**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

----

 

**FORM 10-Q**

 

**Quarterly report pursuant to Section13 or 15(d) of the Securities Exchange Act of 1934**

 

**Forthe quarterly period ended December 27, 2003.**

 

**Commission file number 000-14742**

 

**CANDELA CORPORATION**

(Exact name of registrant as specified in itscharter)

 

| **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** |

 

----

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

Yes ý  No o

 

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

Yes oNo ý

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date.

 
| **Class**                              |   | **Outstanding  at February 5, 2004** |
|----------------------------------------|--------|--------------------------------------|
| Common Stock, $.01 par value per share |   | 11,139,925                           |

** **

 

----

 

**CANDELA CORPORATION**

**Index**

 
|     |                   | **Page**                                                                                                                                                                                                                              |
|----------|------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Part I.  | Financial Information: |                                                                                                                                                                                                                                  |
|     |                   |                                                                                                                                                                                                                                  |
|     | Item 1.                | Financial Statements                                                                                                                                                                                                                  |   |
|     |                   |                                                                                                                                                                                                                                  |   |
|     |                   | Unaudited Condensed Consolidated Balance  Sheets as of December 27, 2003 and June 28, 2003                                                                                                                                            | 3 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     |                   | Unaudited Condensed Consolidated Statements  of Operations for the three-month periods ended December 27, 2003 and  December 28, 2002, and for the six-month  periods ended  December 27, 2003  and  December 28, 2002 | 4 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     |                   | Unaudited Condensed Consolidated Statements  of Cash Flows for the six-month periods ended December 27, 2003 and  December 28, 2002                                                                                              | 5 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     |                   | Notes to Unaudited Condensed Consolidated  Financial Statements                                                                                                                                                                       | 6-12 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Item 2.                | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                                                                                           | 13-18 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Item 3.                | Quantitative and Qualitative Disclosure  about Market Risk                                                                                                                                                                            | 19 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Item 4.                | Controls and Procedures                                                                                                                                                                                                               | 19 |
|     |                   |                                                                                                                                                                                                                                  |   |
| Part II. | Other Information:     |                                                                                                                                                                                                                                  |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Item  1.               | Legal  proceedings                                                                                                                                                                                                                    | 20 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Item 6.                | Exhibits and Reports on Form 8-K                                                                                                                                                                                                      | 20 |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Signatures             |                                                                                                                                                                                                                                  |   |
|     |                   |                                                                                                                                                                                                                                  |   |
|     | Index  to Exhibits     |                                                                                                                                                                                                                                  |

 

2

----

 

**Part I****.  Financial Information**

 

**Item1****- Financial Statements**

 

**CANDELACORPORATION**

**CondensedConsolidated Balance Sheets**

(in thousands)

(unaudited)

 
|                                                 |   | **December  27,  2003** |       | **June 28,  2003** |       |
|------------------------------------------------------|--------|-------------------------|------------|--------------------|------------|
|                                                 |   |                    |       | **(Restated)**     |       |
| **Assets**                                           |   |                    |       |               |       |
| **Current assets:**                                  |   |                    |       |               |       |
| **Cash and cash equivalents**                        |   | **$**                   | **32,397** | ** **         | **$**      | **31,870** | ** ** |
| **Accounts receivable, net**                         |   | **29,299**              | ** ** | **26,572**         | ** ** |
| **Notes receivable**                                 |   | **876**                 | ** ** | **1,086**          | ** ** |
| **Inventories, net**                                 |   | **14,012**              | ** ** | **10,834**         | ** ** |
| **Other current assets**                             |   | **1,329**               | ** ** | **658**            | ** ** |
| **Total current assets**                             |   | **77,913**              | ** ** | **71,020**         | ** ** |
| **Property and equipment, net**                      |   | **3,082**               | ** ** | **3,327**          | ** ** |
| **Deferred tax assets**                              |   | **5,304**               | ** ** | **4,760**          | ** ** |
| **Prepaid licenses**                                 |   | **1,142**               | ** ** | **1,228**          | ** ** |
| **Other assets**                                     |   | **204**                 | ** ** | **166**            | ** ** |
| **Total assets**                                     |   | **$**                   | **87,645** | ** **         | **$**      | **80,501** | ** ** |
|                                                 |   |                    |       |               |       |
| **Liabilities and Stockholders’ Equity**        |   |                    |       |               |       |
| **Current liabilities:**                             |   |                    |       |               |       |
| **Accounts payable**                                 |   | **$**                   | **6,162**  | ** **         | **$**      | **5,271** | ** ** |
| **Accrued payroll and related expenses**             |   | **3,129**               | ** ** | **4,656**          | ** ** |
| **Accrued warranty costs**                           |   | **4,486**               | ** ** | **3,628**          | ** ** |
| **Income taxes payable**                             |   | **2,106**               | ** ** | **3,528**          | ** ** |
| **Other accrued liabilities**                        |   | **3,897**               | ** ** | **2,755**          | ** ** |
| **Deferred income**                                  |   | **2,939**               | ** ** | **2,779**          | ** ** |
| **Current liabilities of discontinued operations**   |   | **1,394**               | ** ** | **1,095**          | ** ** |
| **Total current liabilities**                        |   | **24,113**              | ** ** | **23,712**         | ** ** |
| **Other long-term liabilities**                      |   | **2,650**               | ** ** | **3,393**          | ** ** |
| **Long-term liabilities of discontinued operations** |   | **2,565**               | ** ** | **48**             | ** ** |
| **Total liabilities**                                |   | **29,328**              | ** ** | **27,153**         | ** ** |
|                                                 |   |                    | ** ** |               | ** ** |
| **Stockholders’ equity:**                       |   |                    |       |               |       |
| **Common stock**                                     |   | **133**                 | ** ** | **129**            | ** ** |
| **Additional paid-in capital**                       |   | **50,909**              | ** ** | **48,479**         | ** ** |
| **Accumulated earnings**                             |   | **19,741**              | ** ** | **17,904**         | ** ** |
| **Treasury stock, at cost**                          |   | **(12,997**             | **)**      | **(12,997**        | **)**      |
| **Accumulated other comprehensive income (loss)**    |   | **531**                 | ** ** | **(167**           | **)**      |
| **Total stockholders’ equity**                  |   | **58,317**              | ** ** | **53,348**         | ** ** |
| **Total liabilities and stockholders’ equity**  |   | **$**                   | **87,645** | ** **         | **$**      | **80,501** | ** ** |

 

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

 

3

----

 

