**UNITEDSTATESSECURITIES 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 ended March 27, 2004.**

 

**Commission file number 000-14742**

 

**CANDELACORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

Registrant’s telephone number, including area code:  **(508)358-7400**

 

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Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes  ý   No  o

 

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

Yes  o   No  ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| **Class**                              |   | **Outstanding at May 5, 2004** |
|----------------------------------------|--------|--------------------------------|
| Common Stock, $.01 par value per share |   | 22,456,004                     |

 

 

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**CANDELA CORPORATION**

**Index**

 
| Part I.  | Financial Information: |                                                                                                                                                                                                                                      |
|----------|------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item 1.                | Financial Statements                                                                                                                                                                                                                      |   |
|     |                   |                                                                                                                                                                                                                                      |   |
|     |                   | Unaudited  Condensed Consolidated Balance Sheets as of March 27, 2004 and  June 28, 2003                                                                                                                                        | 3 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     |                   | Unaudited  Condensed Consolidated Statements of Operations for the three-month periods  ended  March 27, 2004 and  March 29, 2003, and for the nine-month periods ended March 27, 2004  and  March 29, 2003 | 4 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     |                   | Unaudited  Condensed Consolidated Statements of Cash Flows for the nine-month periods  ended March 27, 2004 and   March 29, 2003                                                                                           | 5 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     |                   | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                                                                                                                           | 6-11 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item  2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                                                                               | 12-17 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item  3.               | Quantitative  and Qualitative Disclosure about Market Risk                                                                                                                                                                                | 18 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item 4.                | Controls and  Procedures                                                                                                                                                                                                                  | 18 |
|     |                   |                                                                                                                                                                                                                                      |   |
| Part II. | Other Information:     |                                                                                                                                                                                                                                      |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item  1.               | Legal  proceedings                                                                                                                                                                                                                        | 19 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item  4.               | Submission  of Matters to a Vote of Security Holders                                                                                                                                                                                      | 19 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item 5.                | Other Matters                                                                                                                                                                                                                             | 20 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Item 6.                | Exhibits and  Reports on Form 8-K                                                                                                                                                                                                         | 20 |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Signatures             |                                                                                                                                                                                                                                      |
|     |                   |                                                                                                                                                                                                                                      |   |
|     | Index to  Exhibits     |                                                                                                                                                                                                                                      |

 

2

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**PartI.  Financial Information**

**Item1 - Financial Statements**

 

**CANDELACORPORATION**

**CondensedConsolidated Balance Sheets**

(in thousands)

(unaudited)

 
|                                                 |   | **March 27,  2004** |       | **June 28,  2003** |       |
|------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                 |   |                     |       | **(Restated)**          |       |
| **Assets**                                           |   |                     |       |                    |       |
| **Current assets:**                                  |   |                     |       |                    |       |
| **Cash and cash equivalents**                        |   | **$**                    | **32,135** | ** **              | **$**      | **31,870** | ** ** |
| **Accounts receivable, net**                         |   | **31,953**               | ** ** | **26,572**              | ** ** |
| **Notes receivable**                                 |   | **626**                  | ** ** | **1,086**               | ** ** |
| **Inventories, net**                                 |   | **15,352**               | ** ** | **10,834**              | ** ** |
| **Other current assets**                             |   | **1,532**                | ** ** | **658**                 | ** ** |
| **Total current assets**                             |   | **81,598**               | ** ** | **71,020**              | ** ** |
| **Property and equipment, net**                      |   | **3,544**                | ** ** | **3,327**               | ** ** |
| **Deferred tax assets**                              |   | **5,576**                | ** ** | **4,760**               | ** ** |
| **Prepaid licenses**                                 |   | **1,098**                | ** ** | **1,228**               | ** ** |
| **Other assets**                                     |   | **440**                  | ** ** | **166**                 | ** ** |
| **Total assets**                                     |   | **92,256**               | ** ** | **80,501**              | ** ** |
|                                                 |   |                     |       |                    |       |
| **Liabilities and Stockholders’ Equity**        |   |                     |       |                    |       |
| **Current liabilities:**                             |   |                     |       |                    |       |
| **Accounts payable**                                 |   | **$**                    | **6,479**  | ** **              | **$**      | **5,271** | ** ** |
| **Accrued payroll and related expenses**             |   | **3,709**                | ** ** | **4,656**               | ** ** |
| **Accrued warranty costs**                           |   | **4,919**                | ** ** | **3,628**               | ** ** |
| **Income taxes payable**                             |   | **2,430**                | ** ** | **3,528**               | ** ** |
| **Other accrued liabilities**                        |   | **4,002**                | ** ** | **2,755**               | ** ** |
| **Deferred income**                                  |   | **2,707**                | ** ** | **2,779**               | ** ** |
| **Current liabilities of discontinued operations**   |   | **1,224**                | ** ** | **1,095**               | ** ** |
| **Total current liabilities**                        |   | **25,470**               | ** ** | **23,712**              | ** ** |
| **Other long-term liabilities**                      |   | **3,290**                | ** ** | **3,393**               | ** ** |
| **Long-term liabilities of discontinued operations** |   | **2,635**                | ** ** | **48**                  | ** ** |
| **Total liabilities**                                |   | **31,395**               | ** ** | **27,153**              | ** ** |
|                                                 |   |                     | ** ** |                    | ** ** |
| **Stockholders’ equity:**                       |   |                     | ** ** |                    | ** ** |
| **Common stock**                                     |   | **253**                  | ** ** | **129**                 | ** ** |
| **Additional paid-in capital**                       |   | **51,431**               | ** ** | **48,479**              | ** ** |
| **Accumulated earnings**                             |   | **21,701**               | ** ** | **17,904**              | ** ** |
| **Treasury stock, at cost**                          |   | **(12,997**              | **)**      | **(12,997**             | **)**      |
| **Accumulated other comprehensive income (loss)**    |   | **473**                  | ** ** | **(167**                | **)**      |
| **Total stockholders’ equity**                  |   | **60,861**               | ** ** | **53,348**              | ** ** |
| **Total liabilities and stockholders’ equity**  |   | **$**                    | **92,256** | ** **              | **$**      | **80,501** | ** ** |

 

***The accompanyingnotes are an integral part of the unaudited condensed consolidated financialstatements****.*

 

3

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**CANDELACORPORATION**

**CondensedConsolidated Statements of Operations**

(in thousands, except per share data)

