**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

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**FORM 10-Q**

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

**For the quarterly period endedDecember 30, 2006.**

**Commissionfile number 000-14742**

**CANDELA CORPORATION**

(Exact name ofregistrant as specified in its charter)

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

 

Registrant’stelephone 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 x    No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                Acceleratedfiler x                Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule12b-2 of theExchange Act) Yes o    No x

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

| Class                                   | ** ** | **Outstanding at February 2, 2007** |
|-----------------------------------------|------------|-------------------------------------|
| Common Stock,  $.01 par value per share |       | 23,092,424                          |

 

 

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**CANDELA CORPORATIONIndex**

**For theQuarter Ended December 30, 2006**
|           | ** **             | **Page**                                                                                                                                                                                                                           |
|-----------|------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                   |                                                                                                                                                                                                                               |
| Part I.   | Financial Information: |                                                                                                                                                                                                                               |
|      |                   |                                                                                                                                                                                                                               |
|      | Item 1.                | Unaudited Financial Statements                                                                                                                                                                                                     |   |
|      |                   |                                                                                                                                                                                                                               |   |
|      |                   | Consolidated Balance Sheets as of December 30, 2006  and July 1, 2006                                                                                                                                                              | 3 |
|      |                   |                                                                                                                                                                                                                               |   |
|      |                   | Condensed Consolidated Statements of Operations and  Comprehensive Income for the three-month periods ended December 30, 2006 and  December 31, 2005, and for the six-month periods ended December 30, 2006 and  December 31, 2005 | 4 |
|      |                   |                                                                                                                                                                                                                               |   |
|      |                   | Condensed Consolidated Statements of Cash Flows for  the six-month periods ended December 30, 2006 and December 31, 2005                                                                                                           | 5 |
|      |                   |                                                                                                                                                                                                                               |   |
|      |                   | Notes to Unaudited Consolidated Financial Statements                                                                                                                                                                               | 6-14 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Item 2.                | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                                                                                        | 15-20 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Item 3.                | Quantitative and Qualitative Disclosure about Market  Risk                                                                                                                                                                         | 21 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Item  4.               | Controls  and Procedures                                                                                                                                                                                                           | 21 |
|      |                   |                                                                                                                                                                                                                               |   |
| Part  II. | Other  Information:    |                                                                                                                                                                                                                               |
|      |                   |                                                                                                                                                                                                                               |
|      | Item 1.                | Legal proceedings                                                                                                                                                                                                                  | 22 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Item 4.                | Submission of Matters to a Vote of Security Holders                                                                                                                                                                                | 23 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Item 6.                | Exhibits                                                                                                                                                                                                                           | 24 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Signatures             |                                                                                                                                                                                                                               | 25 |
|      |                   |                                                                                                                                                                                                                               |   |
|      | Index to Exhibits      |                                                                                                                                                                                                                               |

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**Part I.Financial Information**

**Item 1 -Financial Statements**

**CANDELA CORPORATIONConsolidated Balance Sheets**(in thousands, exceptper share data)(unaudited)
| ** **                                                                                                                             | ** ** | **December 30,** | ** ** | **July 1,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------|------------|
| ** **                                                                                                                             | ** ** | **2006**              | ** ** | **2006**         | ** ** |
| **Assets**                                                                                                                             | ** ** | ** **            | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                        |       |                  |       |             |       |
| Cash and cash  equivalents                                                                                                             |       | $                     | 40,464     |             | $          | 40,194 |   |
| Restricted cash                                                                                                                        |       | 167                   |       | 166              |       |
| Marketable  securities                                                                                                                 |       | 16,219                |       | 27,332           |       |
| Accounts  receivable, net of allowance for doubtful accounts of $1,425 and $1,831 at  December 30 and July 1, respectively             |       | 32,168                |       | 34,273           |       |
| Notes receivable                                                                                                                       |       | 745                   |       | 1,611            |       |
| Inventories, net                                                                                                                       |       | 18,047                |       | 16,666           |       |
| Other current  assets                                                                                                                  |       | 3,311                 |       | 1,756            |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total current  assets                                                                                                                  |       | 111,121               |       | 121,998          |       |
| Property and equipment,  net                                                                                                           |       | 3,308                 |       | 3,302            |       |
| Deferred tax assets                                                                                                                    |       | 8,356                 |       | 8,142            |       |
| Intangible asset, net                                                                                                                  |       | 4,402                 |       | 3,402            |       |
| Marketable securities,  long-term                                                                                                      |       | 13,332                |       | 11,953           |       |
| Other assets                                                                                                                           |       | 390                   |       | 379              |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total assets                                                                                                                           |       | $                     | 140,909    |             | $          | 149,176 |   |
|                                                                                                                                   |       |                  |       |             |       |
| **Liabilities  and Stockholders’ Equity**                                                                                         | ** ** | ** **            | ** ** | ** **       | ** ** |
| Current liabilities:                                                                                                                   |       |                  |       |             |       |
| Accounts payable                                                                                                                       |       | $                     | 11,583     |             | $          | 15,968 |   |
| Accrued payroll  and related expenses                                                                                                  |       | 3,274                 |       | 5,728            |       |
| Accrued warranty  costs, current                                                                                                       |       | 5,823                 |       | 5,868            |       |
| Income taxes  payable                                                                                                                  |       | —                |       | 933              |       |
| Sales tax  payable                                                                                                                     |       | 871                   |       | 854              |       |
| Royalties  payable                                                                                                                     |       | 771                   |       | 764              |       |
| Other accrued  liabilities                                                                                                             |       | 4,238                 |       | 3,672            |       |
| Deferred  revenue, current                                                                                                             |       | 8,074                 |       | 8,342            |       |
| Current  liabilities of discontinued operations                                                                                        |       | 1,287                 |       | 1,287            |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total current  liabilities                                                                                                             |       | 35,921                |       | 43,416           |       |
| Accrued warranty costs,  long-term                                                                                                     |       | 3,667                 |       | 3,761            |       |
| Deferred revenue,  long-term                                                                                                           |       | 2,005                 |       | 1,987            |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total  liabilities                                                                                                                     |       | 41,593                |       | 49,164           |       |
|                                                                                                                                   |       |                  |       |             |       |
| Stockholders’ equity:                                                                                                             |       |                  |       |             |       |
| Common stock,  $.01 par value, 60,000,000 shares authorized; 25,950,000 and 25,914,000  issued at December 30 and July 1, respectively |       | 260                   |       | 259              |       |
| Treasury stock,  3,020,000 and 2,250,000 common shares at December 30 and July 1,  respectively, at cost                               |       | (21,268               | )          | (12,997          | )          |
| Additional  paid-in capital                                                                                                            |       | 66,581                |       | 64,234           |       |
| Accumulated  earnings                                                                                                                  |       | 53,724                |       | 48,280           |       |
| Accumulated other  comprehensive income                                                                                                |       | 19                    |       | 236              |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total  stockholders’ equity                                                                                                       |       | 99,316                |       | 100,012          |       |
|                                                                                                                                   |       |                  |       |             |       |
| Total liabilities and  stockholders’ equity                                                                                       |       | $                     | 140,909    |             | $          | 149,176 |   |

 