**CANDELACORPORATION**

**CondensedConsolidated Statements of Operations**

(in thousands, except per share data)

(unaudited)

 
|                                                                                                                                                      |   | **For the  three months ended:** |       | **For the  six months ended:** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
|                                                                                                                                                      |   | **December  27,  2003**          |       | **December  28,  2002**        |       | **December  27,  2003** |   | **December  28,  2002** |   |
|                                                                                                                                                      |   |                             |       | **(Restated)**                 |       |   |   | **(Restated)** |   |
| **Revenue**                                                                                                                                               |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products**                                                                                                                             |   | **$**                            | **19,906** | ** **                     | **$**      | **14,912** | ** ** | **$** | **35,260** | ** ** | **$** | **25,400** | ** ** |
| **Product-related service**                                                                                                                               |   | **3,992**                        | ** ** | **3,116**                      | ** ** | **7,324** | ** ** | **5,872** | ** ** |
| **Total revenue**                                                                                                                                         |   | **23,898**                       | ** ** | **18,028**                     | ** ** | **42,584** | ** ** | **31,272** | ** ** |
| **Cost of sales**                                                                                                                                         |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products**                                                                                                                             |   | **9,527**                        | ** ** | **6,772**                      | ** ** | **17,156** | ** ** | **11,373** | ** ** |
| **Product-related service**                                                                                                                               |   | **2,124**                        | ** ** | **2,291**                      | ** ** | **3,869** | ** ** | **4,290** | ** ** |
| **Total cost of sales**                                                                                                                                   |   | **11,651**                       | ** ** | **9,063**                      | ** ** | **21,025** | ** ** | **15,663** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Gross profit**                                                                                                                                          |   | **12,247**                       | ** ** | **8,965**                      | ** ** | **21,559** | ** ** | **15,609** | ** ** |
| **Operating expenses:**                                                                                                                                   |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Selling, general and administrative**                                                                                                                   |   | **7,818**                        | ** ** | **6,014**                      | ** ** | **13,221** | ** ** | **10,624** | ** ** |
| **Research and development**                                                                                                                              |   | **1,415**                        | ** ** | **1,086**                      | ** ** | **2,491** | ** ** | **1,952** | ** ** |
| **Total operating expenses**                                                                                                                              |   | **9,233**                        | ** ** | **7,100**                      | ** ** | **15,712** | ** ** | **12,576** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from operations**                                                                                                                                |   | **3,014**                        | ** ** | **1,865**                      | ** ** | **5,847** | ** ** | **3,033** | ** ** |
| **Other income (expense):**                                                                                                                               |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Interest income**                                                                                                                                       |   | **76**                           | ** ** | **60**                         | ** ** | **155** | ** ** | **134** | ** ** |
| **Interest expense**                                                                                                                                      |   | **(4**                           | **)**      | **(73**                        | **)**      | **(8** | **)** | **(179** | **)** |
| **Other income, net**                                                                                                                                     |   | **379**                          | ** ** | **(623**                       | **)**      | **412** | ** ** | **(281** | **)** |
| **Total other income (expense)**                                                                                                                          |   | **451**                          | ** ** | **(636**                       | **)**      | **559** | ** ** | **(326** | **)** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations before income taxes**                                                                                                 |   | **3,465**                        | ** ** | **1,229**                      | ** ** | **6,406** | ** ** | **2,707** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Provision for income taxes**                                                                                                                            |   | **1,024**                        | ** ** | **423**                        | ** ** | **2,176** | ** ** | **941** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                     |   | **2,441**                        | ** ** | **806**                        | ** ** | **4,230** | ** ** | **1,766** | ** ** |
| **Discontinued operations:**                                                                                                                              |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Loss from discontinued  Skin Care Center operations of $0, $495, $473, and $826 less income tax  benefit of $0 and $159, $175, and $264, respectively** |   | **—**                       | ** ** | **(336**                       | **)**      | **(298** | **)** | **(562** | **)** |
| **Loss on closure of skin care center of $3,348 less income tax benefit  of $1,253**                                                                      |   | **—**                       | ** ** | **—**                     | ** ** | **(2,095** | **)** | **—** | ** ** |
| **Net income**                                                                                                                                            |   | **$**                            | **2,441**  | ** **                     | **$**      | **470** | ** ** | **$** | **1,837** | ** ** | **$** | **1,204** | ** ** |
| **Net income (loss) per share of common stock**                                                                                                           |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Basic:**                                                                                                                                                |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                     |   | **$**                            | **.22**    | ** **                     | **$**      | **.08** | ** ** | **$** | **.39** | ** ** | **$** | **.18** | ** ** |
| **Loss from discontinued operations**                                                                                                                     |   | **—**                       | ** ** | **(.03**                       | **)**      | **(.22** | **)** | **(.06** | **)** |
| **Net income**                                                                                                                                            |   | **$**                            | **.22**    | ** **                     | **$**      | **.05** | ** ** | **$** | **.17** | ** ** | **$** | **.12** | ** ** |
| **Diluted:**                                                                                                                                              |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing operations**                                                                                                                     |   | **$**                            | **.22**    | ** **                     | **$**      | **.08** | ** ** | **$** | **.38** | ** ** | **$** | **.18** | ** ** |
| **Loss from discontinued operations**                                                                                                                     |   | **—**                       | ** ** | **(.03**                       | **)**      | **(.22** | **)** | **(.06** | **)** |
| **Net income**                                                                                                                                            |   | **$**                            | **.22**    | ** **                     | **$**      | **.05** | ** ** | **$** | **.16** | ** ** | **$** | **.12** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Basic weighted average shares outstanding**                                                                                                             |   | **10,869**                       | ** ** | **9,877**                      | ** ** | **10,782** | ** ** | **9,760** | ** ** |
| **Diluted weighted average shares outstanding**                                                                                                           |   | **11,288**                       | ** ** | **10,004**                     | ** ** | **11,190** | ** ** | **9,859** | ** ** |

 

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

 

4

----

 

