |
| **Basic -  pro forma**                                                                                                                             | ** ** | **$**                           | **0.11**   | ** **                    | **$**      | **0.09** | ** ** | **$** | **0.23** | ** ** | **$** | **0.05** | ** ** |
| **Diluted  - as reported**                                                                                                                         | ** ** | **$**                           | **0.11**   | ** **                    | **$**      | **0.11** | ** ** | **$** | **0.24** | ** ** | **$** | **0.08** | ** ** |
| **Diluted  - pro forma**                                                                                                                           | ** ** | **$**                           | **0.11**   | ** **                    | **$**      | **0.09** | ** ** | **$** | **0.22** | ** ** | **$** | **0.05** | ** ** |

 

In computing this pro-formaamount, the Company has used the Black-Scholes pricing model using thefollowing assumptions for options granted in fiscal years 2005 and 2004:

 
| ** **                                       | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|
| **Risk-free  interest rate**                     | ** ** | **4.25**   | **%**      | **4.25**   | **%**      |
| **Estimated  volatility**                        | ** ** | **78**     | **%**      | **76**     | **%**      |
| **Expected  life for stock options (yrs)**       | ** ** | **2.96**   | ** ** | **2.99**   | ** ** |
| **Expected  life for stock purchase plan (yrs)** | ** ** | **0.5**    | ** ** | **0.5**    | ** ** |
| **Expected  dividends**                          | ** ** | **—** | ** ** | **—** | ** ** |

 

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

 

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

 

8

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**4.****                   Earnings PerShare, continued**

 

Common stockequivalents include shares issuable upon the exercise of stock options orwarrants, net of shares assumed to have been purchased with the proceeds, usingthe treasury stock method.

 
| ** **                                                                        | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **(in thousands, except per share  data)**                                        | ** ** | **January 1,  2005**            | ** ** | **December 27,  2003**        | ** ** | **January 1,  2005** | ** ** | **December 27,  2003** | ** ** |
| ** **                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic  shares used in the calculation of earnings per share**                   | ** ** | **22,363**                      | ** ** | **21,739**                    | ** ** | **22,356** | ** ** | **21,563** | ** ** |
| ** **                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Effect  of dilutive securities:**                                               | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Stock  options**                                                                | ** ** | **700**                         | ** ** | **786**                       | ** ** | **702** | ** ** | **767** | ** ** |
| **Stock  warrants**                                                               | ** ** | **—**                      | ** ** | **51**                        | ** ** | **—** | ** ** | **50** | ** ** |
| ** **                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Diluted  shares used in the calculation of earnings per share**                 | ** ** | **23,063**                      | ** ** | **22,576**                    | ** ** | **23,058** | ** ** | **22,380** | ** ** |
| ** **                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per  share effect of dilutive securities on income from continuing operations** | ** ** | **$**                           | **.01**    | ** **                    | **$**      | **.00** | ** ** | **$** | **.00** | ** ** | **$** | **.01** | ** ** |
| ** **                                                                        | ** ** | ** **                      | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per  share effect of dilutive securities on net income**                        | ** ** | **$**                           | **.01**    | ** **                    | **$**      | **.00** | ** ** | **$** | **.00** | ** ** | **$** | **.01** | ** ** |

 

During the threeand six month periods ended January 1, 2005, options to purchase 335 and 351shares of common stock, respectively, were excluded from the calculation ofdiluted earnings per share because the exercise price of such options wasgreater than the average market price of the common stock for the period.  During the three and six month periods ended December27, 2003, options to purchase 927 and 677 shares of common stock, respectively,were excluded from the calculation of diluted earnings per share because theexercise price of such options was greater than the average market price of thecommon stock for the period.