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

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**CANDELACORPORATIONConsolidated Statements of Income and Comprehensive Income**(in thousands, exceptper share data)(unaudited)
| ** **                                                                                                                                | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                | ** ** | **December 30,**                               | ** ** | **December 31,**                             | ** ** | **December 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenue**                                                                                                                               | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Lasers and other  products                                                                                                                |       | $                                                   | 29,108     |                                              | $          | 31,657 |   | $ | 54,997 |   | $ | 53,882 |   |
| Product-related  service                                                                                                                  |       | 8,298                                               |       | 6,063                                             |       | 15,883 |   | 11,925 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Total revenue                                                                                                                             |       | 37,406                                              |       | 37,720                                            |       | 70,880 |   | 65,807 |   |
| **Cost of sales**                                                                                                                         |       |                                                |       |                                              |       |   |   |   |   |
| Lasers and other  products                                                                                                                |       | 13,982                                              |       | 14,062                                            |       | 24,596 |   | 23,547 |   |
| Product-related  service                                                                                                                  |       | 5,647                                               |       | 4,683                                             |       | 11,081 |   | 8,732 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Total cost of  sales                                                                                                                      |       | 19,629                                              |       | 18,745                                            |       | 35,677 |   | 32,279 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Gross profit**                                                                                                                          |       | 17,777                                              |       | 18,975                                            |       | 35,203 |   | 33,528 |   |
| **Operating expenses**                                                                                                                    |       |                                                |       |                                              |       |   |   |   |   |
| Selling, general  and administrative                                                                                                      |       | 12,568                                              |       | 10,537                                            |       | 23,648 |   | 19,255 |   |
| Research and  development                                                                                                                 |       | 4,586                                               |       | 1,800                                             |       | 8,186 |   | 3,442 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Total operating  expenses                                                                                                                 |       | 17,154                                              |       | 12,337                                            |       | 31,834 |   | 22,697 |   |
| **Income from operations**                                                                                                                |       | 623                                                 |       | 6,638                                             |       | 3,369 |   | 10,831 |   |
| **Other income (expense)**                                                                                                                |       |                                                |       |                                              |       |   |   |   |   |
| Interest income                                                                                                                           |       | 752                                                 |       | 262                                               |       | 1,515 |   | 510 |   |
| Other income  (expense), net                                                                                                              |       | 135                                                 |       | (65                                               | )          | 3,641 |   | (3 | ) |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Total other  income                                                                                                                       |       | 887                                                 |       | 197                                               |       | 5,156 |   | 507 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Income before income taxes**                                                                                                            |       | 1,510                                               |       | 6,835                                             |       | 8,525 |   | 11,338 |   |
| Provision for  income taxes                                                                                                               |       | 487                                                 |       | 2,325                                             |       | 3,083 |   | 3,811 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Net income**                                                                                                                            |       | $                                                   | 1,023      |                                              | $          | 4,510 |   | $ | 5,442 |   | $ | 7,527 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Net income per share of common  stock**                                                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Basic                                                                                                                                     |       | $                                                   | 0.04       |                                              | $          | 0.20 |   | $ | 0.23 |   | $ | 0.33 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Diluted                                                                                                                                   |       | $                                                   | 0.04       |                                              | $          | 0.19 |   | $ | 0.23 |   | $ | 0.32 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Weighted average shares  outstanding**                                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Basic                                                                                                                                     |       | 22,910                                              |       | 22,680                                            |       | 23,220 |   | 22,598 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Diluted                                                                                                                                   |       | 23,403                                              |       | 23,498                                            |       | 23,725 |   | 23,366 |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Net income**                                                                                                                            |       | $                                                   | 1,023      |                                              | $          | 4,510 |   | $ | 5,442 |   | $ | 7,527 |   |
| **Other comprehensive income  (loss), net of tax**                                                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Foreign currency  translation adjustment                                                                                                  |       | 318                                                 |       | (356                                              | )          | 115 |   | (374 | ) |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized loss  on available-for-sale securities, net of tax of $235 for the three and six  months ended December 30, 2006, respectively |       | (408                                                | )          | —                                            |       | (332 | ) | — |   |
|                                                                                                                                      |       |                                                |       |                                              |       |   |   |   |   |
| **Comprehensive Income**                                                                                                                  |       | $                                                   | 933        |                                              | $          | 4,154 |   | $ | 5,225 |   | $ | 7,153 |   |

 

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

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**CANDELACORPORATIONCondensed Consolidated Statements of Cash Flows**(in thousands)(unaudited)
| ** **                                                                                   | ** ** | **For the six months ended:** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **December 30,**                             | ** ** | **December 31,** | ** ** |
| ** **                                                                                   | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities:**                                                   | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                                 | 5,442      |   | $ | 7,527 |   |
| Adjustments to  reconcile net income to net cash (used by) provided by operating activities: |       |                                              |       |   |   |
| Gain on exchange  of stock (Note 17)                                                         |       | (3,540                                            | )          | — |   |
| Share-based  compensation expense                                                            |       | 2,035                                             |       | 172 |   |
| Depreciation and  amortization                                                               |       | 590                                               |       | 324 |   |
| Provision for  bad debts                                                                     |       | 600                                               |       | 300 |   |
| Other non-cash  items                                                                        |       | 48                                                |       | 59 |   |
| Increase  (decrease) in cash from working capital                                            |       |                                              |       |   |   |
| Accounts  receivable                                                                         |       | 1,598                                             |       | 1,424 |   |
| Notes receivable                                                                             |       | 824                                               |       | 351 |   |
| Inventories                                                                                  |       | (1,247                                            | )          | (1,190 | ) |
| Other current  assets                                                                        |       | (1,125                                            | )          | (342 | ) |
| Other assets                                                                                 |       | 591                                               |       | (2,887 | ) |
| Accounts payable                                                                             |       | (4,688                                            | )          | (3,988 | ) |
| Accrued payroll  and related expenses                                                        |       | (2,463                                            | )          | (1,581 | ) |
| Deferred revenue                                                                             |       | (257                                              | )          | 1,442 |   |
| Accrued warranty  costs                                                                      |       | (144                                              | )          | (124 | ) |
| Income taxes  payable                                                                        |       | (1,852                                            | )          | (815 | ) |
| Other accrued  liabilities                                                                   |       | 825                                               |       | 426 |   |
| Change in  restricted cash                                                                   |       | 1                                                 |       | 20 |   |
|                                                                                         |       |                                              |       |   |   |
| Net cash (used by)  provided by operating activities                                         |       | (2,762                                            | )          | 1,118 |   |
|                                                                                         |       |                                              |       |   |   |
| **Cash flows from investing  activities:**                                                   |       |                                              |       |   |   |
| Purchases of  property and equipment                                                         |       | (453                                              | )          | (260 | ) |
| Maturities of  held-to-maturity marketable securities                                        |       | 20,933                                            |       | — |   |
| Cash proceeds  from exchange of stock (Note 17)                                              |       | 994                                               |       | — |   |
| Purchases of  held-to-maturity marketable securities                                         |       | (9,377                                            | )          | (9,994 | ) |
| Acquisition of  intangible assets                                                            |       | (1,380                                            | )          | — |   |
|                                                                                         |       |                                              |       |   |   |
| Net cash provided by  (used by) investing activities                                         |       | 10,717                                            |       | (10,254 | ) |
|                                                                                         |       |                                              |       |   |   |
| **Cash flows from financing  activities:**                                                   |       |                                              |       |   |   |
| Proceeds from  the issuance of common stock                                                  |       | 312                                               |       | 2,454 |   |
| Purchase of  treasury stock                                                                  |       | (8,271                                            | )          | — |   |
|                                                                                         |       |                                              |       |   |   |
| Net cash (used by)  provided by financing activities                                         |       | (7,959                                            | )          | 2,454 |   |
|                                                                                         |       |                                              |       |   |   |
| Effect of exchange  rates on cash and cash equivalents                                       |       | 274                                               |       | (118 | ) |
|                                                                                         |       |                                              |       |   |   |
| **Net increase (decrease) in cash  and cash equivalents**                                    |       | 270                                               |       | (6,800 | ) |
|                                                                                         |       |                                              |       |   |   |
| **Cash and cash equivalents at  beginning of period**                                        |       | 40,194                                            |       | 56,383 |   |
|                                                                                         |       |                                              |       |   |   |
| **Cash and cash equivalents at end of period**                                               |       | $                                                 | 40,464     |   | $ | 49,583 |   |

 

***The accompanying notes are an integralpart of the unaudited consolidated financial statements****.*

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**Candela CorporationNotes to Consolidated Financial Statements (unaudited)**(amounts are in thousands except per share data)

**1.****                 Basisof Presentation and Consolidation**

*Basis of Presentation*

The accompanying unaudited consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X. The year-end consolidated balance sheet is derived from our auditedfinancial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States of America. Inthe opinion of management, the accompanying unaudited consolidated financialstatements contain all adjustments, consisting only of those of a normalrecurring nature, considered necessary for a fair presentation of our financialposition, results of operations and cash flows at the dates and for the periodsindicated. Actual results may differ from these estimates.

The results for the interim periods are not necessarily indicative ofresults to be expected for the entire year. The information contained in theinterim financial statements should be read in conjunction with Management’sDiscussion and Analysis and the financial statements and notes thereto includedin the Candela Corporation 2006 Form 10-K filed with the Securities andExchange Commission (“SEC”).

The results of operations for the three andsix months ended December 30, 2006 are not necessarily indicative of theresults expected for the remainder of the fiscal year.