(unaudited)

 
|                                                                                                                                                       |   | **For the  three months ended:** |       | **For the  nine months ended:** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|---------------------------------|------------|
|                                                                                                                                                       |   | **March 27,  2004**         |       | **March 29,  2003**        |       | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                                                                                                       |   |                             |       | **(Restated)**                  |       |   |   | **(Restated)** |   |
| **Revenue**                                                                                                                                                |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products**                                                                                                                              |   | **$**                            | **23,509** | ** **                      | **$**      | **18,045** | ** ** | **$** | **58,769** | ** ** | **$** | **43,444** | ** ** |
| **Product-related service**                                                                                                                                |   | **4,141**                        | ** ** | **3,395**                       | ** ** | **11,465** | ** ** | **9,268** | ** ** |
| **Total revenue**                                                                                                                                          |   | **27,650**                       | ** ** | **21,440**                      | ** ** | **70,234** | ** ** | **52,712** | ** ** |
| **Cost of sales**                                                                                                                                          |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products**                                                                                                                              |   | **11,399**                       | ** ** | **8,133**                       | ** ** | **28,555** | ** ** | **19,506** | ** ** |
| **Product-related service**                                                                                                                                |   | **2,273**                        | ** ** | **2,310**                       | ** ** | **6,142** | ** ** | **6,600** | ** ** |
| **Total cost of sales**                                                                                                                                    |   | **13,672**                       | ** ** | **10,443**                      | ** ** | **34,697** | ** ** | **26,106** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Gross profit**                                                                                                                                           |   | **13,978**                       | ** ** | **10,997**                      | ** ** | **35,537** | ** ** | **26,606** | ** ** |
| **Operating expenses:**                                                                                                                                    |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Selling, general and administrative**                                                                                                                    |   | **9,572**                        | ** ** | **6,256**                       | ** ** | **22,793** | ** ** | **16,880** | ** ** |
| **Research and development**                                                                                                                               |   | **1,460**                        | ** ** | **1,218**                       | ** ** | **3,951** | ** ** | **3,170** | ** ** |
| **Total operating expenses**                                                                                                                               |   | **11,032**                       | ** ** | **7,474**                       | ** ** | **26,744** | ** ** | **20,050** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Income from operations**                                                                                                                                 |   | **2,946**                        | ** ** | **3,523**                       | ** ** | **8,793** | ** ** | **6,556** | ** ** |
| **Other income (expense):**                                                                                                                                |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Interest income**                                                                                                                                        |   | **73**                           | ** ** | **428**                         | ** ** | **228** | ** ** | **562** | ** ** |
| **Interest expense**                                                                                                                                       |   | **(6**                           | **)**      | **(35**                         | **)**      | **(13** | **)** | **(214** | **)** |
| **Other (expense) income, net**                                                                                                                            |   | **(14**                          | **)**      | **255**                         | ** ** | **398** | ** ** | **(26** | **)** |
| **Total other income (expense)**                                                                                                                           |   | **53**                           | ** ** | **648**                         | ** ** | **613** | ** ** | **322** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations before income taxes**                                                                                                  |   | **2,999**                        | ** ** | **4,171**                       | ** ** | **9,406** | ** ** | **6,878** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Provision for income taxes**                                                                                                                             |   | **1,039**                        | ** ** | **1,335**                       | ** ** | **3,215** | ** ** | **2,276** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                      |   | **1,960**                        | ** ** | **2,836**                       | ** ** | **6,191** | ** ** | **4,602** | ** ** |
| **Discontinued operations:**                                                                                                                               |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Loss  from discontinued Skin Care Center operations of $0, $318, $473, and $1144  less income tax benefit of $0 and $102, $175, and $366, respectively** |   | **—**                       | ** ** | **(216**                        | **)**      | **(298** | **)** | **(778** | **)** |
| **Loss on closure of skin care center of $3,348 less income  tax benefit of $1,253**                                                                       |   | **—**                       | ** ** | **—**                      | ** ** | **(2,095** | **)** | **—** | ** ** |
| **Net income**                                                                                                                                             |   | **$**                            | **1,960**  | ** **                      | **$**      | **2,620** | ** ** | **$** | **3,798** | ** ** | **$** | **3,824** | ** ** |
| **Net income (loss) per share of common stock**                                                                                                            |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Basic:**                                                                                                                                                 |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                      |   | **$**                            | **.09**    | ** **                      | **$**      | **.14** | ** ** | **$** | **.28** | ** ** | **$** | **.23** | ** ** |
| **Loss from discontinued operations**                                                                                                                      |   | **—**                       | ** ** | **(.01**                        | **)**      | **(.11** | **)** | **(.04** | **)** |
| **Net income**                                                                                                                                             |   | **$**                            | **.09**    | ** **                      | **$**      | **.13** | ** ** | **$** | **.17** | ** ** | **$** | **.19** | ** ** |
| **Diluted:**                                                                                                                                               |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                      |   | **$**                            | **.09**    | ** **                      | **$**      | **.14** | ** ** | **$** | **.27** | ** ** | **$** | **.23** | ** ** |
| **Loss from discontinued operations**                                                                                                                      |   | **—**                       | ** ** | **(.01**                        | **)**      | **(.10** | **)** | **(.04** | **)** |
| **Net income**                                                                                                                                             |   | **$**                            | **.09**    | ** **                      | **$**      | **.13** | ** ** | **$** | **.17** | ** ** | **$** | **.19** | ** ** |
|                                                                                                                                                       |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Basic weighted average shares outstanding**                                                                                                              |   | **22,150**                       | ** ** | **20,378**                      | ** ** | **21,759** | ** ** | **19,807** | ** ** |
| **Diluted weighted average shares outstanding**                                                                                                            |   | **23,016**                       | ** ** | **20,873**                      | ** ** | **22,601** | ** ** | **20,057** | ** ** |

 

***The accompanyingnotes are an integral part of the unaudited condensed consolidated financialstatements****.*

 