**CANDELACORPORATION**

**CondensedConsolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
|                                                                                              |   | **For the  six months ended:** |       |
|---------------------------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                                              |   | **December  27,  2003**        |       | **December  28,  2002** |   |
|                                                                                              |   |                           | ** ** | **(Restated)** | ** ** |
| **Cash flows from operating activities:**                                                         |   |                           |       |   |   |
| **Net income**                                                                                    |   | **$**                          | **1,837**  | ** ** | **$** | **1,204** | ** ** |
| **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**                                                                 |   | **253**                        | ** ** | **403** | ** ** |
| **Provision for bad debts**                                                                       |   | **111**                        | ** ** | **(43** | **)** |
| **Effect of exchange rate changes on foreign currency denominated  assets and liabilities**       |   | **25**                         | ** ** | **2** | ** ** |
| **Accretion of debt discount**                                                                    |   | **—**                     | ** ** | **475** | ** ** |
| **Increase (decrease) in cash from working capital:**                                             |   |                           | ** ** |   | ** ** |
| **Accounts receivable**                                                                           |   | **(2,220**                     | **)**      | **1,735** | ** ** |
| **Notes receivable**                                                                              |   | **348**                        | ** ** | **686** | ** ** |
| **Inventories**                                                                                   |   | **(2,572**                     | **)**      | **(107** | **)** |
| **Other current assets**                                                                          |   | **(613**                       | **)**      | **(389** | **)** |
| **Other assets**                                                                                  |   | **(80**                        | **)**      | **91** | ** ** |
| **Accounts payable**                                                                              |   | **(501**                       | **)**      | **(3,231** | **)** |
| **Accrued payroll and related expenses**                                                          |   | **(1,593**                     | **)**      | **(770** | **)** |
| **Deferred revenue**                                                                              |   | **59**                         | ** ** | **(661** | **)** |
| **Accrued warranty costs**                                                                        |   | **801**                        | ** ** | **(50** | **)** |
| **Income taxes payable**                                                                          |   | **(717**                       | **)**      | **811** | ** ** |
| **Long term portion of deferred revenue**                                                         |   | **(760**                       | **)**      | **59** | ** ** |
| **Loss from discontinued operations**                                                             |   | **298**                        | ** ** | **826** | ** ** |
| **Other accrued liabilities**                                                                     |   | **1,048**                      | ** ** | **230** | ** ** |
| **Net cash (used for) provided by operating activities**                                          |   | **(2,181**                     | **)**      | **1,271** | ** ** |
|                                                                                              |   |                           | ** ** |   | ** ** |
| **Cash flows from investing activities:**                                                         |   |                           | ** ** |   | ** ** |
| **Purchases of property and equipment**                                                           |   | **(88**                        | **)**      | **(70** | **)** |
| **Net cash used for investing activities**                                                        |   | **(88**                        | **)**      | **(70** | **)** |
|                                                                                              |   |                           | ** ** |   | ** ** |
| **Cash flows from financing activities:**                                                         |   |                           | ** ** |   | ** ** |
| **Principal payments of long-term debt**                                                          |   | **—**                     | ** ** | **(3,433** | **)** |
| **Proceeds from the issuance of common stock**                                                    |   | **2,434**                      | ** ** | **1,368** | ** ** |
| **Net cash provided by (used for) financing activities**                                          |   | **2,434**                      | ** ** | **(2,065** | **)** |
|                                                                                              |   |                           | ** ** |   | ** ** |
| **Effect of exchange rates on cash and cash equivalents**                                         |   | **362**                        | ** ** | **272** | ** ** |
|                                                                                              |   |                           | ** ** |   | ** ** |
| **Net increase (decrease) in cash and cash equivalents**                                          |   | **527**                        | ** ** | **(592** | **)** |
| **Cash and cash equivalents at beginning of period**                                              |   | **$**                          | **31,870** | ** ** | **$** | **19,657** | ** ** |
| **Cash and cash equivalents at end of period**                                                    |   | **$**                          | **32,397** | ** ** | **$** | **19,065** | ** ** |

 

***The accompanying notesare an integral part of the unaudited condensed consolidated financialstatements****.*

 

5

----

 

CandelaCorporation

Notes to Condensed Consolidated Financial Statements

** **

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

 

Theaccompanying unaudited condensed consolidated financial statements and notes donot include all of the disclosures made in the Annual Report on Form 10-K ofCandela Corporation (the “Company”, or “Candela”) for fiscal year 2003, whichshould be read in conjunction with these financial statements.  The financial information included herein isunaudited, with the exception of the condensed consolidated balance sheet as ofJune 28, 2003, which was derived from the audited consolidated balance sheetdated June 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 manner consistentwith the Company’s Annual Report on Form 10-K. The results for the three andsix month periods ended December 27, 2003 are not necessarily indicative of theresults to be expected for the full year.

 

**2.****                   DiscontinuedOperations**

 

On September 27, 2003 management initiated a planto close its only remaining skin care center. The closure is accounted for as adiscontinued operation in accordance with Statement of Financial AccountingStandards (“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 ended September 27,2003, the Company recorded a $2,095 charge for the accrual of $3,000 of futureoccupancy costs, primarily relating to future lease payments for the Bostonfacility, and $348 of severance obligations and other related costs of closure,net of anticipated tax benefits of $1,253. Approximately 45 positions have beeneliminated as a result of this restructuring plan, and 43 employees have beenterminated as of December 27, 2003. In addition, all prior period financialstatements have been restated to reflect skin care centers operations asdiscontinued.

 

Prior tofiscal 2002, the Company recorded combined restructuring charges of $3,721resulting from management’s decision to close the skin care center located inScottsdale, 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 $693,000 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 followingtable reflects the combined restructuring charges incurred in the six monthperiod ended December 27, 2003:

 
| **(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**                      |   | **(170**                   | **)**      | **(123**                                       | **)**      | **(58**             | **)**      | **(351**  | **)**      |
| **Non-cash amortization  relating to the Scottsdale reserve**       |   | **(17**                    | **)**      | **(53**                                        | **)**      | **—**          | ** ** | **(70**   | **)**      |
| **Additions to reserve due  to the closure of the Boston facility** |   | **139**                    | ** ** | **124**                                        | ** ** | **3,085**           | ** ** | **3,348** | ** ** |
| **Balance at December 27,  2003**                                   |   | **$**                      | **2**      | ** **                                     | **$**      | **252**             | ** ** | **$**     | **3,052**  | ** ** | **$** | **3,306** | ** ** |

 

6

----

 

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

 

At December 27, 2003, the discontinued segment hada net liability of approximately $3,959 consisting primarily of theaforementioned reserve of $3,306 and deferred gift certificate revenue of $932partially offset by fixed assets of approximately $292.  Revenues for discontinued operations were $0and $538 for the quarters ended December 27, 2003 and December 28, 2002, respectively,and $413 and $1,096 for the six month periods ended December 27, 2003 andDecember 28, 2002, respectively.