 

**5.      Comprehensive Income**

 

Components of comprehensiveincome include net income and certain transactions that havegenerally been reported in the consolidated statement of stockholders’ equity.

 
| ** **                                   | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **(in thousands)**                           | ** ** | **January 1,  2005**            | ** ** | **December 27,  2003**        | ** ** | **January 1,  2005** | ** ** | **December 27,  2003** | ** ** |
| **Net  income**                              | ** ** | **$**                           | **2,609**  | ** **                    | **$**      | **2,441** | ** ** | **$** | **5,455** | ** ** | **$** | **1,837** | ** ** |
| **Foreign  currency translation adjustment** | ** ** | **1,210**                       | ** ** | **851**                       | ** ** | **1,023** | ** ** | **698** | ** ** |
| **Total  comprehensive income**              | ** ** | **$**                           | **3,819**  | ** **                    | **$**      | **3,292** | ** ** | **$** | **6,478** | ** ** | **$** | **2,535** | ** ** |

 

9

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**6.****                   Inventories**

 
| **(in thousands)**   | ** ** | **January 1,  2005** | ** ** | **July 3,  2004** | ** ** |
|----------------------|------------|----------------------|------------|-------------------|------------|
| ** **           | ** ** | ** **           | ** ** | ** **        | ** ** |
| **Raw  materials**   | ** ** | **$**                | **5,328**  | ** **        | **$**      | **4,833** | ** ** |
| **Work in  process** | ** ** | **441**              | ** ** | **556**           | ** ** |
| **Finished  goods**  | ** ** | **7,910**            | ** ** | **8,182**         | ** ** |
| ** **           | ** ** | **$**                | **13,679** | ** **        | **$**      | **13,571** | ** ** |

 

**7.      Segment Information**

 

The Company operates inone industry segment: the design, manufacture, sale, and service of medicaldevices and related equipment. The results in this segment have been presentedin the Consolidated Statements of Operations for the appropriate periods.

 

**8.****                   Guarantees**

 

The Company’s productsgenerally carry a standard one-year warranty, except for Vbeam products whichtypically carry a three-year warranty. The Company records 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 warrantyclaims incurred. Actual warranty claims incurred and charged to product costsof sales during an interim period may be more or less than the amount ofamortized warranty reserve allocated against them. Factors that affect theCompany’s product 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 six-monthperiod ended January 1, 2005:

 
| **(in thousands)**                              | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Beginning  balance July 3, 2004**             | ** ** | **$**      | **8,257**  | ** ** |
| **Plus  accruals related to new sales**         | ** ** | **2,391**  | ** ** |
| **Less  amortization of prior period accruals** | ** ** | **3,173**  | ** ** |
| **Ending  balance on January 1, 2005**          | ** ** | **$**      | **7,475**  | ** ** |

 

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

 

10

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**8.****                   Guarantees,continued**

 

The following tablereflects changes in the Company’s deferred revenue account during the six-monthperiod ended January 1, 2005:

 
| **(in thousands)**                               | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| **Beginning  balance July 3, 2004**              | ** ** | **$**      | **4,055**  | ** ** |
| **Plus  deferral of new service contract sales** | ** ** | **5,068**  | ** ** |
| **Less  recognition of deferred revenue**        | ** ** | **2,581**  | ** ** |
| **Ending  balance on January 1, 2005**           | ** ** | **$**      | **6,542**  | ** ** |

 

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

 

**9.       Stock split**

 

OnJanuary 28, 2004, the Company announced that its Board of Directors approved atwo-for-one stock split of the Company’s common stock effected in the form of astock dividend paid on March 16, 2004. As a result of this action, 13.3 millionshares were issued to shareholders of record as of February 16, 2004. Par valueof the stock remains at $.01 per share and accordingly $133 was transferredfrom additional paid-in capital to common stock. All references to the numberof common shares and per common share amounts have been restated to giveretroactive effect to the stock split for all periods presented.

 

**10.    Commitments and Contingencies**

 

TheCompany has an Amended and Restated License Agreement (the “License”) with TheRegents of the University of California (“The Regents”) pursuant to which theCompany licenses certain patent rights to its dynamic cooling device (“DCD”)from The Regents.  The Company sells itsDCD as a component part of its Smoothbeam ® laser system and as an accessory toits other laser systems.  In April of2004, The Regents issued a notice of default under the License, asserting,among other things, that the Company is in breach of the License for thealleged failure to make required royalty payments and to make requireddisclosures.  The Regents’ April noticeasserted that the total underpaid royalties, interest and other charges for theperiod from August of 2000 through September 2003 are $1,128,000.  The Regents issued a subsequent notice ofdefault, dated June 30, 2004, relating to the quarterly periods endedDecember 27, 2003 and March 27, 2004, for which The Regents assertedthat the Company underpaid additional royalties amounting to $1,350,000.  The Regents issued a subsequent notice ofdefault, dated September 10, 2004, relating to the quarterly period ended July3, 2004, for which The Regents asserted that the Company underpaid additional royaltiesamounting to $990,000. The Company and The Regents differ in their respectiveinterpretations of which products sold by the Company give rise to a royalty-bearingobligation to The Regents.  The Companybelieves it has made all payments it was required to make.