*Basis of Consolidation*

The financial statements include the accounts ofCandela Corporation and its subsidiaries. Intercompany transactions andbalances have been eliminated. Investments in which we are not able to exercisesignificant influence over the investee are accounted for under the costmethod.

**2.****                ****Recent Accounting Pronouncements**

In September 2006, the Securities andExchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Current Year Misstatements.* SAB No. 108requires analysis of misstatements using both an income statement (rollover)approach and a balance sheet (iron curtain) approach in assessing materialityand provides for a one-time cumulative effect transition adjustment. SABNo. 108 is effective for our fiscal year 2007 annual financial statements.We are currently assessing the potential impact that the adoption of SAB No. 108will have on our financial statements; the impact is not expected to bematerial.

In September 2006, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 157, *Fair Value Measurements,*whichdefines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 does not require any new fair valuemeasurements, but provides guidance on how to measure fair value by providing afair value hierarchy used to classify the source of the information. Thisstatement is effective for our fiscal year 2008. We are currently assessing thepotential impact that the adoption of SFAS No. 157 will have on ourfinancial statements; the impact is not expected to be material.

InJuly 2006, the FASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109* (FIN No. 48). FINNo. 48 clarifies the accounting for uncertainty in income taxes recognizedin an enterprise’s financial statements in accordance with FASB StatementNo. 109,*Accounting for Income Taxes.*FINNo. 48 prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. FIN No. 48 also provides guidance onderecognition,

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classification,interest and penalties, accounting in interim periods and disclosure relativeto uncertain tax positions. FIN No. 48 is effective for fiscal yearsbeginning after December 15, 2006, with early adoption encouraged. We arecurrently assessing the potential impact that the adoption of FIN No. 48will have on our consolidated financial statements.

In February 2006, the FASB issued StatementNo. 155,*Accounting for Certain HybridFinancial Instruments—an amendment of FASB Statements No. 133 and 140*(SFAS No. 155). This standard permits fair value remeasurement for anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation; clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of SFAS No. 133;requires evaluation of interests in securitized financial assets; clarifiesthat concentrations of credit risk in the form of subordination are notembedded derivatives; and eliminates the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. This standard is effective for all financial instruments acquiredor issued for fiscal years beginning after September 15, 2006. We do notbelieve that adoption of SFAS No. 155 will have a material effect on ourfinancial position or results of operations.

**3.****                 DiscontinuedOperations**

On September 27, 2003 management initiated aplan to close its only remaining skin care center. The closure was accountedfor as a discontinued operation in accordance with Statement of FinancialAccounting Standards (“SFAS”) 144 “*Accounting for theImpairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.In determining the amount of the facilities closure accrual, we are required toestimate such factors as future vacancy rates, the time required to subletproperties and sublease rates. These estimates are reviewed quarterly and mayresult in revisions to established facility reserves.

Current liabilities of discontinuedoperations consist of the following:
|                                      | ** ** | **December 30,** | ** ** | **July 1,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|------------------|------------|
| **(in thousands)**              | ** ** | **2006**              | ** ** | **2006**         | ** ** |
| Facility closure  and other costs    |       | $                     | 447        |             | $          | 447 |   |
| Deferred  revenue, gift certificates |       | 840                   |       | 840              |       |
|                                 |       |                  |       |             |       |
|                                 |       | $                     | 1,287      |             | $          | 1,287 |   |

 

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

Effective July 3, 2005, the Company implemented the fair valuerecognition provisions of SFAS No. 123 revised (“SFAS No. 123R”) and StaffAccounting Bulletin 107 (“SAB 107”) for all share-based compensation that wasnot vested as of July 2, 2005. The Company adopted SFAS No. 123R using amodified prospective application, as permitted under SFAS No. 123R.Accordingly, prior period amounts have not been restated. Under thisapplication, the Company is required to record compensation expense for allawards granted after the date of adoption and for the unvested portion ofpreviously granted awards that remain outstanding at the date of adoption. Compensationcost will be recognized over the period that an employee provides service inexchange for the award.

The application of SFAS No. 123R and SAB 107 during the three–monthperiod ended December 30, 2006 and December 31, 2005 resulted in therecognition of share-based compensation expense of approximately $1.2 millionand $0.2 million, respectively. For the six-month period ended December 30,2006 and December 31, 2005, recognition of shared-based compensation expensewas approximately $2.0 million and $0.2 million, respectively. These expenseswere divided between cost of sales and operating expense cost centers basedupon the functional responsibilities of the individuals holding the respectiveoptions.

7

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As of December 30, 2006,there was approximately $3.6 million of total unrecognized compensationcost related to non-vested stock options/Stock Appreciation Rights (“SARs”)granted under the Company’s incentive plans. This cost is expected to berecognized over a weighted-average period of 1.17 years. As of December 31, 2005, there wasapproximately $0.3 million of total unrecognized compensation cost related tononvested stock options granted under the Company’s incentive plans.

The amount of cash received from the exercise of stock options for boththe second quarter and first six months of fiscal 2007 and both the secondquarter and first six months of fiscal 2006 was approximately $0.3 million and$2.5 million, respectively.

**Stock Plans**

### **1990Candela Corporation Employee Stock Purchase Plan**

The 1990 Employee Stock Purchase Plan (the“Purchase Plan”) provides for the sale of up to 1,500,000 shares of commonstock to eligible employees. The shares are issued at 85% of the market priceon the last day of semi-annual periods. Substantially all full-time employeesare eligible to participate in the Purchase Plan. At December 30, 2006 therewere 678,735 shares available for sale. Compensation expense for the purchaseplan is recognized over the vesting period.

**1998 Candela Corporation StockOption Plan**

Effective October 5, 2005, the Second Amendedand Restated 1998 Stock Plan (the “1998 Stock Plan”) was amended to clarify thegranting of incentive stock options, non-qualified stock options, and stockappreciation rights (“SARs”).

Stock options provide the holder with theright to purchase common stock. The exercise price per share of “incentivestock options” within the meaning of Section 422 of the Internal Revenue Codeof 1986, as amended, granted under the 1998 Stock Plan may not be less than thefair market value per share of common stock on the date of grant. In the caseof an incentive stock option granted to an employee possessing more than 10% ofthe total combined voting power of all classes of stock of the Company, theexercise price per share may not be less than 110% of the fair market value pershare of common stock on the date of grant.

SARs provide the holder the right to receivean amount, payable in stock, cash or in any combination of these, as specifiedby a Committee established by the Board of Directors, equal to the excess ofthe market value of our common shares on the date of exercise over the grantprice at the time of the grant. The grant price of a SAR may not be less thanthe fair market value per share of common stock on the date of grant, providedthat the grant price of SARs granted in tandem with stock options shall equalthe exercise price of the related stock option.

Options and rights granted under the 1998 Stock Plan become exercisable on the date of grant or in installments, as specified by a Committee established by the Board of Directors, and expire ten years from the date of the grant. The maximum number of shares for which options and rights may be granted under the 1998 Stock Plan was increased by 2,500,000 shares to 7,800,000 by affirmative vote at the Company’s Annual Meeting of Shareholders held December 12, 2006. Upon exercise of a SAR, only the net number of shares of common stock issued in connection with such exercise shall be deemed “issued” for this purpose. The Company may satisfy the awards upon exercise with either newly-issued or treasury shares.

There were 180,000 and 330,445 stock based SARs granted during the three and six month period ended December 30, 2006, respectively. The SARs granted to employees become exercisable ratably over one to four years, while the SARs granted to directors become exercisable over two years.

There were 2,252,966 outstanding options/SARs at December 30, 2006 with a weighted-average exercise price of $11.08 per share, an aggregate intrinsic value of approximately $2.9 million and a weighted-average remaining contractual term of 7.66 years.

There were 1,231,918 of exercisable options/SARs at December 30, 2006 with a weighted-average exercise price of $8.51 per share, an aggregate intrinsic value of approximately $4.8 million, and a weighted-average remaining contractual term of 6.7 years.

There were 2,723,689 options/SARs available to grant at December 30, 2006.

The total intrinsic value of options exercised during the three and six month period ended December 30, 2006 was approximately $0.2 million and $0.3 million, respectively.

8

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**5.****                 Earningsper Share**

Basic earnings per share is computed by dividing net income by theweighted average number of shares of common stock outstanding for the periodand, if there are dilutive securities, diluted earnings per share is computedby including common stock equivalents outstanding for the period in thedenominator.