 

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

 

InDecember 2002, the Financial Accounting Standards Board (“FASB”) issuedStatement No. 148, “Accounting for Stock-Based Compensation, Transition andDisclosure” (“FAS 148”). FAS 148 provides alternative methods of transition fora voluntary change to the recognition of the cost of the options in thestatement of operations. FAS 148 also requires that disclosures of the proforma effect of using the fair value method of accounting for stock-basedemployee compensation be displayed more prominently and in a tabular format.Additionally, FAS 148 requires disclosure of the pro forma effect in interimfinancial statements. The transition and annual disclosure requirements of FAS148 were effective for fiscal years ended after December 15, 2002. Theinterim disclosure requirements of FAS 148 are effective for interim periodsbeginning after December 15, 2002. The adoption of the provisions of FAS148 did not have an impact on the Company’s consolidated financial statements;however, the Company has modified its disclosures as provided for in the newstandard.

 

TheCompany follows the provisions of FASB Statement No. 123, “Accounting forStock-Based Compensation” (“FAS 123”). The provisions of FAS 123 allowcompanies to either expense the estimated fair value of stock options or tocontinue to follow the intrinsic value method set forth in AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (“APB 25”), but disclose the pro forma effects on net income(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.

 

Inaccordance with APB 25 and related interpretations, compensation expense forstock options is recognized in income based on the excess, if any, of thequoted market price of the stock at the grant date of the award or othermeasurement date over the amount an employee must pay to acquire the stock.Generally, the exercise price for stock options granted to employees equals orexceeds the fair market value of Candela common stock at the date of grant,thereby resulting in no recognition of compensation expense by Candela. For awardsthat generate compensation expense as defined under APB 25, the Companycalculates the amount of compensation expense and recognizes the expense overthe vesting period of the award.

 

7

----

 

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

 

Hadcompensation cost for Candela’s stock option plans been determined based on thefair value method set forth in FAS 123, Candela’s net income (loss) andbasic and diluted net income (loss) per common share would have been changedto the pro forma amounts indicated below:

 
|                                                                                                                                               |   | **For the three months ended:** |       | **For the six months ended:** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|------------|-------------------------------|------------|
| **(in  thousands, excepts per share data)**                                                                                                        |   | **December  27,  2003**         |       | **December  28,  2002**       |       | **December  27,  2003** |   | **December  28,  2002** |   |
|                                                                                                                                               |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Net income , as reported**                                                                                                                       |   | **$**                           | **2,441**  | ** **                    | **$**      | **470** | ** ** | **$** | **1,837** | ** ** | **$** | **1,204** | ** ** |
|                                                                                                                                               |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **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** |   | **(401**                        | **)**      | **—**                    | ** ** | **(775** | **)** | **(413** | **)** |
|                                                                                                                                               |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Pro forma net income**                                                                                                                           |   | **$**                           | **2,040**  | ** **                    | **$**      | **470** | ** ** | **$** | **1,062** | ** ** | **$** | **791** | ** ** |
| **Net income per share of  common stock**                                                                                                          |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Basic - as reported**                                                                                                                            |   | **$**                           | **0.22**   | ** **                    | **$**      | **0.05** | ** ** | **$** | **0.17** | ** ** | **$** | **0.12** | ** ** |
| **Basic - pro forma**                                                                                                                              |   | **$**                           | **0.19**   | ** **                    | **$**      | **0.05** | ** ** | **$** | **0.10** | ** ** | **$** | **0.08** | ** ** |
| **Diluted - as reported**                                                                                                                          |   | **$**                           | **0.22**   | ** **                    | **$**      | **0.05** | ** ** | **$** | **0.16** | ** ** | **$** | **0.12** | ** ** |
| **Diluted - pro forma**                                                                                                                            |   | **$**                           | **0.18**   | ** **                    | **$**      | **0.05** | ** ** | **$** | **0.09** | ** ** | **$** | **0.08** | ** ** |

 

Incomputing this pro-forma amount, the Company has used the Black-Scholes pricingmodel using the following assumptions for options granted in fiscal years 2004and 2003:

 
|                                            |   | **2004**   |       | **2003**   |       |
|-------------------------------------------------|--------|------------|------------|------------|------------|
| **Risk-free interest rate**                     |   | **4.25**   | **%**      | **4.25**   | **%**      |
| **Estimated volatility**                        |   | **76**     | **%**      | **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 earningsper share is computed by dividing net income by the weighted average number ofshares of common stock outstanding for the period and, if there are dilutivesecurities, diluted earnings per share is computed by including common stockequivalents outstanding for the period in the denominator.

 

8

----

 

**4.****                   EarningsPer Share, continued**

 

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

 
|                                                                                         |   | **For the three months ended:** |       | **For the six months ended:** |       |
|----------------------------------------------------------------------------------------------|--------|---------------------------------|------------|-------------------------------|------------|
| **(in  thousands, excepts per share data)**                                                  |   | **December 27,  2003**          |       | **December 28,  2002**        |       | **December 27,  2003** |   | **December 28,  2002** |   |
|                                                                                         |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Basic shares used in the  calculation of**  **earnings  per share**                   |   | **10,869**                      | ** ** | **9,877**                     | ** ** | **10,782** | ** ** | **9,760** | ** ** |
|                                                                                         |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Effect of dilutive  securities:**                                                          |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Stock options**                                                                            |   | **393**                         | ** ** | **111**                       | ** ** | **383** | ** ** | **84** | ** ** |
| **Stock warrants**                                                                           |   | **26**                          | ** ** | **16**                        | ** ** | **25** | ** ** | **15** | ** ** |
|                                                                                         |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Diluted shares used in the  calculation of**  **earnings  per share**                 |   | **11,288**                      | ** ** | **10,004**                    | ** ** | **11,190** | ** ** | **9,859** | ** ** |
|                                                                                         |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Per share effect of  dilutive securities on**   **income from continuing operations** |   | **—**                      | ** ** | **—**                    | ** ** | **$** | **.01** | ** ** | **—** | ** ** |
|                                                                                         |   |                            | ** ** |                          | ** ** |   | ** ** |   | ** ** |
| **Per share effect of  dilutive securities on**   **net income**                        |   | **—**                      | ** ** | **—**                    | ** ** | **$** | **.01** | ** ** | **—** | ** ** |

 

During thethree and six month periods ended December 27, 2003, all options to purchaseshares of common stock were included in the computation of diluted earnings pershare. During the three and six month periods ended December 28, 2002, optionsto purchase 927 and 677 shares of common stock, respectively, were excludedfrom the calculation of diluted earnings per share because the exercise priceof such options was greater than the average market price of the common stockfor the period.