 

11

----

 

**10.    Commitments and Contingencies, continued**

 

Underthe License, disputes are to be settled by binding arbitration through amutually acceptable single arbitrator. On June 14, 2004, the Company filed a Demand for Arbitration toadjudicate the differing interpretations of the License Agreement held by theCompany and The Regents.  On July 8,2004, The Regents filed their response and counterclaim for breach of contract anddeclaratory relief.  Candela depositedapproximately $1.0 million in June of 2004, and an additional $1.0 and $1.4million in August and December, respectively, of 2004, into an escrow fund tobe paid in whole or in part to the Company or The Regents as determined by thearbitrator.  As a result of theestablishment of the escrow fund, The Regents will not terminate or purport toterminate the License Agreement based on any alleged breach by the Companyrelated to any matter now before the arbitrator.  The $3.4 million deposited in the escrow fundhas been included in Other Assets on the accompanying balance sheet, and noexpense has or will be recorded with respect to the escrow fund or anyadditional contingent liabilities while the matter is being arbitrated. A finaldecision of the arbitrator in this matter is presently expected to be deliveredduring the third quarter of fiscal 2005.

 

DuringJanuary of 2005, the Company received a demand for payment of bankruptcypreference claims relating to payments the Company received in the ordinarycourse of business prior to the bankruptcy of DVI Strategic Partner Group (DVI).The Company is in the process of researching the claim, but feels that nopreferential treatment was bestowed upon it during the months leading up to theaforementioned bankruptcy, and accordingly believes the demand is withoutmerit.

 

Fromtime to time, the Company is a party to various legal proceedings incidental toits business.  Except for the pendingarbitration proceedings with The Regents, and the bankruptcy preference claimsin the DVI matter, the Company believes that none of the legal proceedings thatare presently pending, if adversely decided to the Company, will have amaterial adverse effect upon its financial position, results of operations, orliquidity.

 

12

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

 

**Overview**

 

We research, develop, manufacture, market and service lasers used toperform aesthetic and cosmetic procedures. We sell our lasers to physicians andpersonal care practitioners.  We marketour products directly and through a network of distributors to end-users. Ourtraditional customer base includes plastic and cosmetic surgeons anddermatologists. More recently we have expanded our sales to a broader group ofpractitioners consisting of general practitioners and certain specialistsincluding obstetricians, gynecologists and general and vascular surgeons.   We derive our revenue from the sales oflasers and other products, and the provision of product-related services.

 

**Critical Accounting Policies**

 

****This discussion and analysis ofour financial condition and results of operations is based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. We evaluate ourestimates and judgments on an on-going basis, including those related torevenue recognition, bad debts, inventories, warranty obligations, contingencies,restructurings and income taxes. We base our estimates and judgments onhistorical experience and on various other assumptions that we believe to bereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying value of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates and judgments under different assumptions or conditions. A discussionof our critical accounting policies and the related estimates and judgmentsaffecting the preparation of our consolidated financial statements is includedin our Annual Report on Form 10-K for fiscal year 2004.****

 

13

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**Resultsof Operations**

 

***Revenue.***

 

Revenue source bygeographic region is reflected in the following table:

 
| ** **           | ** ** | **For the three months ended:** | ** ** |
|----------------------|------------|---------------------------------|------------|
| **(in thousands)**   | ** ** | **January 1, 2005**             | ** ** | **December 27, 2003** | ** ** | **Change** | ** ** |
| ** **           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US  revenue**      | ** ** | **$**                           | **13,156** | ** ** | **47** | **%** | **$** | **11,242** | ** ** | **47** | **%** | **$** | **1,914** | ** ** | **17** | **%** |
| **Foreign  revenue** | ** ** | **15,048**                      | ** ** | **53** | **%** | **12,656** | ** ** | **53** | **%** | **2,392** | ** ** | **19** | **%** |
| ** **           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**   | ** ** | **$**                           | **28,204** | ** ** | **100** | **%** | **$** | **23,898** | ** ** | **100** | **%** | **$** | **4,306** | ** ** | **18** | **%** |
| ** **           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **           | ** ** | **For the six months ended:**   | ** ** |
| ** **           | ** ** | **January 1, 2005**             | ** ** | **December 27, 2003** | ** ** | **Change** | ** ** |
| ** **           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US  revenue**      | ** ** | **$**                           | **22,580** | ** ** | **45** | **%** | **$** | **19,094** | ** ** | **45** | **%** | **$** | **3,486** | ** ** | **18** | **%** |
| **Foreign  revenue** | ** ** | **28,015**                      | ** ** | **55** | **%** | **23,490** | ** ** | **55** | **%** | **4,525** | ** ** | **19** | **%** |
| ** **           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**   | ** ** | **$**                           | **50,595** | ** ** | **100** | **%** | **$** | **42,584** | ** ** | **100** | **%** | **$** | **8,011** | ** ** | **19** | **%** |

 

Consolidated Overview

 

Consolidated revenue increased$4.3 and $8.0 million, to $28.2 and $50.6 million for the three and six-monthperiods, respectively, ended January 1, 2005, as compared to the three andsix-month periods ended December 27, 2003. The increase was due primarily touniform increase in demand for our products and product-related service on aworldwide basis, coupled with our emerging ability to reach into new markets.

 

Foreign revenue increased 18.9%to $15.0 million for the three-month period ended January 1, 2005, as comparedto the three-month period ended December 27, 2003. Revenues in Japan increasedapproximately $1.4 million quarter over quarter while total European revenuesincreased approximately $0.9 million.

 

Foreign revenue increased19.3% to $28.0 million for the six-month period ended January 1, 2005, ascompared to the six-month period ended December 27, 2003. Year-to-date foreignrevenue increased across all countries with the exception of France whichshowed a slight decrease. Year-to-date revenues in South America increased over360 percent, accounting for approximately $1.2 million or 27% of the year overyear comparative increase while European revenues increased approximately $2.2million accounting for 48% of this comparative increase. Increases in Japanwere more modest, totaling approximately $0.9 million for the year to date orapproximately 20% of the year-to-date increase.

 

US revenue increased by $1.9and $3.5 million, respectively, for the three and six month periods ended January1, 2005, as compared to the same periods during the prior fiscal year. Thisincrease was primarily due to market demand for our GentleYagTM product line which was launched during thethird quarter of last year.

 

14

----

 

Revenue source bytype is reflected in the following table:

 
| ** **                     | ** ** | **For the three months ended:** | ** ** |
|--------------------------------|------------|---------------------------------|------------|
| **(in thousands)**             | ** ** | **January 1, 2005**             | ** ** | **December 27, 2003** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                           | **23,539** | ** ** | **83** | **%** | **$** | **19,906** | ** ** | **83** | **%** | **$** | **3,633** | ** ** | **18** | **%** |
| **Product-related  service**   | ** ** | **4,665**                       | ** ** | **17** | **%** | **3,992** | ** ** | **17** | **%** | **673** | ** ** | **17** | **%** |
| ** **                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**             | ** ** | **$**                           | **28,204** | ** ** | **100** | **%** | **$** | **23,898** | ** ** | **100** | **%** | **$** | **4,306** | ** ** | **18** | **%** |
| ** **                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **For the six months ended:**   | ** ** |
| ** **                     | ** ** | **January 1, 2005**             | ** ** | **December 27, 2003** | ** ** | **Change** | ** ** |
| **Revenue**                    | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers  and other products** | ** ** | **$**                           | **41,882** | ** ** | **83** | **%** | **$** | **35,260** | ** ** | **83** | **%** | **$** | **6,622** | ** ** | **19** | **%** |
| **Product-related  service**   | ** ** | **8,713**                       | ** ** | **17** | **%** | **7,324** | ** ** | **17** | **%** | **1,389** | ** ** | **19** | **%** |
| ** **                     | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  revenue**             | ** ** | **$**                           | **50,595** | ** ** | **100** | **%** | **$** | **42,584** | ** ** | **100** | **%** | **$** | **8,011** | ** ** | **19** | **%** |

 

Theincrease in laser and other product revenue for the three month period ended January1, 2005, compared to the three month period ended December 27, 2003, resultedprimarily from an incremental increase in sales volume of our GentleYagTMproduct line of approximately $5.6 million. This increase was partially offsetby a reduction in sales volume of both the VBeamTM and SmoothbeamTM product linesof approximately $1.1 and $0.8 million, respectively. Product-related serviceincreased $0.7 million as compared to the same period of the prior year due tomore service-related contracts being sold through to our installed base.