Common stock equivalents include shares issuable upon the exercise ofstock options or warrants, net of shares assumed to have been purchased withthe proceeds, using the treasury stock method.
|                                                                    | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                         | ** ** | **December 30,**                               | ** ** | **December 31,**                             | ** ** | **December 30,** | ** ** | **December 31,** | ** ** |
| **(in thousands, except per share data)** | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Shares used in  the calculation of Basic earnings per share        |       | 22,910                                              |       | 22,680                                            |       | 23,220 |   | 22,598 |   |
| Effect of  dilutive securities:  Stock options/SAR’s          |       | 493                                                 |       | 818                                               |       | 505 |   | 768 |   |
|                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Diluted shares  used in the calculation of earnings per share      |       | 23,403                                              |       | 23,498                                            |       | 23,725 |   | 23,366 |   |
|                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Per share effect  of dilutive securities on net income             |       | $                                                   | —     |                                              | $          | 0.01 |   | $ | — |   | $ | 0.01 |   |
|                                                                    |            |                                                     |            |                                                   |            |  |  |  |  |  |  |  |  |

 

During the three and six month periods endedDecember 31, 2006, options/SARs to purchase 879 and 867 shares of commonstock, respectively, were excluded from the calculations of diluted earningsper share as their effect would have been anti-dilutive.

During the three-month period endedDecember 31, 2005 all shares were included in the calculation of dilutedearnings per share as they had exercise prices that were less than the averagemarket prices of our common stock for the period. During the six month periodended December 31, 2005, options/SARs to purchase 379 shares of commonstock were excluded from the calculations of diluted earnings per share astheir effect would have been anti-dilutive.

**6.****                 MarketableSecurities**

The Company accounts for marketable securities in accordance with SFAS115, *Accounting for Certain Investments in Debt andEquity Securities*. SFAS 115 establishes the accounting and reportingrequirements for all debt securities and for investments in equity securitiesthat have readily determinable fair values. All marketable securities must beclassified as one of the following: held-to-maturity, available-for-sale, ortrading. The Company classifies its marketable debt securities asheld-to-maturity as the Company has the intent and ability to hold them tomaturity. The Company has classified its equity investments asavailable-for-sale securities. Accordingly, such investments are reported atfair market value, with the resultant unrealized gains and losses reported as aseparate component of shareholders’ equity. Held-to-maturity debt securitiesare reported at amortized cost which approximates fair value. Currentmarketable securities include debt investments with original maturities thatare expected to mature in more than three months and up to twelve months andequity investments. Long-term marketable securities include debt securitiesthat have remaining maturities of one to three years and equity investments. Unrealizedlosses related to the held-to-maturity securities are not considered apermanent decline in the market value of such securities.

9

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Marketable securities consist of the following:
|                                          | ** ** | **December 30, 2006** | ** ** | **July 1, 2006** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|----------------------------|------------|
| **(in thousands)**                  | ** ** | **Net Carrying  Amount**   | ** ** | **Fair Value**        | ** ** | **Unrealized  loss** | ** ** | **Net Carrying  Amount** | ** ** | **Fair Value** | ** ** | **Unrealized  loss** | ** ** |
| Short-term  (Held-to-maturity):          |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Government-backed securities             |       | $                               | 11,997     |                       | $          | 11,991 |   | $ | (6 | ) | $ | 17,997 |   | $ | 17,946 |   | $ | (51 | ) |
| Certificates of deposit                  |       | 2,243                           |       | 2,238                      |       | (5 | ) | 2,368 |   | 2,356 |   | (12 | ) |
| Corporate bonds                          |       | —                          |       | —                     |       | — |   | 3,005 |   | 2,996 |   | (9 | ) |
| Commercial paper                         |       | —                          |       | —                     |       | — |   | 3,962 |   | 3,960 |   | (2 | ) |
|                                     |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
|                                     |       | 14,240                          |       | 14,229                     |       | (11 | ) | 27,332 |   | 27,258 |   | (74 | ) |
| Short-term  (Available-for-sale):        |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Equity investments                       |       | 1,979                           |       | 1,979                      |       | — |   | — |   | — |   | — |   |
|                                     |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Total marketable  securities, short-term |       | $                               | 16,219     |                       | $          | 16,208 |   | $ | (11 | ) | $ | 27,332 |   | $ | 27,258 |   | $ | (74 | ) |
|                                     |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term  (Held-to-maturity):           |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Government-backed securities             |       | $                               | 9,994      |                       | $          | 9,988 |   | $ | (6 | ) | $ | 8,998 |   | $ | 8,917 |   | $ | (81 | ) |
| Certificates of deposit                  |       | 3,338                           |       | 3,313                      |       | (25 | ) | 2,955 |   | 2,903 |   | (52 | ) |
|                                     |       |                            |       |                       |       |   |   |   |   |   |   |   |   |
| Total marketable  securities, long-term  |       | $                               | 13,332     |                       | $          | 13,301 |   | $ | (31 | ) | $ | 11,953 |   | $ | 11,820 |   | $ | (133 | ) |

 

There have been no material realized gains or losses for the three andsix months ended December 30, 2006.

**7.****                 Inventories**

Inventories consist of the following:
|                         | ** ** | **December 30,** | ** ** | **July 1,** | ** ** |
|-------------------------|------------|-----------------------|------------|------------------|------------|
| **(in thousands)** | ** ** | **2006**              | ** ** | **2006**         | ** ** |
| Raw materials           |       | $                     | 6,380      |             | $          | 5,936 |   |
| Work in process         |       | 1,382                 |       | 1,151            |       |
| Finished goods          |       | 10,285                |       | 9,579            |       |
|                    |       |                  |       |             |       |
|                    |       | $                     | 18,047     |             | $          | 16,666 |   |

 

**8.****                 Propertyand Equipment**

Property and equipment consists of the following:
|                                           | ** ** | **December 30,** | ** ** | **July 1,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|------------------|------------|
| **(in thousands)**                   | ** ** | **2006**              | ** ** | **2006**         | ** ** |
| Leasehold  improvements                   |       | $                     | 1,002      |             | $          | 920 |   |
| Office furniture                          |       | 679                   |       | 603              |       |
| Computers,  software, and other equipment |       | 9,531                 |       | 9,236            |       |
|                                      |       |                  |       |             |       |
|                                      |       | $                     | 11,212     |             | $          | 10,759 |   |
| Less:  accumulated depreciation           |       | (7,904                | )          | (7,457           | )          |
|                                      |       |                  |       |             |       |
| Property and equipment,  net              |       | $                     | 3,308      |             | $          | 3,302 |   |

 

Depreciation expense was approximately$0.2 million and $0.5 million for the three and six month periods endedDecember 30, 2006, respectively. Depreciation expense was approximately$0.2 million and $0.4 million for the three and six month periodsended December 31, 2005, respectively.

10

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# **9.****                 Intangibleassets**

Intangible assets with finite lives (amortized) consist of thefollowing: 
|                         | ** ** | **December 30, 2006** | ** ** | **July 1, 2006**    | ** ** |
|-------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **(in thousands)** | ** ** | **Gross  Carrying  Amount**     | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
| Patent                  |       | $                               | 1,379      |                          | $          | (142 | ) | $ | 1,237 |   | $ | — |   | $ | — |   | $ | — |   |
| Prepaid license         |       | 3,878                           |       | (713                          | )          | 3,165 |   | 3,878 |   | (476 | ) | 3,402 |   |
|                    |       |                            |       |                          |       |   |   |   |   |   |   |   |   |
|                    |       | $                               | 5,257      |                          | $          | (855 | ) | $ | 4,402 |   | $ | 3,878 |   | $ | (476 | ) | $ | 3,402 |   |

 

**10.****         ****Derivative Instruments and Hedging Activity**

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

The Company had two foreign currency forwardcontracts outstanding at December 30, 2006, serving to mitigate the foreigncurrency risk of a substantial portion of Euro-denominated intercompanybalances, in the notional amount of approximately 1.6 million Euro. Thefair value of the foreign currency derivative contracts outstanding at December30, 2006 was approximately $2.1 million. Any gains or losses on the fair valueof the effective portion of the derivative contract are largely offset by thelosses and gains on the underlying transactions.

# **11.****         ****Warranty Reserve**

The Company’s products generally carry astandard warranty. The Company maintains a reserve based on anticipatedwarranty claims at the time product revenue is recognized. Factors that affectthe Company’s product warranty liability include the number of installed units,the anticipated cost of warranty repairs and historical and anticipated ratesof warranty claims.