 

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

 

Componentsof comprehensive income include net income and certain transactionsthat have generally been reported in the consolidated statement ofstockholders’ equity.

 
|                                         |   | **For the three months ended:** |       | **For the six months ended:** |       |
|----------------------------------------------|--------|---------------------------------|------------|-------------------------------|------------|
| **(in  thousands)**                          |   | **December 27,  2003**          |       | **December 28,  2002**        |       | **December 27,  2003** |   | **December 28,  2002** |   |
| **Net income**                               |   | **$**                           | **2,441**  | ** **                    | **$**      | **470** | ** ** | **$** | **1,837** | ** ** | **$** | **1,204** | ** ** |
| **Foreign currency  translation adjustment** |   | **851**                         | ** ** | **195**                       | ** ** | **698** | ** ** | **183** | ** ** |
| **Total comprehensive income**               |   | **$**                           | **3,292**  | ** **                    | **$**      | **665** | ** ** | **$** | **2,535** | ** ** | **$** | **1,387** | ** ** |

 

9

----

 

**6.****                   Inventories**

** **
| **(in thousands)**  |   | **December 27,  2003** |       | **June 28,  2003** |       |
|---------------------|--------|------------------------|------------|--------------------|------------|
|                |   |                   | ** ** | **(restated)**     | ** ** |
| **Raw materials**   |   | **$**                  | **4,195**  | ** **         | **$**      | **4,123** | ** ** |
| **Work in process** |   | **884**                | ** ** | **469**            | ** ** |
| **Finished goods**  |   | **8,933**              | ** ** | **6,242**          | ** ** |
|                |   | **$**                  | **14,012** |               | **$**      | **10,834** | ** ** |

 

**7.****                   SegmentInformation**

 

The Company operates principally in one industry segment: the design,manufacture, sale, and service of medical devices and related equipment. Theresults in this segment have been presented in the Consolidated Statements ofOperations for the appropriate periods.

 

**8.****                   Guarantees**

 

The Company’sproducts generally carry a standard one-year warranty, except for Vbeamproducts which typically carry a three-year warranty. The Company records areserve based on anticipated warranty claims at the time product revenue isrecognized. In anticipation of actual warranty claims, the Company amortizesthe reserve ratably over the life of the warranty, thereby offsetting actualwarranty claims incurred. Actual warranty claims incurred and charged toproduct costs of sales during an interim period may be more or less than theamount of amortized warranty reserve allocated against them. Factors thataffect the Company’s product warranty liability include the number of installedunits, the anticipated cost of warranty repairs, and historical and anticipatedrates of warranty claims.

 

The followingtable reflects changes in the Company’s accrued warranty account during thesix-month period ended December 27, 2003:

 

 
| **(in  thousands)**                             |   |      |       |
|-------------------------------------------------|--------|-----------|------------|
| **Beginning balance June 28,  2003**            |   | **$**     | **6,666**  | ** ** |
| **Plus accruals related to  new sales**         |   | **3,063** | ** ** |
| **Less amortization of prior  period accruals** |   | **2,593** | ** ** |
| **Ending balance on December  27, 2003**        |   | **$**     | **7,136**  | ** ** |

 

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

 

10

----

 

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

 

The followingtable reflects changes in the Company’s deferred revenue account during thesix-month period ended December 27, 2003:

 
| **(in  thousands)**                              |   |      |       |
|--------------------------------------------------|--------|-----------|------------|
| **Beginning balance June 28,  2003**             |   | **$**     | **3,086**  | ** ** |
| **Plus deferral of new  service contract sales** |   | **2,185** | ** ** |
| **Less recognition of  deferred revenue**        |   | **2,332** | ** ** |
| **Ending balance on December  27, 2003**         |   | **$**     | **2,939**  | ** ** |

 

The Company hasan agreement (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 AppliedOptronics, the diode division of Schwartz Electro-Optics, Inc., forapproximately $1,200 in cash. Applied Optronics was a leading manufacturer ofhigh-powered, pulsed lasers, and was a component supplier to the OEM marketthat serves a variety of industries including the military, medical, industrial,research and robotics fields. Applied Optronics was the lead supplier of thediodes for the Company’s SmoothbeamTM diode laser system. In accordance withSFAS No. 141 “*Business Combinations*,” the Company records acquisitionsunder the purchase method of accounting. Accordingly, the purchase price isallocated to the tangible assets and liabilities and intangible assetsacquired, based on their estimated fair values.

 

The assetacquisition consisted primarily of fixed assets, including production andoffice equipment, and inventory located at the division’s facility in NewJersey. The acquisition increased the Company’s net property and equipment byapproximately $800 and inventory by approximately $400. For the period fromJune 29, 2003 to December 27, 2003, the Applied Optronics operation generatedapproximately $249 in revenue from diode sales to third-party customers.

 

11

----

 

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

 

On January 28, 2004, the Company announced that itsBoard of Directors approved a two-for-one stock split, payable in the form of a100% stock dividend. All shareholders of record at the close of business onFebruary 16, 2004 will receive one additional share for each share of commonstock owned. The additional shares will be distributed to shareholders on orabout March 16, 2004. Upon completion of this split, Candela will haveapproximately 22 million shares of common stock outstanding.

 

The following table sets forth pro forma, share andper share earnings amounts to reflect the effect of this stock split on currentand prior year share and per share earnings.