4

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**CANDELACORPORATION**

**CondensedConsolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
|                                                                                              |   | **For the  nine months ended:** |       |
|---------------------------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                                              |   | **March 27,  2004**        |       | **March 29,  2003** |   |
|                                                                                              |   |                            |       | **(Restated)** |   |
| **Cash flows from operating activities:**                                                         |   |                            | ** ** |   | ** ** |
| **Net income**                                                                                    |   | **$**                           | **3,798**  | ** ** | **$** | **3,824** | ** ** |
| **Adjustments to reconcile net income to net cash provided by  (used for) operating activities:** |   |                            | ** ** |   | ** ** |
| **Provision for disposal of discontinued operations**                                             |   | **2,095**                       | ** ** | **—** | ** ** |
| **Depreciation and amortization**                                                                 |   | **471**                         | ** ** | **647** | ** ** |
| **Provision for bad debts**                                                                       |   | **754**                         | ** ** | **(259** | **)** |
| **Effect of exchange rate changes on foreign currency  denominated assets and liabilities**       |   | **15**                          | ** ** | **18** | ** ** |
| **Accretion of debt discount**                                                                    |   | **—**                      | ** ** | **475** | ** ** |
| **Increase (decrease) in cash from working capital:**                                             |   |                            | ** ** |   | ** ** |
| **Accounts receivable**                                                                           |   | **(5,549**                      | **)**      | **(1,324** | **)** |
| **Notes receivable**                                                                              |   | **596**                         | ** ** | **467** | ** ** |
| **Inventories**                                                                                   |   | **(4,430**                      | **)**      | **714** | ** ** |
| **Other current assets**                                                                          |   | **(827**                        | **)**      | **(1,309** | **)** |
| **Other assets**                                                                                  |   | **(278**                        | **)**      | **125** | ** ** |
| **Accounts payable**                                                                              |   | **(503**                        | **)**      | **(2,335** | **)** |
| **Accrued payroll and related expenses**                                                          |   | **(960**                        | **)**      | **(4** | **)** |
| **Deferred revenue**                                                                              |   | **408**                         | ** ** | **(240** | **)** |
| **Accrued warranty costs**                                                                        |   | **1,226**                       | ** ** | **132** | ** ** |
| **Income taxes payable**                                                                          |   | **(665**                        | **)**      | **1,837** | ** ** |
| **Long term portion of deferred revenue**                                                         |   | **(693**                        | **)**      | **81** | ** ** |
| **Loss from discontinued operations**                                                             |   | **298**                         | ** ** | **778** | ** ** |
| **Other accrued liabilities**                                                                     |   | **1,111**                       | ** ** | **491** | ** ** |
| **Net cash (used for) provided by operating activities**                                          |   | **(3,133**                      | **)**      | **4,118** | ** ** |
|                                                                                              |   |                            | ** ** |   | ** ** |
| **Cash flows from investing activities:**                                                         |   |                            | ** ** |   | ** ** |
| **Purchases of property and equipment**                                                           |   | **(193**                        | **)**      | **(967** | **)** |
| **Net cash used for investing activities**                                                        |   | **(193**                        | **)**      | **(967** | **)** |
|                                                                                              |   |                            | ** ** |   | ** ** |
| **Cash flows from financing activities:**                                                         |   |                            | ** ** |   | ** ** |
| **Principal payments of long-term debt**                                                          |   | **—**                      | ** ** | **(3,330** | **)** |
| **Proceeds from the issuance of common stock**                                                    |   | **3,277**                       | ** ** | **1,902** | ** ** |
| **Net cash provided by (used for) financing activities**                                          |   | **3,277**                       | ** ** | **(1,428** | **)** |
|                                                                                              |   |                            | ** ** |   | ** ** |
| **Effect of exchange rates on cash and cash equivalents**                                         |   | **314**                         | ** ** | **(89** | **)** |
|                                                                                              |   |                            | ** ** |   | ** ** |
| **Net increase in cash and cash equivalents**                                                     |   | **265**                         | ** ** | **1,634** | ** ** |
| **Cash and cash equivalents at beginning of period**                                              |   | **$**                           | **31,870** | ** ** | **$** | **19,657** | ** ** |
| **Cash and cash equivalents at end of period**                                                    |   | **$**                           | **32,135** | ** ** | **$** | **21,291** | ** ** |

 

***The accompanyingnotes are an integral part of the unaudited condensed consolidated financialstatements****.*

 

5

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**1.****                                      Basisof Presentation**

 

The accompanyingunaudited condensed consolidated financial statements and notes do not includeall of the disclosures made in the Annual Report on Form 10-K of CandelaCorporation (the “Company”, or “Candela”) for fiscal year 2003, which should beread in conjunction with these financial statements.  The financial information included herein is unaudited, with theexception of the condensed consolidated balance sheet as of June 28, 2003,which was derived from the audited consolidated balance sheet datedJune 28, 2003.  However, in theopinion of management, the financial statements include all necessaryadjustments, consisting of normal recurring accruals, for a fair presentationof the quarterly results and are prepared and presented in a mannerconsistent with the Company’s Annual Report on Form 10-K. The results for thethree and nine month periods ended March 27, 2004 are not necessarilyindicative of the results to be expected for the full year.

 

**2.****                                      DiscontinuedOperations**

 

On September 27, 2003 management initiated aplan to close its only remaining skin care center. The closure is accounted foras a discontinued operation in accordance with Statement of FinancialAccounting Standards (“SFAS”) 144 “*Accounting for the Impairment or Disposal ofLong-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or DisposalActivities*”. As a result, in the fiscal quarter endedSeptember 27, 2003, the Company recorded a $2,095 charge for the accrualof $3,000 of future occupancy costs, primarily relating to future leasepayments for the Boston facility, and $348 of severance obligations and otherrelated costs of closure, net of anticipated tax benefits of $1,253.Approximately 45 positions have been eliminated as a result of thisrestructuring plan, and 44 employees have been terminated as of March 27,2004.In addition, all prior period financial statements have been restated toreflect skin care centers operations as discontinued.

 

Prior to fiscal 2002, theCompany recorded combined restructuring charges of $3,721 resulting frommanagement’s decision to close the skin care center located in Scottsdale,Arizona. During the three month-period ended December 29, 2001, theCompany secured a sublease for the Scottsdale facility.  The sublessee commenced making payments tothe landlord on behalf of the Company on April 1, 2002.  As a result of the sublease, the Companyrevised the estimate of future costs associated with the Scottsdale facilityand, in the quarter ended March 30, 2002, reversed $693 of the restructuringreserve which represents primarily the amount of future contractual subleasepayments as well as revisions to the net realizable value of certain leaseholdimprovements.

 

The following tablereflects the combined restructuring charges incurred in the nine month periodended March 27, 2004:

 
| **(in thousands)**                                                  |   | **Payroll  and  Severance** |       | **Leasehold  Improvements  and Fixed  Assets** |       | **Facility  Costs** |       | **Total** |       |
|---------------------------------------------------------------------|--------|-----------------------------|------------|------------------------------------------------|------------|---------------------|------------|-----------|------------|
| **Balance at June 28, 2003**                                   |   | **$**                       | **50**     | ** **                                     | **$**      | **304**             | ** ** | **$**     | **25**     | ** ** | **$** | **379** | ** ** |
| **Reduction of reserve due to cash payments**                       |   | **(171**                    | **)**      | **(126**                                       | **)**      | **(216**            | **)**      | **(513**  | **)**      |
| **Non-cash amortization**                                           |   | **(18**                     | **)**      | **(79**                                        | **)**      | **11**              | ** ** | **(86**   | **)**      |
| **Additions to reserve due to the closure of the Boston  facility** |   | **139**                     | ** ** | **124**                                        | ** ** | **3,085**           | ** ** | **3,348** | ** ** |
| **Balance at March 27, 2004**                                  |   | **$**                       | **0**      | ** **                                     | **$**      | **223**             | ** ** | **$**     | **2,905**  | ** ** | **$** | **3,128** | ** ** |

 

6

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At March 27, 2004, the discontinuedsegment had a net liability of approximately $3.9 million consisting primarilyof the aforementioned reserve of $3.1 million and deferred gift certificaterevenue of $.8 million partially offset by fixed assets of approximately $.3 million.  Revenues for discontinued operations were $0and $548 for the quarters ended March 27, 2004 and March 29,2003,respectively, and $413 and $1,644 for the nine month periods ended March 27,2004 and March 29,2003, respectively.

 

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

 

In December 2002, the Financial AccountingStandards Board (“FASB”) issued Statement No. 148, “Accounting forStock-Based Compensation, Transition and Disclosure” (“FAS 148”). FAS 148provides alternative methods of transition for a voluntary change to therecognition of the cost of the options in the statement of operations. FAS 148also requires that disclosures of the pro forma effect of using the fair valuemethod of accounting for stock-based employee compensation be displayed moreprominently and in a tabular format. Additionally, FAS 148 requires disclosureof the pro forma effect in interim financial statements. The transition andannual disclosure requirements of FAS 148 were effective for fiscal years endedafter December 15, 2002. The interim disclosure requirements of FAS 148are effective for interim periods beginning after December 15, 2002. Theadoption of the provisions of FAS 148 did not have an impact on the Company’sconsolidated financial statements; however, the Company has modified itsdisclosures as provided for in the new standard.