The following table reflects changes in the Company’s accrued warrantyaccount during the three and six months ended December 30, 2006 and December31, 2005, respectively:
|                                       | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **December 30,**                               | ** ** | **December 31,**                             | ** ** | **December 30,** | ** ** | **December 31,** | ** ** |
| **(in thousands)**               | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Beginning  balance                    |       | $                                                   | 9,492      |                                              | $          | 8,489 |   | $ | 9,629 |   | $ | 8,646 |   |
| Incremental accruals on current sales |       | 1,891                                               |       | 2,161                                             |       | 3,582 |   | 3,686 |   |
| Amortization of prior-period accruals |       | (1,893                                              | )          | (1,760                                            | )          | (3,721 | ) | (3,442 | ) |
|                                  |       |                                                |       |                                              |       |   |   |   |   |
| Ending balance                        |       | $                                                   | 9,490      |                                              | $          | 8,890 |   | $ | 9,490 |   | $ | 8,890 |   |

 

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#  

# **12.****                               DeferredRevenue**

# TheCompany offers extended service contracts that may be purchased for periodsfrom one to five years. The Company recognizes service contract revenue ratablyover the life of the contract. Actual service contract expenses incurred andcharged to service costs of sales during an interim period may be more or lessthan the amount of amortized service contract revenue recognized in thatperiod.

# Revenuesare recognized when a signed non-cancelable purchase order exists, the productis shipped, title and risk have passed to the customer, the fee is fixed ordeterminable, and collection is considered probable. Circumstances whichgenerally preclude the immediate recognition of revenue include shipping termsof FOB destination or the existence of a customer acceptance clause in acontract based upon customer inspection of the product. In these instances,revenue is deferred until adequate documentation is obtained to ensure thatthese criteria have been fulfilled.

# Thefollowing table reflects changes in the Company’s deferred revenue accountduring the three and six months ended December 30, 2006 and December 31, 2005,respectively:

|                                            | ** ** | **For the three months ended:** | ** ** | **For the six months ended:** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                 | ** ** | **December 30,**                               | ** ** | **December 31,**                             | ** ** | **December 30,** | ** ** | **December 31,** | ** ** |
| **(in thousands)**                    | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Beginning  balance                         |       | $                                                   | 10,104     |                                              | $          | 8,049 |   | $ | 10,329 |   | $ | 8,350 |   |
| Deferral of new sales                      |       | 3,347                                               |       | 2,735                                             |       | 5,080 |   | 6,511 |   |
| Recognition of previously deferred revenue |       | (3,372                                              | )          | (1,459                                            | )          | (5,330 | ) | (5,536 | ) |
|                                       |       |                                                |       |                                              |       |   |   |   |   |
| Ending balance                             |       | $                                                   | 10,079     |                                              | $          | 9,325 |   | $ | 10,079 |   | $ | 9,325 |   |

 

**13.****         ****Common Stock Buyback**

On October 31, 2005, the Company’s Board of Directors authorized thepurchase by the Company of up to 10% of the Company’s outstanding shares of itscommon stock during a two-year period which expires on October 31, 2007.

770 shares of common stock were purchased for $8.3 million during thesix-month period ended December 30, 2006.

**14.****         ****Segment Information**

SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information*, definesoperating segments as components of an enterprise about which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker, or decision-making group, in deciding how to allocateresources and in assessing performance. Our chief operating decision-makinggroup consists our executive officers. The Company operates principally in oneindustry segment: the design, manufacture, sale, and service of medical devicesand related equipment. The results in this segment have been presented in the ConsolidatedStatements of Income for the appropriate periods.

**15.****         ****Commitments and Contingencies**

The Company has anagreement with the Regents of the University of California (the “Regents”) forexclusive license rights to the Dynamic Cooling Device (“DCD”), subject tocertain limited license rights of Cool Touch, Inc. (“Cool Touch”), in thefollowing fields of use: procedures that involve skin resurfacing andrejuvenation, vascular skin lesions, and laser hair removal. Cool Touch, asubsidiary of New Star Technology, Inc., obtained a license to the DCD on aco-exclusive basis with the Company, in certain narrower fields of use.

The Company’sagreement with the Regents called for an annual license fee of $0.3 million anda royalty obligation of 3%. The annual fee of $0.3 million was paid to theRegents in a lump sum of $3.0 million and is being amortized over the remaininglife of the patent agreement, which as of December 30, 2006 was less than 9years. The royalty and the amortization of the annual license fee payment arereflected in the Company’s consolidated statement of income. The unamortizedportion of the license fee payment is reflected in intangible assets in theDecember 30, 2006 and July 1, 2006 balance sheets (Note 9).

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** **

**16.****                              ****Legal Proceedings**

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

·                  OnAugust 9, 2006, Palomar filed suit against the Company in the United StatesDistrict Court for the District of Massachusetts, asserting infringement bythe Company of U.S. Patent No. 5,735,844. Palomar served its complaint andsummons on the Company on August 15, 2006. Palomar seeks compensatory andtreble damages, as well as attorneys’ fees and an injunction againstthe Company. On November 6, 2006, the Company answered the complaint by denyingPalomar’s allegations and asserting a variety of affirmative defenses andcounterclaims against Palomar. This response included a counterclaim by theCompany against Palomar seeking a declaratory judgment that Palomar’s 5,595,568patent (“’568 Patent”) is invalid and/or not infringed by Company products. OnNovember 27, 2006, Palomar answered the counterclaim and the companies are inthe midst of pre-trial fact discovery.

·                  OnAugust 10, 2006, the Company filed suit against Palomar in the United StatesDistrict Court for the District of Massachusetts, assertinginfringement by Palomar of U.S. Patent Nos. 6,659,999, 5,312,395, and6,743,222. The Company seeks compensatory and treble damages, as well as attorneys’ feesand an injunction against Palomar. The Company served its complaint andsummons on Palomar on August 10, 2006. On October 25, 2006, theCompany filed a First Amended Complaint, which amended the Company’s suitagainst Palomar by removing from the suit Patent 6,659,999. On October 30,2006, Palomar answered the amended complaint by denying the Company’sallegations and asserting an affirmative defense of inequitable conduct withrespect to the ‘395 patent. In addition, Palomar filed a declaratory judgmentcounterclaim seeking an order that Palomar products either do not infringe suchpatents or that such patents are invalid. On November 31, 2006, the Companyanswered the counterclaim by denying Palomar’s allegations.

·                  OnDecember 19, 2006, the Company filed suit against Palomar in the United StatesDistrict Court for the Eastern District of Texas, Lufkin Division assertingthat Palomar’s Lux V and 1540 Fractional hand pieces infringe upon one or moreof United States patents: 5,810,801, 6,659,999 and 6,120,497. The Company seekscompensatory and treble damages, as well as attorneys’ fees and aninjunction against Palomar. On January 10, 2007, Palomar answered thecomplaint by denying Palomar’s allegations and filed a declaratory judgmentcounterclaim seeking a ruling that its products do not infringe such patentsand/or that such patents are invalid. In addition, Palomar filed a motion totransfer the case to the United States District Court for the District ofMassachusetts.

While the Company intends to vigorouslycontest Palomar’s allegations, and to pursue its ownclaims against Palomar, each lawsuit is inherently uncertain andunpredictable as to its ultimate outcome. An adverse outcomein Palomar’s suit against the Company would materially hurt thebusiness, financial condition, results of operations and cash flows.

From time to time, the Company is party tovarious legal proceedings incidental to its business. The Company believes thatnone of the legal proceedings, other than Palomar, that are presently pending,if adversely decided against us, will have a material adverse effect upon itsfinancial position, results of operations, or liquidity.

13

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** **

**17.****                              ****Other Income**

During the six-month period ended December 30, 2006, the Companyrecognized a $3.5 million gain on the exchange of common stock of Solx Inc. forcash and common stock of Occulogix Inc. (NasdaqGM: OCCX). The gain was a resultof the acquisition of Solx Inc., a privately-held company, by Occulogix Inc., apublicly traded company. The Company held 19.99% of the outstanding commonstock of Solx Inc. on an as-converted basis, prior to the merger. As a resultof the merger, the Company received approximately $1.0 million in cash plusapproximately 1,260 shares of common stock in Occulogix Inc.