 

Theincrease in laser and other product revenue for the six month period ended January1, 2005, compared to the six month period ended December 27, 2003, resulted primarilyfrom an increase in the sales volume of our GentleYagTM product line ofapproximately $9.0 million, partially offset by a reduction in SmoothbeamTMproduct sales of approximately $1.6 million. Product-related service increased$1.4 million during the quarter due to more service-related contracts beingsold through to our installed base.

 

***Gross Profit. ***Grossprofit increased to approximately $14.0 million or 49.6% of revenues for thethree month period ended January 1, 2005, compared to gross profit ofapproximately $12.2 million or 51.2% for the same period one year earlier.  Gross profit increased to approximately $26.0million or 51.4% of revenues for the six-month period ended January 1, 2005,compared to gross profit of approximately $21.6 million or 50.3% for the sameperiod one year earlier.  The increasesin gross profit result principally from the increase in sales volume.

 

***Selling,General and Administrative Expense. ***Selling,general and administrative expenses increased to approximately $10.0 millionfor the three-month period ended January 1, 2005 from approximately $7.8million for the three-month period ended December 27, 2003. The increase wasprimarily due to an increase in marketing program spending of approximately $0.6million, increased legal expenses of approximately $0.6 million, and employeerelated expenses of approximately $0.5 million coupled with increasedadministrative costs as a result of our expansion efforts into Portugal andItaly.  As a percentage of quarterly revenue,selling, general and administrative expenses increased to 35.4% from 33.7% ofrevenues for the same respective period in the prior year. The majority of thiscomparative increase is due to potentially recoverable legal costs incurred inconjunction with the ongoing Regents arbitration (see Note 10). To date, theCompany has incurred approximately $0.5 million in legal fees in thearbitration which, if a favorable ruling is received, will appear as a creditto expense during the period the ruling is adjudicated. For the six-monthperiod ended January 1, 2005, selling, general and administrative expensesincreased to approximately $16.7 million from approximately $13.2 million forthe six-month period ended December 27, 2003. The increase in selling, generaland administrative expenses is due primarily from the aforementioned increasein legal expense due to the ongoing Regents arbitration, increased employee-relatedand marketing expense on a period over period basis.

 

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As a percentage ofrevenue, selling, general and administrative expenses increased to 32.9% from 31.0%of revenues as compared to the same six-month period one year earlier.

 

***Researchand Development Expense.***         Researchand development spending increased to $1.6 million for the three-month periodended January 1, 2005 from $1.4 for the three-month period ended December 27,2003 due primarily to an increase in the number of active projects and anincrease in employee costs. Spending in this area increased to $3.0 million forthe six-month period ended January 1, 2005 from $2.5 for the six-month periodended December 27, 2003 due primarily to the aforementioned increase in projectspending and an increase in employee-related costs.

 

***OtherIncome/Expense. ***Netother income was approximately $0.2 million for the three months ended January1, 2005 compared to net other income of approximately $0.5 million for the threemonths ended December 27, 2003. For the six-month period ended January 1, 2005,net other income was approximately $0.4 million compared to net other income ofapproximately $0.6 million for the six-month period ended December 27, 2003. Theseamounts principally represent interest income on cash holdings.

 

***IncomeTaxes.*** The provision for income taxes results from acombination of activities of both the domestic and foreign subsidiaries of theCompany.  Excluding discontinuedoperations, we recorded a 32% effective tax rate for both the three- and six-monthperiods ended January 1, 2005, compared to the three- and six-month periodsended December 27, 2003, in which we recorded a 29% effective tax rate.  The provision for income taxes differs fromthe U.S. statutory rate as a result of tax provisions calculated for incomegenerated by foreign subsidiaries at a rate that differs from the U.S.statutory rate.