 

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

 

In accordance with APB 25 and relatedinterpretations, compensation expense for stock options is recognized in incomebased on the excess, if any, of the quoted market price of the stock at thegrant date of the award or other measurement date over the amount an employeemust pay to acquire the stock. Generally, the exercise price for stock optionsgranted to employees equals or exceeds the fair market value of Candela commonstock at the date of grant, thereby resulting in no recognition of compensationexpense by Candela. For awards that generate compensation expense as definedunder APB 25, the Company calculates the amount of compensation expense andrecognizes the expense over the vesting period of the award.

 

7

----

 

Had compensation cost for Candela’s stock optionplans been determined based on the fair value method set forth in FAS 123,Candela’s net income and basic and diluted net income per commonshare would have been changed to the pro forma amounts indicated below:

 
|                                                                                                                                               |   | **For the  three months ended:** |       | **For the  nine months ended:** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|---------------------------------|------------|
| **(in thousands, except per share  data)**                                                                                                         |   | **March 27,  2004**         |       | **March 29,  2003**        |       | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                                                                                               |   |                             |       |                            |       |   |   |   |   |
| **Net income , as reported**                                                                                                                       |   | **$**                            | **1,960**  | ** **                      | **$**      | **2,620** | ** ** | **$** | **3,798** | ** ** | **$** | **3,824** | ** ** |
|                                                                                                                                               |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Add:  stock-based employee compensation expense included in reported net income,  net of related tax effects**                                   |   | **—**                       | ** ** | **—**                      | ** ** | **—** | ** ** | **—** | ** ** |
|                                                                                                                                               |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Deduct:  total stock-based employee compensation expense, determined under fair value  based method for all awards, net of related tax effects** |   | **(969**                         | **)**      | **(79**                         | **)**      | **(731** | **)** | **(36** | **)** |
|                                                                                                                                               |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Pro forma net income**                                                                                                                           |   | **$**                            | **991**    | ** **                      | **$**      | **2,541** | ** ** | **$** | **3,067** | ** ** | **$** | **3,788** | ** ** |
| **Net income per share of common stock**                                                                                                           |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Basic - as reported**                                                                                                                            |   | **$**                            | **.09**    | ** **                      | **$**      | **.13** | ** ** | **$** | **.17** | ** ** | **$** | **.19** | ** ** |
| **Basic - pro forma**                                                                                                                              |   | **$**                            | **.04**    | ** **                      | **$**      | **.12** | ** ** | **$** | **.14** | ** ** | **$** | **.19** | ** ** |
| **Diluted - as reported**                                                                                                                          |   | **$**                            | **.09**    | ** **                      | **$**      | **.13** | ** ** | **$** | **.17** | ** ** | **$** | **.19** | ** ** |
| **Diluted - pro forma**                                                                                                                            |   | **$**                            | **.04**    | ** **                      | **$**      | **.12** | ** ** | **$** | **.14** | ** ** | **$** | **.19** | ** ** |

 

In computing this pro-forma amount, the Company hasused the Black-Scholes pricing model using the following assumptions foroptions granted in fiscal years 2004 and 2003:

 
|                                            |   | **2004**   |       | **2003**   |       |
|-------------------------------------------------|--------|------------|------------|------------|------------|
| **Risk-free interest rate**                     |   | **4.25**   | **%**      | **4.25**   | **%**      |
| **Estimated volatility**                        |   | **81**     | **%**      | **76**     | **%**      |
| **Expected life for stock options (yrs)**       |   | **2.99**   | ** ** | **3.65**   | ** ** |
| **Expected life for stock purchase plan (yrs)** |   | **0.5**    | ** ** | **0.5**    | ** ** |
| **Expected dividends**                          |   | **—** | ** ** | **—** | ** ** |

 

**4.****                                      EarningsPer Share**

 

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

 

8

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Common stock equivalentsinclude shares issuable upon the exercise of stock options or warrants, net ofshares assumed to have been purchased with the proceeds, using the treasurystock method.

 
|                                                                              |   | **For the  three months ended:** |       | **For the  nine months ended:** |       |
|-----------------------------------------------------------------------------------|--------|----------------------------------|------------|---------------------------------|------------|
| **(in thousands, except per share  data)**                                        |   | **March 27,  2004**         |       | **March 29,  2003**        |       | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                              |   |                             |       |                            |       |   |   |   |   |
| **Basic shares used in the calculation of earnings per share**                    |   | **22,150**                       | ** ** | **20,378**                      | ** ** | **21,759** | ** ** | **19,807** | ** ** |
|                                                                              |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Effect of dilutive securities:**                                                |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Stock options**                                                                 |   | **866**                          | ** ** | **454**                         | ** ** | **842** | ** ** | **209** | ** ** |
| **Stock warrants**                                                                |   | **—**                       | ** ** | **41**                          | ** ** | **—** | ** ** | **41** | ** ** |
|                                                                              |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Diluted shares used in the calculation of earnings per share**                  |   | **23,016**                       | ** ** | **20,873**                      | ** ** | **22,601** | ** ** | **20,057** | ** ** |
|                                                                              |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Per share effect of dilutive securities on income from  continuing operations** |   | **—**                       | ** ** | **—**                      | ** ** | **$** | **.01** | ** ** | **—** | ** ** |
|                                                                              |   |                             | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| **Per share effect of dilutive securities on net income**                         |   | **—**                       | ** ** | **—**                      | ** ** | **—** | ** ** | **—** | ** ** |
|                                                                                   |        |                                  |            |                                 |            |  |  |  |  |  |

 

During the three and ninemonth periods ended March 27, 2004, options to purchase 217,625 and125,518 shares of common stock, respectively, were excluded from thecalculation of diluted earnings per share because the exercise price of suchoptions was greater than the average market price of the common stock for theperiod.  During the three and nine monthperiods ended March 29, 2003, options to purchase 87,280 and 228,095shares of common stock, respectively, were excluded from the calculation ofdiluted earnings per share because the exercise price of such options wasgreater than the average market price of the common stock for the period.