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**CANDELA CORPORATION**

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

**Overview**

We research, develop,manufacture, market and service lasers used to perform aesthetic and cosmeticprocedures. We sell our lasers to physicians and personal care practitioners. Wemarket our products directly and through a network of distributors toend-users. Our traditional customer base includes plastic and cosmetic surgeonsand dermatologists. More recently, we have expanded our sales to a broadergroup of practitioners consisting of general practitioners and certainspecialists including obstetricians, gynecologists and general and vascularsurgeons. We derive our revenue from the sales of lasers, light-based devices,and other products, as well as the provision of product-related services.

**Critical Accounting Policies**

** **

****Thisdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. Weevaluate our estimates and judgments on an on-going basis, including thoserelated to revenue recognition, allowance for doubtful accounts, inventoriesreserves, warranty reserves, contingencies, valuation of long-lived assets,stock based compensation, restructurings and income taxes. We base ourestimates and judgments on historical experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valueof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates and judgments under differentassumptions or conditions. A discussion of our critical accounting policies andthe related estimates and judgments affecting the preparation of ourconsolidated financial statements is included in our Annual Report on Form 10-Kfor fiscal year 2006.****

**RecentAccounting Pronouncements**

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin (“SAB”) No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Current YearMisstatements.* SAB No. 108 requires analysis of misstatementsusing both an income statement (rollover) approach and a balance sheet (ironcurtain) approach in assessing materiality and provides for a one-timecumulative effect transition adjustment. SAB No. 108 is effective for ourfiscal year 2007 annual financial statements. We are currently assessing thepotential impact that the adoption of SAB No. 108 will have on ourfinancial statements; the impact is not expected to be material.

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements,*which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.SFAS No. 157 does not require any new fair value measurements, butprovides guidance on how to measure fair value by providing a fair valuehierarchy used to classify the source of the information. This statement iseffective for our fiscal year 2008. We are currently assessing the potentialimpact that the adoption of SFAS No. 157 will have on our financialstatements; the impact is not expected to be material.

InJuly 2006, the FASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes-aninterpretation of FASB Statement No. 109* (FIN No. 48). FINNo. 48 clarifies the accounting for uncertainty in income taxes recognizedin an enterprise’s financial statements in accordance with FASB StatementNo. 109,*Accounting for Income Taxes.*FINNo. 48 prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be

15

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takenin a tax return. FIN No. 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods anddisclosure relative to uncertain tax positions. FIN No. 48 is effectivefor fiscal years beginning after December 15, 2006, with early adoptionencouraged. We are currently assessing the potential impact that the adoptionof FIN No. 48 will have our consolidated financial statements.

InFebruary 2006, the FASB issued Statement No. 155,*Accounting for Certain Hybrid FinancialInstruments—an amendment of FASB Statements No. 133 and 140*(SFAS No. 155). This standard permits fair value remeasurement for anyhybrid financial instrument that contains an embedded derivative that otherwisewould require bifurcation; clarifies which interest-only strips andprincipal-only strips are not subject to the requirements of SFAS No. 133;requires evaluation of interests in securitized financial assets; clarifiesthat concentrations of credit risk in the form of subordination are notembedded derivatives; and eliminates the prohibition on a qualifyingspecial-purpose entity from holding a derivative financial instrument thatpertains to a beneficial interest other than another derivative financialinstrument. This standard is effective for all financial instruments acquiredor issued for fiscal years beginning after September 15, 2006. We do notbelieve that adoption of SFAS No. 155 will have a material effect on ourfinancial position or results of operations.

**Results of Operations**

***Revenue***

Revenue source bygeographic region is reflected in the following table:

|                          | ** ** | **For the three months ended:** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **December 30,**                               | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**  | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **Increase (Decrease)** | ** ** |
| U.S.                     |       | $                                                   | 16,851     |   | 45 | % | $ | 18,469 |   | 49 | % | $ | (1,618 | ) | -9 | % |
| All other  countries     |       | 20,555                                              |       | 55 | % | 19,251 |   | 51 | % | 1,304 |   | 7 | % |
|                     |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide  revenue |       | $                                                   | 37,406     |   | 100 | % | $ | 37,720 |   | 100 | % | $ | (314 | ) | -1 | % |

 

|                          | ** ** | **For the six months ended:** | ** ** |
|--------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **December 30,**                             | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**  | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **Increase (Decrease)** | ** ** |
| U.S.                     |       | $                                                 | 32,696     |   | 46 | % | $ | 28,737 |   | 44 | % | $ | 3,959 |   | 14 | % |
| All other  countries     |       | 38,184                                            |       | 54 | % | 37,070 |   | 56 | % | 1,114 |   | 3 | % |
|                     |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Total worldwide  revenue |       | $                                                 | 70,880     |   | 100 | % | $ | 65,807 |   | 100 | % | $ | 5,073 |   | 8 | % |

 

Consolidatedrevenue decreased 1% or $0.3 million to $37.4 million for the three-monthperiod ended December 30, 2006 compared to the three-month period endedDecember 31, 2005. Consolidated revenue increased 8% or $5.1 million to $70.9million for the six-month period ending December 30, 2006 compared to thesix-month period ending December 31, 2005. The slight decrease in thethree-month period ended December 30, 2006 was due primarily to a decrease salesin Latin America and the U.S. offset by increases in Europe and Asia. Theincrease in the six-month period ended December 30, 2006 compared to thesix-month period ended December 31, 2005 was due to an increase in the U.S.,Asia, and Europe, offset by a decrease in Latin America.

Foreignrevenue accounted for approximately 55% of the consolidated total revenue forthe three-month period ended December 30, 2006. The increase of 7% to $20.6million for the three-month period ended December 30, 2006, as compared to thethree-month period ended December 31, 2005, was comprised of increases inEurope and Asia of $1.4 million and $1.1 million, respectively, offset by adecrease in Latin America of $1.2 million.

Foreignrevenue accounted for approximately 54% of the consolidated total revenue forthe six-month period ended December 30, 2006. Foreign revenue increased 3% to$38.2 million for the six-month period ended December 30, 2006, as compared tothe six-month period ended December 31, 2005. Year-to-date foreign

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revenueincreased in Europe and Asia offset by the decrease in Latin America. Thedecrease in Latin America was primarily due to exceptionally high revenue forthe demographics of the region for the six-month period ended December 31,2005.

U.S.revenue decreased 9% or $1.6 million for the three-month period ended December30, 2006, as compared to the three-month period ended December 31, 2005, dueprimarily to the decrease in revenue related to a slow-down in the growth plansof a national spa franchisor. U.S. revenue increased 14% or $4.0 million forthe six-month period ended December compared to the six-month period endedDecember 31, 2005.

Revenue source by type isreflected in the following table:

|                            | ** ** | **For the three months ended:** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **December 30,**                               | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**    | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **Increase (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                   | 29,107     |   | 78 | % | $ | 31,657 |   | 84 | % | $ | (2,550 | ) | -8 | % |
| Product-related  services  |       | 8,299                                               |       | 22 | % | 6,063 |   | 16 | % | 2,236 |   | 37 | % |
|                       |       |                                                |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                   | 37,406     |   | 100 | % | $ | 37,720 |   | 100 | % | $ | (314 | ) | -1 | % |

 

|                            | ** ** | **For the six months ended:** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **December 30,**                             | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(in thousands)**    | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **Increase (Decrease)** | ** ** |
| Lasers and other  products |       | $                                                 | 54,997     |   | 78 | % | $ | 53,882 |   | 82 | % | $ | 1,115 |   | 2 | % |
| Product-related  services  |       | 15,883                                            |       | 22 | % | 11,925 |   | 18 | % | 3,958 |   | 33 | % |
|                       |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Total revenue              |       | $                                                 | 70,880     |   | 100 | % | $ | 65,807 |   | 100 | % | $ | 5,073 |   | 8 | % |

 

The decrease in revenuefrom lasers and other products for the three-month period ended December 30,2006, as compared to the three-month period ended December 31, 2005, was spread between all productsexcept the V-beam which showed an increase of $1.5 million. Theincrease in revenue from product-related service for the three-month periodended December 30, 2006, as compared to the three-month period ended December31, 2005, resulted primarily from an increase in the number of service-relatedcontracts sold in addition to an increase in the number of consumables andaccessories sold to support our installed base.

The increase in laserand other product revenue for the six-month period ended December 30, 2006, ascompared to the six-month period ended December 31, 2005, resulted primarilyfrom an increase in the sales volume of our V-beam product line of approximately$3.8 million offset by decreases in our other products.