 
|                                                                                                                                                      |   | **For the  three months ended:** |       | **For the  six months ended:** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
| **In thousands, except per share  data**                                                                                                                  |   | **December  27,  2003**          |       | **December  28,  2002**        |       | **December  27,  2003** |   | **December  28,  2002** |   |
|                                                                                                                                                      |   |                             |       | **(Restated)**                 |       |   |   | **(Restated)** |   |
| **Income from continuing operations**                                                                                                                     |   | **2,441**                        | ** ** | **806**                        | ** ** | **4,230** | ** ** | **1,766** | ** ** |
| **Discontinued operations:**                                                                                                                              |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Loss from discontinued  Skin Care Center operations of $0, $495, $473, and $826 less income tax  benefit of $0 and $159, $175, and $264, respectively** |   | **—**                       | ** ** | **(336**                       | **)**      | **(298** | **)** | **(562** | **)** |
| **Loss on closure of skin care center of $3,348 less income tax benefit  of $1,253**                                                                      |   | **—**                       | ** ** | **—**                     | ** ** | **(2,095** | **)** | **—** | ** ** |
| **Net Income**                                                                                                                                            |   | **$**                            | **2,441**  | ** **                     | **$**      | **470** | ** ** | **$** | **1,837** | ** ** | **$** | **1,204** | ** ** |
| **Net income (loss) per share of common stock**                                                                                                           |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Basic:**                                                                                                                                                |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing**  **operations**                                                                                                           |   | **$**                            | **.11**    | ** **                     | **$**      | **.04** | ** ** | **$** | **.20** | ** ** | **$** | **.09** | ** ** |
| **Loss from discontinued**  **operations**                                                                                                           |   | **—**                       | ** ** | **(.02**                       | **)**      | **(.11** | **)** | **(.03** | **)** |
| **Net income**                                                                                                                                            |   | **$**                            | **.11**    | ** **                     | **$**      | **.02** | ** ** | **$** | **.09** | ** ** | **$** | **.06** | ** ** |
| **Diluted:**                                                                                                                                              |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Income from continuing**  **operations**                                                                                                           |   | **$**                            | **.11**    | ** **                     | **$**      | **.04** | ** ** | **$** | **.19** | ** ** | **$** | **.09** | ** ** |
| **Loss from discontinued**  **operations**                                                                                                           |   | **—**                       | ** ** | **(.02**                       | **)**      | **(.11** | **)** | **(.03** | **)** |
| **Net income**                                                                                                                                            |   | **$**                            | **.11**    | ** **                     | **$**      | **.02** | ** ** | **$** | **.08** | ** ** | **$** | **.06** | ** ** |
|                                                                                                                                                      |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| **Basic weighted average shares**                                                                                                                         |   | **21,739**                       | ** ** | **19,754**                     | ** ** | **21,563** | ** ** | **19,521** | ** ** |
| **Diluted weighted average shares**                                                                                                                       |   | **22,576**                       | ** ** | **20,007**                     | ** ** | **22,380** | ** ** | **19,718** | ** ** |

 

12

----

 

**CANDELACORPORATION**

 

**Item 2****-****Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Overview**

 

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

 

**Critical AccountingPolicies**

 

This discussion and analysis ofour financial condition and results of operations is based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses, andrelated disclosure of contingent assets and liabilities. We evaluate ourestimates and judgments, including those related to revenue recognition, baddebts, inventories, warranty obligations, contingencies, restructurings andincome taxes. We base our estimates and judgments on historical experience andon various other assumptions that we believe to be reasonable under the circumstances,the results of which form the basis for making judgments about the carryingvalue of assets and liabilities that are not readily apparent from othersources. Actual results may differ from these estimates under differentassumptions or conditions. A discussion of our critical accounting policies andthe related estimates and judgments affecting the preparation of ourconsolidated financial statements is included in our Annual Report on Form 10-Kfor fiscal year 2003.

 

13

----

 

**Results of Operations**

 

***Revenue.***

 

Revenue source by geographic region is reflected in the followingtable:

 
|                 |   | **For the three months  ended:** |       |
|----------------------|--------|----------------------------------|------------|
| **(in  thousands)**  |   | **December 27, 2003**       |       | **December 28, 2002** | ** ** | **Change** | ** ** |
|                 |   |                             |       |   |   |   |   |   |   |   |   |   |   |
| **US  revenue**      |   | **$**                            | **11,242** | ** ** | **47** | **%** | **$** | **7,867** | ** ** | **44** | **%** | **$** | **3,375** | ** ** | **43** | **%** |
| **Foreign  revenue** |   | **12,656**                       | ** ** | **53** | **%** | **10,161** | ** ** | **56** | **%** | **2,495** | ** ** | **25** | **%** |
|                 |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total  revenue**   |   | **$**                            | **23,898** | ** ** | **100** | **%** | **$** | **18,028** | ** ** | **100** | **%** | **$** | **5,870** | ** ** | **33** | **%** |

 
|                 |   | **For the six months ended:** |       |
|----------------------|--------|-------------------------------|------------|
|                 |   | **December 27, 2003**    |       | **December 28, 2002** |   | **Change** |   |
|                 |   |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **US  revenue**      |   | **$**                         | **19,094** | ** ** | **45** | **%** | **$** | **13,422** | ** ** | **43** | **%** | **$** | **5,672** | ** ** | **42** | **%** |
| **Foreign  revenue** |   | **23,490**                    | ** ** | **55** | **%** | **17,850** | ** ** | **57** | **%** | **5,640** | ** ** | **32** | **%** |
|                 |   |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total  revenue**   |   | **$**                         | **42,584** | ** ** | **100** | **%** | **$** | **31,272** | ** ** | **100** | **%** | **$** | **11,312** | ** ** | **36** | **%** |

 

Consolidated Overview

 

Our consolidated  revenue for thesecond  quarter of 2004 was $23.9  million, compared  to revenue of  $18.0  million for the same  period  in 2003. The increase in year over year revenue resulted primarily from  an increase in worldwide demand for theCompany’s products. Specifically, sales in the GentleLase product lineincreased approximately $4.2 million when compared to the same period lastyear.

 

Consolidated revenue for the first six months of2004 was $42.6 million, compared to revenue of $31.3 million for the sameperiod in 2003. This increase again resulted primarily from a $7.2 millionimprovement in sales of our GentleLase product line.

 

US revenue increased by $3.4 and $5.7 million,respectively, for the three and six month periods ended December 27, 2003,as compared to the same periods during the prior fiscal year.  Foreign revenue increased by $2.5 and $5.6million, respectively, for the three and six month periods ended December 27,2003, as compared to the same periods during the prior fiscal year.

 

14

----

 

Revenue source by type is reflected in the following table:

 
|                          |   | **For the three months  ended:** |       |
|-------------------------------|--------|----------------------------------|------------|
| **(in  thousands)**           |   | **December 27, 2003**       |       | **December 28, 2002** |   | **Change** |   |
| **Revenue**                   |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products** |   | **$**                            | **19,906** | ** ** | **83** | **%** | **$** | **14,912** | ** ** | **83** | **%** | **$** | **4,994** | ** ** | **33** | **%** |
| **Product-related service**   |   | **3,992**                        | ** ** | **17** | **%** | **3,116** | ** ** | **17** | **%** | **876** | ** ** | **28** | **%** |
|                          |   |                             | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**             |   | **$**                            | **23,898** | ** ** | **100** | **%** | **$** | **18,028** | ** ** | **100** | **%** | **$** | **5,870** | ** ** | **33** | **%** |

 
|                          |   | **For the six months ended:** |       |
|-------------------------------|--------|-------------------------------|------------|
|                          |   | **December 27, 2003**    |       | **December 28, 2002** |   | **Change** |   |
| **Revenue**                   |   |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Lasers and other products** |   | **$**                         | **35,260** | ** ** | **83** | **%** | **$** | **25,400** | ** ** | **81** | **%** | **$** | **9,860** | ** ** | **39** | **%** |
| **Product-related service**   |   | **7,324**                     | ** ** | **17** | **%** | **5,872** | ** ** | **19** | **%** | **1,452** | ** ** | **25** | **%** |
|                          |   |                          | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Total revenue**             |   | **$**                         | **42,584** | ** ** | **100** | **%** | **$** | **31,272** | ** ** | **100** | **%** | **$** | **11,312** | ** ** | **36** | **%** |