 

**5.****                                     ****ComprehensiveIncome**

 

Components of comprehensive income include netincome and certain transactions that have generally been reported in the consolidated statement ofstockholders’ equity.

 
|                                        |   | **For the  three months ended:** |      | **For the  nine months ended:** |       |
|---------------------------------------------|--------|----------------------------------|-----------|---------------------------------|------------|
| **(in thousands)**                          |   | **March 27,  2004**         |      | **March 29,  2003**        |       | **March 27,  2004** |   | **March 29,  2003** |   |
| **Net income**                              |   | **$**                            | **1,960** | ** **                      | **$**      | **2,620** | ** ** | **$** | **3,798** | ** ** | **$** | **3,824** | ** ** |
| **Foreign currency translation adjustment** |   | **(58**                          | **)**     | **78**                          | ** ** | **637** | ** ** | **258** | ** ** |
| **Total comprehensive income**              |   | **$**                            | **1,902** | ** **                      | **$**      | **2,698** | ** ** | **$** | **4,435** | ** ** | **$** | **4,082** | ** ** |

 

9

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**6.****                                      Inventories**

 
| **(in thousands)**  |   | **March 27,  2004** |       | **June 28,  2003** |       |
|---------------------|--------|--------------------------|------------|-------------------------|------------|
|                |   |                     |       | **(restated)**          |       |
|                |   |                     |       |                    |       |
| **Raw materials**   |   | **$**                    | **6,080**  | ** **              | **$**      | **4,123** | ** ** |
| **Work in process** |   | **691**                  | ** ** | **469**                 | ** ** |
| **Finished goods**  |   | **8,581**                | ** ** | **6,242**               | ** ** |
|                |   | **$**                    | **15,352** |                    | **$**      | **10,834** | ** ** |

 

**7.****                                      SegmentInformation**

 

The Company operatesprincipally in one industry segment: the design, manufacture, sale, and serviceof medical devices and related equipment. The results in this segment have beenpresented in the Condensed Consolidated Statements of Operations for theappropriate periods.

 

**8.****                                      Guarantees**

 

The Company’s productsgenerally carry a standard one-year warranty, except for Vbeam products whichtypically carry a three-year warranty. The Company records a reserve based onanticipated warranty claims at the time product revenue is recognized. Inanticipation of actual warranty claims, the Company amortizes the reserveratably over the life of the warranty, thereby offsetting actual warrantyclaims incurred. Actual warranty claims incurred and charged to product costsof sales during an interim period may be more or less than the amount of amortizedwarranty reserve allocated against them. Factors that affect the Company’sproduct warranty liability include the number of installed units, theanticipated cost of warranty repairs, and historical and anticipated rates ofwarranty claims.

 

The following tablereflects changes in the Company’s accrued warranty account during thenine-month period ended March 27, 2004:

 

 
| **(in thousands)**                             |   |      |       |
|------------------------------------------------|--------|-----------|------------|
| **Beginning balance June 28, 2003**       |   | **$**     | **6,666**  | ** ** |
| **Plus accruals related to new sales**         |   | **4,992** | ** ** |
| **Less amortization of prior period accruals** |   | **4,021** | ** ** |
| **Ending balance on March 27, 2004**      |   | **$**     | **7,637**  | ** ** |

 

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

 

10

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The following tablereflects changes in the Company’s deferred revenue account during thenine-month period ended March 27, 2004:

 
| **(in thousands)**                              |   |      |       |
|-------------------------------------------------|--------|-----------|------------|
| **Beginning balance June 28, 2003**        |   | **$**     | **3,086**  | ** ** |
| **Plus deferral of new service contract sales** |   | **3,358** | ** ** |
| **Less recognition of deferred revenue**        |   | **3,165** | ** ** |
| **Ending balance on March 27, 2004**       |   | **$**     | **3,279**  | ** ** |

 

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

 

**9.****                                      AssetAcquisition**

 

On January 8, 2003,the Company acquired substantially all of the assets of Applied Optronics, thediode division of Schwartz Electro-Optics, Inc., for approximately $1,200 incash. Applied Optronics was a leading manufacturer of high-powered, pulsedlasers, and was a component supplier to the OEM market that serves a variety ofindustries including the military, medical, industrial, research and roboticsfields. Applied Optronics was the lead supplier of the diodes for the Company’sSmoothbeamTM diode laser system. In accordance with SFAS No. 141 “*BusinessCombinations*,” the Company records acquisitions under the purchasemethod of accounting. Accordingly, the purchase price is allocated to thetangible assets and liabilities and intangible assets acquired, based on theirestimated fair values.

 

The asset acquisitionconsisted primarily of fixed assets, including production and office equipment,and inventory located at the division’s facility in New Jersey. The acquisitionincreased the Company’s net property and equipment by approximately $800 andinventory by approximately $400. For the nine months ended March 27, 2004**,**theApplied Optronics operation generated approximately $280 in revenue from diodesales to third-party customers.

 

**10.****                               Stock split**

 

On January 28, 2004, the Company announcedthat its Board of Directors approved a two-for-one stock split of the Company’scommon stock effected in the form of a stock dividend paid on March 16, 2004.As a result of this action 13.3 million shares were issued to shareholders ofrecord as of February 16, 2004. Par value of the stock remains at $.01 pershare and accordingly, $133 thousand was transferred from additional paid-incapital to common stock. All references to the number of common shares and percommon share amounts have been restated to give retroactive effect to the stocksplit for all periods presented.

 

**11.****                               Commitments andContingencies**

 

The Company has anAmended and Restated License Agreement (the “License”) with The Regents of theUniversity of California (“The Regents”) pursuant to which the Company licensescertain patent rights to its dynamic cooling device (“DCD”). The Company sellsits DCD as a component part of its Smoothbeam (®) laser system and as anaccessory to its other laser systems. In April of 2004, The Regents issued anotice of default under the License, asserting, among other things, that theCompany is in breach of the License for the alleged failure to make required royaltypayments and make required disclosures. The notice asserted that the totalunderpaid royalties, interest and other charges for the period from August of2000 through September 2003 is $1,128,000, and that unless paid, The Regentsmay terminate the License. The Company believes it has made all payments thatit was required to make and is in the process of reviewing the underlyinginformation in support of the alleged deficiencies recently furnished by TheRegents to the Company. No legal action has been commenced by either TheRegents or the Company at this time, and Candela is hopeful that the partiescan resolve the issues raised by The Regents without formal legal proceedings.However, should The Regents attempt to terminate the License, the matter wouldlikely result in a formal legal proceeding to determine the respective rightsof the parties.

 

From time to time, we area party to various legal proceedings incidental to our business. Except for thepotential legal proceedings with The Regents, we believe that none of the legalproceedings which are presently pending, if adversely decided to the Company,will have a material adverse effect upon our financial position, results ofoperations, or liquidity.

 

 

11

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**CANDELA CORPORATION**

 

**Item2 -****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 principally to medical practitioners.  We market our products directly and througha network of distributors to end-users. Our traditional customer base includesplastic and cosmetic surgeons and dermatologists. More recently we haveexpanded our sales to a broader group of practitioners consisting of generalpractitioners and certain specialists including obstetricians, gynecologistsand general and vascular surgeons.   Wederive our revenue from the sales of lasers and other products, and theprovision of product-related services.

 

**Critical Accounting Policies**

 

This discussion and analysis of our financial condition and results ofoperations is based upon our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. We evaluate our estimates and judgments on an on-going basis,including those related to revenue recognition, bad debts, inventories,warranty obligations, contingencies, restructurings and income taxes. We baseour estimates 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 our condensedconsolidated financial statements is included in our Annual Report on Form 10-Kfor fiscal year 2003.