Product-related servicesincreased approximately $4.0 million during the six-month period ended December30, 2006, as compared to the six-month period ended December 31 2005, dueprimarily to an increase in the number of service-related contracts sold inaddition to an increase in the number of consumables and accessories sold tosupport our installed base.

***Gross Profit.***Gross profit decreasedto approximately $17.8 million or 47.5% of revenues for the three-month periodended December 30, 2006, as compared to gross profit of approximately $19.0million or 50.3% for the same period one year earlier. Gross profit increasedto approximately $35.2 million or 49.7% of revenues for the six-month periodended December 30, 2006, as compared to gross profit of approximately $33.5million or 50.9% for the same period one year earlier. The change in grossprofit results principally from the changes in sales volume and product mix.

***Selling,General and Administrative Expense.***Selling, general andadministrative expenses increased to approximately $12.6 million for thethree-month period ended December 30, 2006, from approximately $10.5 millionfor the three-month period ended December 31, 2005. As a percentage of revenue,selling, general and administrative expenses increased to 33.6% from 28% ofrevenues from the comparative prior year period. The increase was primarily dueto legal fees related to the Palomar litigation and to incremental

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share-based compensationexpense. For the six-month period ended December 30, 2006, selling, general andadministrative expenses increased to approximately $23.6 million fromapproximately $19.3 million for the six-month period ended December 31 2005. Asa percentage of revenue, selling, general and administrative expenses increasedto 33.4% from 29.3%. The increase is due primarily to legal fees related to thePalomar litigation and to share-based compensation expense.

***Researchand Development Expense.***Research and developmentspending increased to $4.6 million for the three-month period ended December30, 2006, from $1.8 million for the three-month period ended December 31, 2005,due primarily to an increase in the number of active projects and an increasein employee costs. Spending in this area increased to $8.2 million for thesix-month period ended December 30, 2006, from $3.4 million for the six-monthperiod ended December 31, 2005 due primarily to the aforementioned increase inproject spending and an increase in employee-related costs.

***OtherIncome/Expense.***Other income increased to approximately$0.9 million for the three-months ended December 30, 2006 compared to $0.2million for the three-month period ended December 31, 2005 due primarily to anincrease in interest income earned on the higher level of cash and cashequivalents. For the six-month period ended December 30, 2006, other income wasapproximately $5.2 million compared to other income of approximately $0.5million for the six-month period ended December 31, 2005. The increase is dueprimarily to an increase in interest income as a result of an increase in cashand cash equivalents, marketable securities, and a recognized $3.5 million gainon the exchange of common stock of Solx Inc. for cash and common stock ofOcculogix Inc.

The gain was a result ofthe acquisition of Solx Inc., a privately-held company, by Occulogix Inc., apublicly traded company. We held 19.99% of the outstanding common stock of SolxInc. on an as-converted basis, prior to the merger. As a result of the merger,we received approximately $1.0 million cash plus approximately 1,260 shares ofcommon stock in Occulogix Inc., a company publicly traded on the Nasdaq GlobalMarket.

***IncomeTaxes.*** The provision for income taxes results from a combinationof activities of both the domestic and foreign subsidiaries of the Company. Werecorded effective tax rates of approximately 32% and 34% for the three-monthperiods ended December 30, 2006 and December 31, 2005, respectively. Thedecrease was due primarily to the retroactive reinstatement of the domesticresearch & development (“R&D”) tax credit. We recorded effective taxrates of approximately 36% and 34% for the six-month periods ended December 30,2006 and December 31, 2005, respectively. The increase was due primarily to thephase out of the extraterritorial income exclusion deduction in fiscal year2007 and a decrease in the valuation allowances for foreign jurisdictions inthe same quarter in the previous year, offset slightly by the retroactivereinstatement of the R&D tax credit mentioned above.

**Liquidity and Capital Resources**

Ourcash and cash equivalents and marketable securities at December 30, 2006totaled approximately $70.0 million compared with approximately $79.5 millionat July 1, 2006. We continue to have no long-term debt. We believe that thecombination of existing cash and cash equivalents, and marketable securities onhand, along with cash to be generated by future operations and amountsavailable under our line of credit, will be sufficient to meet our ongoingoperating and capital expenditure requirements for the foreseeable future.However, we cannot be sure that we will not require additional capital beyondthe amounts currently forecasted by us, or that any such required additionalcapital will be available on reasonable terms, if at all, as it becomesrequired.

Cashused in operating activities amounted to approximately $2.8 million for thesix-month period ended December 30, 2006 as compared to cash provided byoperating activities of approximately $1.1 million for the same period in theprior year. The increase in cash used by operating activities is due to thepayment of prior year liabilities combined with a decrease in net income.

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Cashprovided by investing activities amounted to approximately $10.7 million forthe six-month period ended December 30, 2006 as compared to cash used byinvesting activities of approximately $10.3 million for the six-month periodended December 31, 2005. The activity for both six-month periods primarilyreflects the maturity or purchase of held-to-maturity investments.

Cashused by financing activities amounted to approximately $8.0 million for thesix-month period ended December 30, 2006 and primarily reflects the purchase oftreasury stock during the period.

Cash provided byfinancing activities amounted to approximately $2.5 million for the six-monthperiod ended December 31, 2005 and primarily reflects the proceeds from theissuance of common stock by the Company to its employees under the existingstock option plan and stock purchase plan.

**Off-BalanceSheet Arrangements**

Ouronly off-balance sheet arrangements consist of non-cancelable operating leasesentered into in the ordinary course of business and the license agreement withthe Regents. The table below in the next section titled “ContractualObligations” shows the amounts of our operating lease commitments and purchasecommitments payable by year.

**Contractual Obligations**

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

| (in thousands)            | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **After  5 years** | ** ** |
|--------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-------------------------|------------|
| Royalty  commitments           |       | $         | 5,250      |                            | $          | 1,000                          |       | $                              | 2,000      |                    | $          | 1,250 |   | $ | 1,000 |   |
| Operating leases               |       | 2,143     |       | 1,172                           |       | 903                            |       | 68                             |       | —                  |       |
|                           |       |      |       |                            |       |                           |       |                           |       |                    |       |
| Total  contractual obligations |       | $         | 7,393      |                            | $          | 2,172                          |       | $                              | 2,903      |                    | $          | 1,318 |   | $ | 1,000 |   |

 

#### **CautionaryStatements**

Certain statementscontained herein may constitute “forward-looking statements” within the meaningof the Private Securities Litigation Reform Act of 1995 (“Reform Act”). We mayalso make forward-looking statements in other reports filed with the Securitiesand Exchange Commission, in materials delivered to stockholders and in pressreleases. In addition, our representatives may from time to time make oralforward-looking statements. Forward-looking statements provide currentexpectations of future events based on certain assumptions and include anystatement that does not directly relate to any historical or current fact.Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,”“plans,” “projects,” and similar expressions, may identify such forward-lookingstatements. Such forward-looking statements include but are not limited to:that we have the necessary infrastructure in place to capitalize on expansion;the affordability of our products will allow for expansion; that we can lowerproduction costs; or that the market will expand beyond baby boomers. We assumeno obligation to update or revise any forward-looking statements whether as aresult of new information, future events or otherwise. The risks anduncertainties that may affect forward-looking statements and/or our businessinclude, among others, those discussed in “Cautionary Statements” in our AnnualReport filed on Form 10-K for the fiscal year ended July 1, 2006, as well asother risks and uncertainties referenced in this Quarterly Report on Form 10-Q,and the following:

·                                          OnAugust 9, 2006, one of our competitors, Palomar Medical Technologies, Inc.(“Palomar”), alleged that the manufacture, use and sale of our products forlaser hair removal infringe certain United States patents. Public announcementsconcerning this litigation that are unfavorable to us may result in significantdeclines in our stock price. An adverse ruling or judgment in this matter islikely to cause our stock price to decline significantly. Litigation withPalomar is expensive and is likely to be protracted, and our intellectualproperty position may be weakened as a result of an adverse ruling or judgment.Whether or not we are successful in the pending lawsuit, litigation may consumesubstantial amounts of our financial resources and divert management’sattention away from our core business. Please see Part II, Item 1 (LegalProceedings) for a further discussion of the Palomar litigation.

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·                                          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.