 

The increase in laser product revenue for the three month period endedDecember 27, 2003, compared to the three month period endedDecember 28, 2002, resulted from an increase in the sales volume of bothour GentleLaseTM and SmoothbeamTM product lines. The GentleLaseTM contributedapproximately $4.2 million, and the SmoothbeamTM contributed approximately $0.4million to this increase in revenue. Product related service increased $0.9million during the quarter due to more service related contracts.

 

The increase in laser product revenue for the six month period endedDecember 27, 2003, compared to the six month period endedDecember 28, 2002, resulted from an increase in the sales volume of bothour GentleLaseTM and SmoothbeamTM product lines. The GentleLaseTM contributedapproximately $7.2 million, and the SmoothbeamTM contributed approximately $1.3million to this increase in revenue. Product related service increased $1.4million during the quarter due to more service related contracts.

 

***Gross Profit. ***Gross profitincreased to approximately $12.2 million or 51.2% of revenues for the threemonth period ended December 27, 2003, compared to gross profit ofapproximately $9.0 million or 49.7% for the same period one year earlier.  Gross profit increased to approximately$21.6 million or 50.3% of revenues for the six-month period endedDecember 27, 2003, compared to gross profit of approximately $15.6 millionor 49.9% for the same period one year earlier. The increases in gross profit result principally from the increase insales volume.

 

***Selling, General andAdministrative Expense. ***Selling,general and administrative expenses increased to approximately $7.8 million forthe three-month period ended December 27, 2003 from approximately $6.0million for the three-month period December 28, 2002. The increase wasprimarily due to commissions and employee related expenses of approximately$1.5 million, and increased marketing programs of approximately $0.2 million.As a percentage of revenue, selling, general and administrative expensesdecreased to 32.7% from 33.4% of revenues for the same respective periods.Selling, general and administrative expenses increased to approximately $13.2million for the six-month period ended December 27, 2003 fromapproximately $10.6 million for the six-month period ended December 28,2002. The increase is primarily due to commission and employee related expensesof $1.9 million, professional fees of $0.3 million, and additional marketing programsof $0.2 million. For the six-month period ended December 27, 2003,selling, general and administrative expenses decreased to 31.0% from 34.0% ofrevenues as compared to the same period one year earlier. The decrease inselling, general and administrative expenses as a percentage of revenues is dueprimarily from the benefit of the aforementioned increase in sales on a periodover period basis.

 

15

----

 

***Research andDevelopment Expense.***   Research anddevelopment spending increased to $1.4 million for the three-month period endedDecember 27, 2003 from $1.1 for the three-month period endedDecember 28, 2002 due primarily to an increase in the number of activeprojects. Spending in this area increased to $2.5 million for the six-monthperiod ended December 27, 2003 from $2.0 for the six-month period endedDecember 28, 2002 due primarily to the aforementioned increase in projectspending.

 

***OtherIncome/Expense. ***Netother income was approximately $0.5 million for the three months endedDecember 27, 2003 compared to net other expense of approximately $0.6million for the three months ended December 28, 2002. For the six-monthperiod ended December 27, 2003, net other income was approximately $0.6million compared to net other expense of approximately $0.3 million for thesix-month period ended December 28, 2002. The increase in net other income(expense) for the three-month and six-month period ended December 27, 2003resulted primarily from a one-time charge of $0.7 million in the prior year,related to the extinguishment of our long-term debt coupled with an increase ininterest income due to higher cash balances.

 

***Income Taxes.***The provision for income taxes results from a combination of activities of boththe domestic and foreign subsidiaries of the Company.  We recorded a 29% effective tax rate for both the three- andsix-month periods ended December 27, 2003, compared to the three- andsix-month periods ended December 29, 2002, in which we recorded a 36% effectivetax rate.   The provision for incometaxes for the six months ended December 27, 2003 differs from the U.S.statutory rate as a result of  taxprovisions calculated for income generated by foreign subsidiaries at a ratethat differs from the U.S. statutory rate.

 

**DiscontinuedOperations**

 

On September 27, 2003, we permanently closed our only remainingskin care center, which was located in Boston. The closure of the Boston skincare center, together with the earlier closing of our Scottsdale, Arizona spa,and the associated cessation of this line of business, is accounted for asdiscontinued operations. As a result of the closure of the Boston skin carecenter, in the fiscal quarter ended September 27, 2003, we recorded a $2.1million charge for the accrual of $3.0 million of future occupancy costs and$0.3 million of severance obligations and other related costs of closure, netof anticipated tax benefits of $1.3 million. In addition, both the financialstatements for the six months ended December 27, 2003 and all priorfinancial statements have been restated to reflect skin care center operationsas discontinued. While the building landlord has given the Company writtennotice that it believes the Company is in default under the lease, the Companyhas indicated that it plans to honor all of its obligations under the lease.The Company believes that the size of the accrual that it has established issufficient to cover all future leasehold expenses for the remainder of thelease term. Leasehold expenses could potentially be mitigated if the landlordelects to relet or sublease the property.

 

16

----

 

**Liquidity and CapitalResources**

 

Cash used in operating activities amounted to $2.2 million for the sixmonths ended December 27, 2003, in comparison to cash provided byoperating activities of $1.3 million for the same period in the prior year.This increase in cash used by operating activities primarily reflects cashoutlay for inventory during a strong sales cycle. Sales during the third monthof the quarter were particularly strong, providing little time to replenishcash through collection of receivables. Cash used by investing activitiesremained relatively flat for the six months ended December 27, 2003, comparedto the same period in the prior year. Cash provided by financing activities amounted to $2.4 million for thesix-months  ended December 27, 2003in comparison to cash used of $2.1 million for the same period during the prioryear.  The increase reflects theproceeds for the issuance of stock by the corporation, primarily to employeesunder the existing stock option plan, and the absence of prior-year paymentsused to pay-off long-term debt.