 

**DiscontinuedOperations**

 

On September 27,2003, we permanently closed our only remaining skin care center, which waslocated in Boston. The closure of the Boston skin care center, together withthe earlier closing of our Scottsdale, Arizona spa, and the associatedcessation of this line of business, is accounted for as discontinuedoperations. As a result of the closure of the Boston skin care center, in thefiscal quarter ended September 27, 2003, we recorded a $2.1 million charge forthe accrual of $3.0 million of future occupancy costs and $0.3 million ofseverance obligations and other related costs of closure, net of anticipatedtax benefits of $1.3 million. In addition, both the financial statements forthe three months ended October 2, 2004 and all prior financial statements havebeen restated to reflect skin care center operations as discontinued.  During the three-month period ended October 2,2004, the landlord for the Boston facility secured a sublease for thatproperty.  The Company was not able todetermine the future economic benefit of the sublease at that time. Thesublessee commenced making payments to the landlord during December of2004.  As a result of these and futurepayments scheduled under the sublease, the Company revised the estimated futurecosts associated with the Boston facility and, in the quarter ended January 1,2005, has reversed approximately $0.9 million of the restructuring reserve.This reversal represents the aforementioned anticipated economic benefit due tosublessee payments of $1.7 million, net of legal and other fees ofapproximately $0.3 million and income taxes of approximately $0.5 million, andwas recognized in the three-month period ended January 1, 2005.

 

The Companybelieves that the size of the remaining accrual is sufficient to cover allfuture leasehold expenses for the remainder of the lease term. These expensescould potentially increase if the sublessee were not to honor its obligation.

 

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**Liquidityand Capital Resources**

 

Cash provided byoperating activities amounted to $7.6 million for the six months ended January1, 2005, in comparison to cash used in operating activities of $2.2 million forthe same period in the prior year. This increase in cash provided by operatingactivities primarily reflects collection of outstanding accounts receivable andincreased inventory turns. Cash used by investing activities reflected thepurchase of vans to better equip our sales force during the six months ended January1, 2005, compared to the same period in the prior year.  Cash provided by financing activitiesamounted to $0.4 million for the six-months ended January 1, 2005 in comparisonto cash provided of $2.4 million for the same period during the prior year.  The decrease reflects reduced proceeds forthe issuance of stock by the corporation, primarily to employees under theexisting stock option plan.

 

Our outstandingcontractual obligations as of January 1, 2005, are reflected in the followingtable:

 
| **(in thousands)**    | ** ** | **Total** | ** ** | **Maturity****Less than  1 year** | ** ** | **Maturity****1-3 years** | ** ** | **Maturity****4-5 years** | ** ** | **Maturity****in excess of  5 years** | ** ** |
|-----------------------|------------|-----------|------------|-----------------------------------|------------|---------------------------|------------|---------------------------|------------|---------------------------------------|------------|
| **Operating  leases** | ** ** | **$**     | **2,070**  | ** **                        | **$**      | **679**                   | ** ** | **$**                     | **1,017**  | ** **                            | **$**      | **221** | ** ** | **$** | **153** | ** ** |
|                       |            |           |            |                                   |            |                           |            |                           |            |                                       |            |  |  |  |  |  |

 

We also maintain arenewable $10,000,000 revolving credit agreement with a major bank withinterest at the bank’s base rate, or LIBOR plus 2.25%.  Any borrowings outstanding under the line ofcredit are due on demand or according to a payment schedule established at thetime funds are borrowed.  The line ofcredit is unsecured.  The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock.  No amountswere outstanding under the line of credit as of January 1, 2005.

 

We believe that ourcurrent cash balances will be sufficient to meet anticipated cash requirementsfor the next twelve months.  However, wecannot be sure that we will not require additional capital beyond the amountscurrently forecasted by us, or that any such required additional capital willbe available on reasonable terms, if at all, when such capital becomesrequired.