 

12

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**Results of Operations**

 

***Revenue.***

 

Revenue source bygeographic region is reflected in the following table:

 
|                |   | **For the  three months ended:** |       |
|---------------------|--------|----------------------------------|------------|
| **(in thousands)**  |   | **March 27,  2004**         |       | **March 29,  2003** |   | **Change** |   |
|                |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| **US revenue**      |   | **$**                            | **12,975** | ** ** | **47** | **%** | **$** | **10,468** | ** ** | **49** | **%** | **$** | **2,507** | ** ** | **24** | **%** |
| **Foreign revenue** |   | **14,675**                       | ** ** | **53** | **%** | **10,972** | ** ** | **51** | **%** | **3,703** | ** ** | **34** | **%** |
|                |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**   |   | **$**                            | **27,650** | ** ** | **100** | **%** | **$** | **21,440** | ** ** | **100** | **%** | **$** | **6,210** | ** ** | **29** | **%** |
|                |   |                             |       |   |   |   |   |   |   |   |   |   |   |
|                |   | **For the  nine months ended:**  | ** ** |
|                |   | **March 27,  2004**         | ** ** | **March 29,  2003** | ** ** | **Change** | ** ** |
|                |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| **US revenue**      |   | **$**                            | **32,069** | ** ** | **46** | **%** | **$** | **23,890** | ** ** | **45** | **%** | **$** | **8,179** | ** ** | **34** | **%** |
| **Foreign revenue** |   | **38,165**                       | ** ** | **54** | **%** | **28,822** | ** ** | **55** | **%** | **9,343** | ** ** | **32** | **%** |
|                |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**   |   | **$**                            | **70,234** | ** ** | **100** | **%** | **$** | **52,712** | ** ** | **100** | **%** | **$** | **17,522** | ** ** | **33** | **%** |

 

ConsolidatedOverview

 

Consolidatedrevenue increased 29%, to $27.7 million for the three months ended March 27,2004, from $21.4 million for the three months ended March 29, 2003.  This increase in revenue resulted primarilyfrom an increase in worldwide demand for our products and related services.Specifically, revenues from the introduction of our new GentleYagTM productcontributed approximately $5.9 million to this increase while the remainder wasderived from an incremental increase in comparative revenue from our GentlelaseTM product line.

 

Consolidatedrevenue increased 33% to $70.2 million for the first nine months of fiscal2004, compared to $52.7 million for the nine months ended March 29, 2003.This increase in revenue resulted primarily from an increase in worldwidedemand for our products and related services. Specifically, wider market penetration and acceptance of our GentleLaseTM product linerepresented approximately $10.0 million of the increase and the introduction ofour new GentleYagTM product contributed approximately $5.9 million to this increase.

 

USrevenue increased 24% to $13.0 million and 34% to $32.1 million, respectively,for the three and nine month periods ended March 27, 2004, as compared tothe three and nine month periods ended March 29, 2003.  Foreign revenue increased 34%, and 32% to$14.7 million and $38.2 million, respectively, for the three and nine month periodsended March 27, 2004, as compared to the three and nine month periodsended March 29, 2003.

 

13

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Revenue source by type isreflected in the following table:

 
|                          |   | **For the  three months ended:** |       |
|-------------------------------|--------|----------------------------------|------------|
| **(in thousands)**            |   | **March 27,  2004**         |       | **March 29,  2003** | **Change** |   |
| **Revenue**                   |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products** |   | **$**                            | **23,509** | ** ** | **85** | **%** | **$** | **18,045** | ** ** | **84** | **%** | **$** | **5,464** | ** ** | **30** | **%** |
| **Product-related service**   |   | **4,141**                        | ** ** | **15** | **%** | **3,395** | ** ** | **16** | **%** | **746** | ** ** | **22** | **%** |
|                          |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**             |   | **$**                            | **27,650** | ** ** | **100** | **%** | **$** | **21,440** | ** ** | **100** | **%** | **$** | **6,210** | ** ** | **29** | **%** |
|                          |   |                             |       |   |   |   |   |   |   |   |   |   |   |
|                          |   | **For the  nine months ended:**  | ** ** |
|                          |   | **March 27,  2004**         | ** ** | **March 29,  2003** | ** ** | **Change** | ** ** |
| **Revenue**                   |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products** |   | **$**                            | **58,769** | ** ** | **84** | **%** | **$** | **43,444** | ** ** | **82** | **%** | **$** | **15,325** | ** ** | **35** | **%** |
| **Product-related service**   |   | **11,465**                       | ** ** | **16** | **%** | **9,268** | ** ** | **18** | **%** | **2,197** | ** ** | **24** | **%** |
|                          |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**             |   | **$**                            | **70,234** | ** ** | **100** | **%** | **$** | **52,712** | ** ** | **100** | **%** | **$** | **17,522** | ** ** | **33** | **%** |

 

The increase in revenuefrom lasers and other products for the three months ended March 27, 2004,compared to the three month period ended March 29, 2003, resulted from anincrease in the sales volume of our new GentleYagTM product. The new GentleYagTMcontributed approximately $5.9 million in revenue. The increase in revenue fromproduct-related service for the three months ended March 27, 2004 comparedto the three months ended March 29, 2003 resulted from an increase in thenumber of service related contracts sold.

 

The increase in revenuefrom lasers and other products for the nine months ended March 27, 2004,compared to the nine month period ended March 29, 2003, resulted from theintroduction of our new GentleYagTM product and an increase in the sales volumeof our GentleLaseTM product line. Wider market acceptance of the GentleLaseTMproduct line helped to contribute approximately $10.0 million to this increase,while the introduction of our new GentleYagTM product contributed approximately$5.9 million to this increase in revenue. The increase in revenue fromproduct-related service for the nine months ended March 27, 2004 comparedto the nine months ended March 29, 2003 resulted from an increase in thenumber of service related contracts sold.

 

***Cost of Sales.***Cost of sales increased 31% to $13.7 million for thethree months ended March 27, 2004 as compared to cost of sales of $10.4million for the three months ended March 29, 2003.** As a percentage of revenue the increase was less than 1% on acomparative basis, quarter over quarter. Cost of sales increased 33% to $34.7for the nine months ended March 27, 2004 as compared to cost of sales of$26.1 million for the nine months ended March 29, 2003.** As a percentage of revenue, cost of salesdecreased slightly on a comparative basis, year over year. This decrease incost of sales resulted primarily from benefits of scale achieved during agrowing sales cycle.

 

***Gross Profit. ***Grossprofit for the three month period ended March 27, 2004 increased to $14.0million, or 50.6%, which is approximately $3.0 million or 27% higher than grossprofit of approximately $11.0 million, or 51.3%, for the same period one yearearlier.  The decrease of 0.7% resultedprimarily from one-time costs associated with the introduction of a new productline. Gross profit for the nine month period ended March 27, 2004increased to $35.5 million, or 50.6% which is approximately $8.9 million or 34%higher than gross profit of approximately $26.6 million, or 50.5%, for the sameperiod one year earlier.  The increasein gross profit resulted principally from the increase in sales volume.