·                                          Ourprincipal source of liquidity is our current cash and equivalents andmarketable investments. Our ability to generate cash from operations isdependant upon our ability to generate revenue from selling our lasers andother products and providing product-related services. A decrease in demand forour products and related services or increases in operating costs would likelyhave an adverse effect on our liquidity.

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

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

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

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

·                                          We have modifiedsome of our products without FDA clearance. The FDA could retroactively decidethe modifications were improper and require us to cease marketing and/or recallthe modified products.

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

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

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

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

We caution readers not toplace undue reliance upon any forward-looking statements, which speak only asof the date made. We expressly disclaim any obligation or undertaking torelease publicly any updates or revisions to any such statements to reflect anychange in our expectations or any change in events, conditions or circumstanceson which any such statement is based.

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

Wehave cash equivalents and marketable securities that consist of money marketmutual funds, certificates of deposit, US government securities, fixed incomecorporate securities and equity investments. The majority of these investmentshave maturities within one to three years. We believe that our exposure tointerest rate risk is minimal due to the term and type of our investments andthose fluctuations in interest rates would not have a material adverse effecton our results of operations.

We have international subsidiaries that transact business in both local and foreign currencies and therefore we are exposed to foreign currency exchange risk resulting from fluctuations in foreign currencies. This risk could adversely impact our results and financial condition. From time to time, we may enter into foreign currency exchange contracts to reduce our exposure to foreign currency exchange risk and variability in operating results due to fluctuation in exchange rates underlying the value of current transactions and anticipated transactions denominated in foreign currencies. These contracts obligate us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates. These contracts are denominated in the same currency in which the underlying transactions are denominated and bear a contract value and maturity date that approximate the value and expected settlement date, respectively, of the underlying transactions. Unrealized gains and losses on open contracts at the end of each period, resulting from changes in the fair value of these contracts, are recognized in other comprehensive income in the same period as exchange gains and losses on the underlying foreign denominated receivables. We do not engage in foreign currency speculation.

We had two forward exchange contracts outstanding serving as a hedge of our Euro-denominated intercompany receivables at December 30, 2006. These contracts serve as hedges of a substantial portion of our Euro-denominated intercompany balances. Any gains and losses on the fair value of the derivative contract would be largely offset by losses and gains on the underlying transaction.

# **Item 4 - Controls and Procedures**

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

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

***Changes in Internal Controls over Financial Reporting***

Therehave been no changes in the Company’s internal controls over financialreporting that occurred during the quarter ended December 30, 2006 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**CANDELA CORPORATION**

**Part II. Other Information**

# **Item 1 - Legal Proceedings**

TheCompany is currently involved in three litigation matters with Palomar MedicalTechnologies, Inc. (“Palomar”).

·                  OnAugust 9, 2006, Palomar filed suit against the Company in the United StatesDistrict Court for the District of Massachusetts, assertinginfringement by the Company of U.S. Patent No. 5,735,844. Palomarserved its complaint and summons on the Company on August 15, 2006. Palomarseeks compensatory and treble damages, as well as attorneys’ fees and aninjunction against the Company. On November 6, 2006, the Company answeredthe complaint by denying Palomar’s allegations and asserting a variety ofaffirmative defenses and counterclaims against Palomar. This response includeda counterclaim by the Company against Palomar seeking a declaratory judgmentthat Palomar’s 5,595,568 patent (“’568 Patent”) is invalid and/or not infringedby Company products. On November 27, 2006, Palomar answered the counterclaimand the companies are in the midst of pre-trial fact discovery.

·                  OnAugust 10, 2006, the Company filed suit against Palomar in the United StatesDistrict Court for the District of Massachusetts, assertinginfringement by Palomar of U.S. Patent Nos. 6,659,999, 5,312,395, and6,743,222. The Company seeks compensatory and treble damages, as well asattorneys’ fees and an injunction against Palomar. The Company servedits complaint and summons on Palomar on August 10, 2006. On October25, 2006, the Company filed a First Amended Complaint, which amended the Company’ssuit against Palomar by removing from the suit Patent 6,659,999. On October 30,2006, Palomar answered the amended complaint by denying the Company’sallegations and asserting an affirmative defense of inequitable conduct withrespect to the ‘395 patent. In addition, Palomar filed a declaratory judgmentcounterclaim seeking an order that Palomar products either do not infringe suchpatents or that such patents are invalid. On November 31, 2006, the Companyanswered the counterclaim by denying Palomar’s allegations.

·                  OnDecember 19, 2006, the Company filed suit against Palomar in the United StatesDistrict Court for the Eastern District of Texas, Lufkin Division assertingthat Palomar’s Lux V and 1540 Fractional hand pieces infringe upon one or moreof United States patents: 5,810,801, 6,659,999 and 6,120,497. The Company seekscompensatory and treble damages, as well as attorneys’ fees and aninjunction against Palomar. On January 10, 2007, Palomar answered thecomplaint by denying Palomar’s allegations and filed a declaratory judgmentcounterclaim seeking a ruling that its products do not infringe such patentsand/or that such patents are invalid. In addition, Palomar filed a motion totransfer the case to the United States District Court for the District ofMassachusetts.

Whilethe Company intends to vigorously contest Palomar’s allegations, andto pursue its own claims against Palomar, each lawsuit isinherently uncertain and unpredictable as to its ultimateoutcome. An adverse outcome in Palomar’s suit against theCompany would materially hurt the business, financial condition, resultsof operations and cash flows.

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

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**Item 4. Submission of Matters to a Vote of Security Holders**

OnDecember 12, 2006, the Company held its annual meeting of shareholders andvoted on four proposals.

1)                                      At the Meeting, the proposal to approve andadopt an amendment to the Company’s Certificate of Incorporation, as amended,to, among other things, divide the Board of Directors into three classes, withDirectors in each class to serve staggered three-year terms, was defeated asfollows:

| FOR        | ** ** | **AGAINST** | ** ** | **ABSTAIN** |
|------------|------------|-------------|------------|-------------|
| ** ** | ** ** | ** **  | ** ** | ** **  |
| 5,392,857  |       | 9,668,369   |       | 102,785     |

 

2)                                      At the Meeting, six (6) directors wereelected to hold office until the Company’s next annual meeting. The vote was asfollows:
|                     | ** ** | **FOR**    | ** ** | **WITHHOLD** | ** ** |
|---------------------|------------|------------|------------|--------------|------------|
|                | ** ** | ** ** | ** ** | ** **   | ** ** |
| George A. Abe       |       | 19,047,395 |       | 1,492,172    |       |
| Ben Bailey III      |       | 19,777,533 |       | 762,034      |       |
| Nancy Nager         |       | 19,059,253 |       | 1,480,314    |       |
| Gerard E. Puorro    |       | 19,097,472 |       | 1,442,095    |       |
| Kenneth D.  Roberts |       | 19,117,442 |       | 1,422,125    |       |
| Douglas W. Scott    |       | 18,390,904 |       | 2,148,663    |       |

 

3)                                      At the Meeting, the proposal to approve andadopt an amendment to the Company’s Second Amended and Restated 1998 Stock Planto increase the number of shares of common stock that may be issued pursuant tothe Second Amended and Restated 1998 Stock Plan by 2,500,000 shares to7,800,000 shares of common stock in the aggregate, was approved as follows:

| FOR        | ** ** | **AGAINST** | ** ** | **ABSTAIN** |
|------------|------------|-------------|------------|-------------|
| ** ** | ** ** | ** **  | ** ** | ** **  |
| 7,594,774  |       | 7,544,492   |       | 21,745      |

 

4)                                      At the Meeting, a proposal to ratify theselection of BDO Seidman, LLP to serve as the Company’s independent registeredpublic accounting firm for the fiscal year ending June 30, 2007, was approvedas follows:

| FOR        | ** ** | **AGAINST** | ** ** | **ABSTAIN** |
|------------|------------|-------------|------------|-------------|
| ** ** | ** ** | ** **  | ** ** | ** **  |
| 20,476,747 |       | 40,233      |       | 22,587      |

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# **ITEM 6 - Exhibits**

(a)             Exhibits
| Exhibit 10.1 |   | Amendment No. 1 to Second Amended and Restated  1998 Stock Plan                                                                                    |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                    |
| 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 5, 2007                                    |   | /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 |       | Amendment No. 1 to Second Amended and Restated 1998  Stock Plan                                                                                         |
|         |       |                                                                                                                                                    |
| 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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