 

**Cautionary Statements**

 

This QuarterlyReport on Form 10-Q contains forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Forward-looking statements are not promisesor guarantees and are subject to risks and uncertainties that could cause ouractual results to differ materially from those anticipated.  Such statements may relate to, among otherthings, the future of the industry, product development, business strategy(including the possibility of future acquisitions), anticipated operational andcapital expenditure levels, continued acceptance and growth of our products,and dependence on significant customers and suppliers.  Forward-looking statements may also include,without limitation, 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 and uncertainties that may affectforward-looking statements and/or our business include, among others, thosediscussed in “Cautionary Statements” in our Annual Report filed on Form 10-Kfor the fiscal year ended July 3, 2004, as well as other risks anduncertainties referenced in this Quarterly Report.  These risks and uncertainties include, butare not limited to, the following:

 

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**Cautionary Statements, continued**

 

•                  Ourprincipal source of liquidity is our current cash and equivalents. Our abilityto generate cash from operations is dependant upon our ability to generaterevenue from selling our lasers and other products and providingproduct-related services. A decrease in demand for our products and relatedservices or increases in operating costs would likely have an adverse effect onour 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.

 

•                  Anadverse result in the arbitration proceeding pending against The Regents of theUniversity of California would result in additional expenditures and wouldnegatively impact our operating results.

 

•                  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.

 

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

 

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

 

We have foreign subsidiaries in Japan, Spain, France and Germany.  Approximately 55% of our revenues for the sixmonths ended January 1, 2005 were from operations outside the UnitedStates.  These subsidiaries transactbusiness in both local and foreigncurrency.  Therefore, we are exposed toforeign currency exchange risks and fluctuations in foreign currencies, whichcould adversely impact our results and financial condition.  However, sales from the United States madedirectly to customers or distributors in foreign countries are invoiced in U.S.dollars and are not exposed to foreign currency risk.

 

From time to time, we may enter into foreign currency exchange andoption contracts to reduce our exposure to foreign currency risk andvariability in operating results due to fluctuation in exchange ratesunderlying the value of current transactions and anticipated transactionsdenominated in foreign currencies.  These contracts obligate us to exchangepredetermined amounts of specified foreign currencies at specified exchangerates on specified dates.  Thesecontracts are denominated in the same currency in which the underlyingtransactions are denominated and bear a contract value and maturity date thatapproximate the value and expected settlement date, respectively, of theunderlying transactions. We do not engage in foreign currencyspeculation.

 

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

 

**Item 4 - Controls and Procedures**

 

(a) Evaluation of disclosure controls and procedures. An evaluation wasperformed under the supervision and with the participation of members of our management,including our Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our “disclosure controls andprocedures” (as defined in the Securities Exchange Act of 1934 Rule 13a-15(e))as of January 1, 2005 (the “Evaluation Date”). Based on that evaluation, members of our management, including our ChiefExecutive Officer and our Chief Financial Officer, have concluded that, as ofthe Evaluation Date, our disclosure controls and procedures were effective inenabling us to record, process, summarize and report the information requiredto be included in this quarterly report within the required time period.

 

(b) Changes tointernal control over financial reporting. There were no changes in our internal control over financial reportingduring the fiscal quarter ended January 1, 2005 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**CANDELA CORPORATION**

 

**Part II.  Other Information**

 

**Item 1 - Legal Proceedings**

 

The Company has an Amended and RestatedLicense Agreement (the “License”) with The Regents of the University ofCalifornia (“The Regents”) pursuant to which the Company licenses certainpatent rights to its dynamic cooling device (“DCD”) from The Regents.  The Company sells its DCD as a component partof its Smoothbeam ® laser system and as an accessory to its other lasersystems.  In April of 2004, The Regentsissued a notice of default under the License, asserting, among other things,that the Company is in breach of the License for the alleged failure to makerequired royalty payments and to make required disclosures.  The Regents’ April notice asserted that thetotal underpaid royalties, interest and other charges for the period fromAugust of 2000 through September 2003 are $1,128,000.  The Regents issued a subsequent notice ofdefault, dated June 30, 2004, relating to the quarterly periods endedDecember 27, 2003 and March 27, 2004, for which The Regents assertedthat the Company underpaid additional royalties amounting to $1,350,000.  The Regents issued a subsequent notice ofdefault, dated September 10, 2004, relating to the quarterly period ended July3, 2004, for which The Regents asserted that the Company underpaid additionalroyalties amounting to $990,000. The Company and The Regents differ in theirrespective interpretations of which products sold by the Company give rise to aroyalty-bearing obligation to The Regents. The Company believes it has made all payments it was required to make.