 

14

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***Selling, General and Administrative Expense. ***Selling, general andadministrative expenses increased 53%, to approximately $9.6 million for thethree-month period ended March 27, 2004 from approximately $6.3 millionfor the three-month period ended March 29, 2003. As a percentage ofrevenue, selling, general and administrative expenses increased to 34.6% from29.2% of revenues for the same respective period. This increase was primarilydue to commissions and employee related expenses of approximately $1.5 million,and legal and professional fees expense of approximately $0.6 million. Selling,general and administrative expenses increased to approximately $22.8 millionfor the nine-month period ended March 27, 2004 from approximately $16.9million for the nine-month period ended March 29, 2003. As a percentage ofrevenue, for the nine-month period ended March 27, 2004, selling, generaland administrative expenses increased to 32.5% from 32.0% as compared to thesame period one year earlier. The increase in selling, general andadministrative expenses as a percentage of revenues is due primarily to theaforementioned increase in commission and employee related expenses.

 

***Research and Development Expense.    ***Researchand development spending increased to $1.5 million for the three-month periodended March 27, 2004 from $1.2 million for the three-month period endedMarch 29, 2003 due primarily to an increase in the number of activeprojects. Spending in this area increased to $4.0 million for the nine-monthperiod ended March 27, 2004 from $3.2 million for the nine-month periodended March 29, 2003 due primarily to the aforementioned increase inproject spending.

 

***Other Income/Expense. ***Net other income was approximately $0.1 millionfor the three months ended March 27, 2004 compared to net other income ofapproximately $0.6 million for the three months ended March 29, 2003. Forthe nine-month period ended March 27, 2004, net other income wasapproximately $0.6 million compared to net other income of approximately $0.3million for the nine-month period ended March 29, 2003. The decrease innet interest income for the three-month and nine-month period endedMarch 27, 2004 results primarily from a one-time benefit of $0.6 millionin the prior year, related to a favorable arbitration decision partially offset by a current-year increase in interestincome due to higher cash balances.

 

***Income Taxes.*** The provision for incometaxes results from a combination of activities of both the domestic and foreignsubsidiaries of the Company.  Werecorded a 34% effective tax rate for the three-month period endedMarch 27, 2004, which brought our nine-month effective tax rate toapproximately 32%. This compares to the three and nine-month periods endedMarch 29, 2003, in which we recorded a 33% effective tax rate.  The provision for income taxes for the threemonths ended March 27, 2004 differs from the U.S. statutory rate as aresult of tax provisions calculated for income generated by foreignsubsidiaries at a rate that differs from the U.S. statutory rate.

 

**Discontinued Operations**

 

On September 27,2003, we permanently closed our only remaining skin care center, which waslocated in Boston. The closure of the Boston skin care center, together withthe earlier closing of our Scottsdale, Arizona spa, and the associatedcessation of this line of business, is accounted for as discontinuedoperations. As a result of the closure of the Boston skin care center, in thefiscal quarter ended September 27, 2003, we recorded a $2.1 million chargefor the accrual of $3.0 million of future occupancy costs and $0.3 million ofseverance obligations and other related costs of closure, net of anticipatedtax benefits of $1.3 million. In addition, both the financial statements forthe nine months ended March 27, 2004 and all prior financial statementshave been restated to reflect skin care center operations as discontinued.While the building landlord has given the Company written notice that itbelieves the Company is in default under the lease, the Company has indicatedthat it plans to honor all of its obligations under the lease. The Companybelieves that the size of the accrual that it has established is sufficient tocover all future leasehold expenses for the remainder of the lease term.Leasehold expenses could potentially be mitigated if the landlord elects torelet or sublease the property.

 

15

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**Liquidity and Capital Resources**

 

Cash used in operatingactivities amounted to $3.1 million for the nine months ended March 27,2004, in comparison to cash provided by operating activities of $4.1 millionfor the same period in the prior year. This increase in cash used by operatingactivities primarily reflects cash outlay for inventory during a strong salescycle. Sales during the third month of the quarter were particularly strong,providing little time to replenish cash through collection of receivables. Cashused by investing activities remained relatively flat for the nine months endedMarch 27, 2004, as the Company continued its conservative policy towardscapital outlays for property, plant and equipment.  Cash provided by financing activities amounted to $3.3 millionfor the nine-months ended March 27, 2004 in comparison to cash used of$1.4 million for the same period during the prior year.  The increase reflects the proceeds for theissuance of common stock by the Company, primarily to employees under theexisting stock option plan, and the absence of prior-year payments used toextinguish long-term debt.

 

Our outstandingcontractual obligations as of March 27, 2004, are reflected in thefollowing table:

 
| **(in thousands)**   |   | **Total**  |       | **Maturity****Less than  1 year** |       | **Maturity****1-3 years** |       | **Maturity****4-5 years** |       | **Maturity****in excess  of  5 years** |   |
|----------------------|--------|------------|------------|-----------------------------------|------------|---------------------------|------------|---------------------------|------------|----------------------------------------|--------|
| **Operating leases** |   | **$4,928** | ** ** | **$1,204**                        | ** ** | **$1,094**                | ** ** | **$1,123**                | ** ** | **$1,507**                             |   |

 

We also maintain arenewable $10,000,000 revolving credit agreement with a major bank withinterest at the bank’s base rate, or LIBOR plus 2.25%.  Any borrowings outstanding under the line ofcredit are due on demand or according to a payment schedule established atthe time funds are borrowed.  The lineof credit is unsecured.  The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock.  No amountswere outstanding under the line of credit as of March 27, 2004.

 

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

 

**CautionaryStatements**

 

This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements are not promises or guarantees and aresubject to risks and uncertainties that could cause our actual results todiffer materially from those anticipated. Such statements may relate to, among other things, the future of theindustry, product development, business strategy (including the possibility offuture acquisitions), anticipated operational and capital expenditure levels,continued acceptance and growth of our products, and dependence on significantcustomers and suppliers. Forward-looking statements may also include, without limitation, anystatement relating to future events, conditions or circumstances or using wordssuch as (or similar to):  anticipate;believe; continue; could; estimate; expect; intend; plan; predict; project;may; or will.  The risks anduncertainties that may affect forward-looking statements and/or our businessinclude, among others, those discussed in “Cautionary Statements” in our AnnualReport filed on Form 10-K for the fiscal year ended June 28, 2003, as wellas other risks and uncertainties referenced in this Quarterly Report.  These risks and uncertainties include, butare not limited to, the following:

 

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

 

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

 

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

 

•                  Thecost of closing our remaining skin care center may be higher than managementhas estimated to date, and higher actual costs would negatively impact ouroperating results.

 

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

 

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

 

•                  Wehave modified some of our products without clearance from the Food and DrugAdministration (the “FDA”). The FDA could retroactively decide themodifications were improper and require us to cease marketing and/or recall themodified products.

 

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

 

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

 

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

 

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

 

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

 

We caution readers not toplace undue reliance upon any forward-looking statements, which speak only asof the date made.  We expressly disclaimany obligation or undertaking to release publicly any updates or revisions toany such statements to reflect any change in our expectations or any change inevents, conditions or circumstances on which any such statement is based.