 

Our outstanding contractual obligations as of December 27, 2003,are reflected in the following 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** |   | **$**     | **4,648** | ** **                      | **$**  | **1,146**               | ** ** | **$**                   | **1,020** | ** **                          | **$**  | **907** | ** ** | **$** | **1,575** | ** ** |
|                       |        |           |           |                                 |        |                         |            |                         |           |                                     |        |  |  |  |  |  |

 

We also maintain a renewable $10,000,000 revolving credit agreementwith a major bank with interest at the bank’s base rate, or LIBOR plus2.25%.  Any borrowings outstanding underthe line of credit are due on demand or according to a paymentschedule established at the time funds are borrowed.  The line of credit is unsecured.  The agreement contains restrictive covenantslimiting the establishment of new liens, and the purchase of margin stock.  No amounts were outstanding under the lineof credit as of December 27, 2003.

 

We believe that our current cash balances will be sufficient to meetanticipated cash requirements for the next twelve months.  However, we cannot be sure that we will notrequire additional capital beyond the amounts currently forecasted by us, orthat any such required additional capital will be available on reasonableterms, if at all, when such capital becomes required.

 

**Cautionary Statements**

 

This Quarterly Report on Form 10-Q contains forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of1995.  Forward-looking statements arenot promises or guarantees and are subject to risks and uncertainties thatcould cause our actual results to differ materially from those anticipated.  Such statements may relate to, among otherthings,  including, without limitation,statements concerning the future of the industry, product development, businessstrategy (including the possibility of future acquisitions), anticipatedoperational and capital expenditure levels, continued acceptance and growth ofour products, and dependence on significant customers and suppliers.  Forward-looking statements may also include,without limitation, any statement relating to future events, conditions orcircumstances or using words such as (or similar to):  anticipate; believe; continue; could; estimate; expect; intend;plan; predict; project; may; or will. The risks and uncertainties that may affect forward-looking statementsand/or our business include, among others, those discussed in “Cautionary Statements”in our Annual Report filed on Form 10-K dated for the fiscal year endedJune 28, 2003, as well as other risks and uncertainties referenced in thisQuarterly Report.  These risks anduncertainties include, but are not limited to, the following:

 

17

----

 

•                  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 to areinvalid, could prevent us from manufacturing and selling some of our productsor require us to incur substantial costs from litigation or development ofnon-infringing technology.

 

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

 

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

 

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

 

We caution readers not to place undue reliance upon any forward-lookingstatements, which speak only as of the date made.  We expressly disclaim any obligation or undertaking to releasepublicly any updates or revisions to any such statements to reflect any changein our expectations or any change in events, conditions or circumstances onwhich any such statement is based.

 

18

----

 

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

 

We have foreign subsidiaries in Japan, Spain,France and Germany.  Approximately 55%of our revenues for the six months ended December 27, 2003 were from ouroperations outside the United States. These subsidiaries transact business in both local and foreign currency. Therefore, we are exposed to foreign currency exchange risks andfluctuations in foreign currencies, which could adversely impact our resultsand financial condition.  However, salesfrom the United States made directly to customers or distributors in foreigncountries are invoiced in U.S. dollars and are not exposed to foreign currencyrisk.

 

From time to time, we may enter into foreigncurrency exchange and option contracts to reduce our exposure to foreigncurrency risk and variability in operating results due to fluctuation inexchange rates underlying the value of current transactions and anticipatedtransactions denominated in foreign currencies.  These contracts obligateus to exchange predetermined amounts of specified foreign currencies atspecified exchange rates on specified dates. These contracts are denominated in the same currency in which theunderlying transactions are denominated and bear a contract value and maturitydate that approximate the value and expected settlement date, respectively, ofthe underlying transactions. We do not engage in foreign currencyspeculation. On December 27, 2003, we did not hold any open foreigncurrency exchange or option contracts.

 

We have cash equivalents that primarily consist of commercial paper,overnight repurchase agreements and money market accounts.  We believe that any near term changes ininterest rates will be immaterial to any potential losses in future earnings,cash flow and fair values.

 

**Item 4****- Controls and Procedures**

 

(a) Evaluation of disclosure controls and procedures. An evaluation wasperformed under the supervision and with the participation of members of ourmanagement, including our Chief Executive Officer and our Chief FinancialOfficer, of the effectiveness of the design and operation of our “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934Rules 13a-15(e)) as of December 27, 2003 (the “Evaluation Date”).  Based on that evaluation, members of ourmanagement, including our Chief Executive Officer and our Chief FinancialOfficer, have concluded that, as of the Evaluation Date, our disclosurecontrols and procedures were effective in enabling us to record, process,summarize and report the information required to be included in this quarterlyreport within the required time period.

 

(b) Changes to internal controls.  As previously disclosed, during fiscal 2003we began the implementation of a new accounting software system.  In response to complications associated withthe implementation of this system and the transition from our prior system, wemade certain changes in our internal control over financial reporting.  These changes were primarily made during thefiscal quarter ended September 27, 2003. We continued to monitor these changes during the fiscal quarter endedDecember 27, 2003, and also continued our ongoing process of routinelyreviewing and evaluating our internal controls over financial reporting.  Based on that review and evaluation,management believes that it has implemented additional controls sufficient toprevent the problems we encountered during the implementation of our newaccounting software system from occurring in the future, and that it has takenthe necessary steps so that adequate control procedures are in place and willbe followed.  There were no otherchanges in our internal controls over financial reporting during the fiscalquarter ended December 27, 2003 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

19

----

 

**CANDELA CORPORATION**

 

**Part II****.  Other Information**

 

**Item 1 - LegalProceedings**

 

From time to time, we are a party to various legal proceedingsincidental to our business. We believe that none of the legal proceedings whichare presently pending will have a material adverse effect upon our financialposition, results of operations, or liquidity.

 

**ITEM 6****- Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits

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

 

(b)         Reports on Form 8-K

 

On October 29, 2003, Candela Corporation fileda current report on Form 8-K regarding its financial results for its firstfiscal quarter ended September 27, 2003.

 

On December 9, 2003, Candela Corporation filed a current report onForm 8-K regarding a change in its certifying accountant.

 

20

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|   | CANDELA CORPORATION                                                              |
|--------|----------------------------------------------------------------------------------|
|   |                                                                             |
|   |                                                                             |
| Date:  | February 9, 2004                                                            |   | /s/ F. Paul Broyer |   |
|   | F. Paul Broyer                                                                   |
|   | (Senior Vice President, Finance and Administration  and Chief Financial Officer) |
|        |                                                                                  |  |  |  |

 

21

----

 

**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 |

 

22

----