 

Under the License, disputes are to be settledby binding arbitration through a mutually acceptable single arbitrator.  On June 14, 2004, the Company filed a Demandfor Arbitration to adjudicate the differing interpretations of the License heldby the Company and The Regents.  On July8, 2004, The Regents filed their response and counterclaim for breach ofcontract and declaratory relief.  Candeladeposited approximately $1.0 million in June of 2004, and an additional $1.0and $1.4 million in August and December, respectively, of 2004, into an escrowfund to be paid in whole or in part to the Company or The Regents as determinedby the arbitrator.  As a result of theestablishment of the escrow fund, The Regents will not terminate or purport toterminate the License based on any alleged breach by the Company related to anymatter now before the arbitrator.  Afinal decision of the arbitrator in this matter is presently expected to be deliveredduring the third quarter of fiscal 2005.

 

During January of 2005, the Company receiveda demand for payment of bankruptcy preference claims relating to payments theCompany received in the ordinary course of business prior to the bankruptcy ofDVI Strategic Partner Group (DVI). The Company is in the process of researchingthe claim, but feels that no preferential treatment was bestowed upon it duringthe months leading up to the aforementioned bankruptcy, and accordinglybelieves the demand is without merit.

 

From time to time, the we are a party tovarious legal proceedings incidental to its business.  Except for the pending arbitrationproceedings with The Regents, and the bankruptcy preference claims in the DVImatter, the Company believes that none of the legal proceedings that arepresently pending, if adversely decided to the Company, will have a materialadverse effect upon its financial position, results of operations, orliquidity.

 

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**Part II.  Other Information, continued**

 

**Item4. Submission of Matters to a Vote of Security Holders**

 

On December 14, 2004, theCompany held its annual meeting of shareholders and voted on three proposals.

 

1)                                      At the Meeting, the vote on the election ofSeven (7) directors to hold office until the Company’s next****annual meeting, was as follows:

 
| ** **             | ** ** | **FOR**    | ** ** | **WITHHOLD** | ** ** |
|------------------------|------------|------------|------------|--------------|------------|
|                   |       |       |       |         |       |
| George A. Abe          |       | 20,214,091 |       | 415,631      |       |
| Ben Bailey III         |       | 20,499,286 |       | 130,436      |       |
| Dr. Eric F.  Bernstein |       | 20,489,636 |       | 140,086      |       |
| Nancy Nager            |       | 20,476,527 |       | 153,195      |       |
| Gerard E. Puorro       |       | 23,332,803 |       | 296,919      |       |
| Kenneth D.  Roberts    |       | 20,386,490 |       | 243,232      |       |
| Douglas W. Scott       |       | 20,114,910 |       | 514,812      |       |

 

2)                                      At the Meeting, the vote on a proposal toincrease the authorized number of shares of common stock from 30,000,000 sharesto 60,000,000 shares in the aggregate, was as follows:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 19,752,800 |       | 827,920     |       | 49,002      |       |

 

3)                                      At the Meeting, the vote on a proposal toratify BDO Seidman, LLP, was as follows:

 
| **FOR**    | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 20,552,607 |       | 56,553      |       | 50,583      |       |

 

**ITEM 6 -Exhibits**

 

(a)                                  Exhibits

 
| Exhibit 10.1 |   | Distribution Agreement with Danish Dermatologic Development A/S (DDD)                                                                                   |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   | (Confidential treatment has been obtained or  requested for certain portions of this document)                                                          |
|         |   |                                                                                                                                                    |
| 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:  | February 7, 2005                                   |   | /s/ F. Paul Broyer |   |
|   | F. Paul Broyer                                     |
|   | (Senior Vice President, Finance and Administration |
|   | and Chief Financial Officer)                       |
|        |                                                    |  |  |  |

 

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**Candela Corporation**

 

**INDEX TO EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                         |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                    |
| Exhibit 10.1    |       | Distribution Agreement with Danish Dermatologic Development A/S (DDD)                                                                                   |
|            |       | (Confidential treatment has been obtained or  requested for certain portions of this document)                                                          |
|            |       |                                                                                                                                                    |
| 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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