 

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**Item3 - Quantitative and Qualitative Disclosures About Market Risk**

 

Wehave foreign subsidiaries in Japan, Spain, France and Germany.  Approximately 54% of our revenues for thenine months ended March 27, 2004 were from our operations outside theUnited States.  These subsidiariestransact business in both local andforeign currency.  Therefore, weare exposed to foreign currency exchange risks and fluctuations in foreigncurrencies, which could adversely impact our results and financialcondition.  However, sales from theUnited States made directly to customers or distributors in foreign countriesare invoiced in U.S. dollars and are not exposed to foreign currency risk.

 

Fromtime to time, we may enter into foreign currency exchange and option contractsto reduce our exposure to foreign currency risk and variability in operatingresults due to fluctuation in exchange rates underlying the value of currenttransactions and anticipated transactions denominated in foreigncurrencies.  These contracts obligate us to exchange predetermined amounts ofspecified foreign currencies at specified exchange rates on specifieddates.  These contracts are denominatedin the same currency in which the underlying transactions are denominated andbear a contract value and maturity date that approximate the value and expectedsettlement date, respectively, of the underlying transactions. We do notengage in foreign currency speculation.

 

We have cash equivalentsthat primarily consist of commercial paper, overnight repurchase agreements andmoney market accounts.  We believe thatany near term changes in interest rates will be immaterial to any potentiallosses in future earnings, cash flow and fair values.

 

**Item 4 - Controls and Procedures**

 

(a) Evaluation ofdisclosure controls and procedures. An evaluation was performed under thesupervision and with the participation of members of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our “disclosure controls andprocedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e))as of March 27, 2004 (the “Evaluation Date”).  Based on that evaluation, members of our management, includingour Chief Executive Officer and our Chief Financial Officer, have concludedthat, as of the Evaluation Date, our disclosure controls and procedures wereeffective in enabling us to record, process, summarize and report theinformation required to be included in this quarterly report within therequired time period.

 

(b) Changes tointernal controls.  As previouslydisclosed, during fiscal 2003 we began the implementation of a new accountingsoftware system.  In response tocomplications associated with the implementation of this system and thetransition from our prior system, we made certain changes in our internalcontrol over financial reporting.  Thesechanges were primarily made during the fiscal quarter ended September 27,2003.  We continued to monitor thesechanges during the fiscal quarter ended March 27, 2004, and also continuedour ongoing process of routinely reviewing and evaluating our internal controlsover financial reporting.  Based on thatreview and evaluation, management believes that it has implemented additionalcontrols sufficient to prevent the problems we encountered during theimplementation of our new accounting software system from occurring in the future,and that it has taken the necessary steps so that adequate control proceduresare in place and will be followed. There were no other changes in our internal controls over financialreporting during the fiscal quarter ended March 27, 2004 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlsover financial reporting.

 

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**CANDELA CORPORATION**

 

**Part II.  OtherInformation**

 

**Item 1 - Legal Proceedings**

 

The Company has an Amended and Restated LicenseAgreement (the “License”) with The Regents of the University of California(“The Regents”) pursuant to which the Company licenses certain patent rights toits dynamic cooling device (“DCD”).  TheCompany sells its DCD as a component part of its Smoothbeam (®) laser systemand as an accessory to its other laser systems.  In April of 2004, The Regents issued a notice of defaultunder the License, asserting, among other things, that the Company is in breachof the License for the alleged failure to make required royalty payments andmake required disclosures.  The noticeasserted that the total underpaid royalties, interest and other charges for theperiod from August of 2000 through September 2003 is $1,128,000, andthat unless paid, The Regents may terminate the License.  The Company believes it has made allpayments that it was required to make and is in the process of reviewing theunderlying information in support of the alleged deficiencies recentlyfurnished by The Regents to the Company. No legal action has been commenced by either The Regents or the Companyat this time, and Candela is hopeful that the parties can resolve the issuesraised by The Regents without formal legal proceedings.  However, should The Regents attempt toterminate the License, the matter would likely result in a formal legalproceeding to determine the respective rights of the parties.

 

From time to time, we are a party to various legalproceedings incidental to our business. Except for the potential legal proceedings with The Regents, we believethat none of the legal proceedings which are presently pending, if adverselydecided to the Company, will have a material adverse effect upon our financialposition, results of operations, or liquidity.

 

**ITEM 4 - Submission of matters to a vote of security holders**

 

Electionof Directors

 

Our  annual shareholder’s  meeting  was held on January 29, 2004.  Six  directors nominated for  re-election by the Board of Directors  werenamed in proxies for the meeting,  whichproxies were solicited  pursuant to  Regulations 14A of the Securities and Exchange Act of 1934.

 
|             |   | **VOTES FOR** |   | **WITHHELD** |   |
|------------------|--------|---------------|--------|--------------|--------|
| Kenneth  Roberts |   | 8,949,388     |   | 594,821      |   |
| Gerard  Puorro   |   | 5,257,196     |   | 4,287,013    |   |
| George  Abe      |   | 8,846,822     |   | 697,387      |   |
| Ben  Bailey III  |   | 8,943,188     |   | 601,021      |   |
| Nancy  Nager     |   | 8,942,560     |   | 601,649      |   |
| Douglas  Scott   |   | 8,844,355     |   | 699,854      |   |

 

Ratificationof Independent Public Accountants

 

Shareholders  ratified the  appointment  of BDO Seidman  LLP as ourIndependent  Public  Accountants for the fiscal year ending July 3, 2004: for 9,469,063;  against 63,414; abstain 11,732.

 

Adoptan Amendment to the Company’s Amended and Restated 1998 Stock Plan

 

Shareholders  voted to increase the number of shares of Common Stock  that may be issued pursuant to the Amendedand Restated 1998 Stock Plan by 1,000,000 shares to 2,650,000 shares of CommonStock in the aggregate: for 5,241,725; against 1,629,940;  abstain33,531; no-vote 2,639,013.

 

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**Item 5.  OtherInformation**

 

OnJanuary 26, 2004, the Company’s Board of Directors resolved to have itsNominating Committee review all stockholder proposals submitted to the Companyrelating to the nomination of a member of the Board of Directors.  The Nominating Committee will also recommendto the Board of Directors appropriate action with respect to each suchproposal.

 

**ITEM 6 - Exhibits and Reports on Form8-K**

 

(a)                                  Exhibits

 

Exhibit31.1                                    Rule13a-14(a)/15d-14(a) Certification of the Chief Executive Officer

 

Exhibit31.2                                    Rule13a-14(a)/15d-14(a) Certification of the Chief Financial Officer

 

Exhibit32.1                                    Certificationof the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Exhibit32.2                                    Certificationof the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)                                 Reportson Form 8-K

 

On January 28, 2004,Candela Corporation filed a current report on Form 8-K regarding its financialresults for its second fiscal quarter ended December 27, 2003.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   | CANDELA CORPORATION                                                               |
|--------|-----------------------------------------------------------------------------------|
|   |                                                                              |
|   |                                                                              |
| Date:  | May 7, 2004                                                                       |   | /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 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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