**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,DC 20549**

 

----

 

**FORM 10-Q**

 

**Quarterly report pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

 

**For thequarterly period ended April 2, 2005.**

 

**Commissionfile number 000-14742**

 

**CANDELA CORPORATION**

(Exact name of registrant asspecified in its charter)

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

 

----

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes ý  No  o

 

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

Yes ý  No  o

 

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

 

| **Class**                               | ** ** | **Outstanding at May 5, 2005** |
|-----------------------------------------|------------|--------------------------------|
| Common  Stock, $.01 par value per share |       | 22,582,974                     |

 

 

----

 

**CANDELACORPORATION**

**Index**

 
| Part I.  | Financial Information: |                                                                                                                                                                                                            |
|---------------|------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |                   |                                                                                                                                                                                                            |   |
|          | Item 1.                | Financial Statements Unaudited Consolidated Balance Sheets as of  April 2, 2005 and July 3, 2004                                                                                                      | 3 |
|          |                   |                                                                                                                                                                                                            |   |
|          |                   | Unaudited Consolidated Statements of Operations for the three-month  periods ended April 2, 2005 and March 27, 2004, and for the nine-month  periods ended April 2, 2005 and March 27, 2004 | 4 |
|          |                   |                                                                                                                                                                                                            |   |
|          |                   | Unaudited Consolidated Statements of Cash  Flows for the nine-month periods ended April 2, 2005 and March 27,  2004                                                                                   | 5 |
|          |                   |                                                                                                                                                                                                            |   |
|          |                   | Notes to Unaudited Consolidated Financial  Statements                                                                                                                                                           | 6-11 |
|          |                   |                                                                                                                                                                                                            |   |
|          |  Item  2.         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                                                                     | 12-18 |
|          |                   |                                                                                                                                                                                                            |   |
|          | Item 3.                | Quantitative and Qualitative Disclosure  about Market Risk                                                                                                                                                      | 18 |
|          |                   |                                                                                                                                                                                                            |   |
|          | Item 4.                | Controls and Procedures                                                                                                                                                                                         | 18 |
|          |                   |                                                                                                                                                                                                            |
| Part II. | Other Information:     |                                                                                                                                                                                                            |
|          |                   |                                                                                                                                                                                                            |   |
|          | Item 1.                | Legal proceedings                                                                                                                                                                                               | 19 |
|          |                   |                                                                                                                                                                                                            |   |
|          | Item 6.                | Exhibits                                                                                                                                                                                                        | 19 |
|          |                   |                                                                                                                                                                                                            |   |
|          | Signatures             |                                                                                                                                                                                                            |
|          |                   |                                                                                                                                                                                                            |
|          | Index to Exhibits      |                                                                                                                                                                                                            |

 

2

----

 

**Part I.  Financial Information**

 

**Item 1 - Financial Statements**

 

**CANDELA CORPORATION ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| **(in thousands)**                                | ** ** | **April 2,  2005** | ** **  | **July 3,  2004** | ** ** |
|---------------------------------------------------|------------|-------------------------|-------------|------------------------|------------|
| ** **                                        | ** ** | **(unaudited)**         | ** **  | ** **             | ** ** |
| **Assets:**                                       | ** ** | ** **              | ** **  | ** **             | ** ** |
| Current assets:                                   |       |                    |        |                   |       |
| Cash and cash equivalents                         | ** ** | **$**                   | **47,302**  | ** **             | **$**      | **37,139** | ** ** |
| Restricted cash                                   | ** ** | **225**                 | ** **  | **257**                | ** ** |
| Accounts receivable, net                          | ** ** | **34,014**              | ** **  | **34,302**             | ** ** |
| Notes receivable                                  | ** ** | **1,390**               | ** **  | **1,151**              | ** ** |
| Inventories, net                                  | ** ** | **12,815**              | ** **  | **13,571**             | ** ** |
| Other current assets                              | ** ** | **2,171**               | ** **  | **2,184**              | ** ** |
| Total current assets                              | ** ** | **97,917**              | ** **  | **88,604**             | ** ** |
| ** **                                        | ** ** | ** **              | ** **  | ** **             | ** ** |
| Property and equipment, net                       | ** ** | **3,375**               | ** **  | **3,406**              | ** ** |
| Deferred tax assets                               | ** ** | **5,661**               | ** **  | **5,914**              | ** ** |
| Prepaid licenses                                  | ** ** | **922**                 | ** **  | **1,054**              | ** ** |
| Other assets                                      | ** ** | **223**                 | ** **  | **1,501**              | ** ** |
| Total assets                                      | ** ** | **$**                   | **108,098** | ** **             | **$**      | **100,479** | ** ** |
|                                              |       |                    |        |                   |       |
| **Liabilities and Stockholders’ Equity**     |       |                    |        |                   |       |
| Current liabilities:                              |       |                    |        |                   |       |
| Accounts payable                                  | ** ** | **$**                   | **9,501**   | ** **             | **$**      | **6,973** | ** ** |
| Accrued payroll and related expenses              | ** ** | **3,899**               | ** **  | **5,428**              | ** ** |
| Accrued warranty costs                            | ** ** | **5,063**               | ** **  | **4,946**              | ** ** |
| Income taxes payable                              | ** ** | **1,837**               | ** **  | **1,844**              | ** ** |
| Other accrued liabilities                         | ** ** | **4,286**               | ** **  | **3,586**              | ** ** |
| Deferred income (current portion)                 | ** ** | **5,050**               | ** **  | **3,421**              | ** ** |
| Current liabilities of discontinued  operations   | ** ** | **1,315**               | ** **  | **1,019**              | ** ** |
| Total current liabilities                         | ** ** | **30,951**              | ** **  | **27,217**             | ** ** |
| Other long-term liabilities                       | ** ** | **5,105**               | ** **  | **3,945**              | ** ** |
| Long-term liabilities of discontinued  operations | ** ** | **546**                 | ** **  | **2,548**              | ** ** |
| Total liabilities                                 | ** ** | **36,602**              | ** **  | **33,710**             | ** ** |
| ** **                                        | ** ** | ** **              | ** **  | ** **             | ** ** |
| Stockholders’ equity:                        | ** ** | ** **              | ** **  | ** **             | ** ** |
| Common stock                                      | ** ** | **247**                 | ** **  | **246**                | ** ** |
| Treasury stock, at cost                           | ** ** | **(12,997**             | **)**       | **(12,997**            | **)**      |
| Additional paid-in capital                        | ** ** | **53,569**              | ** **  | **53,069**             | ** ** |
| Accumulated earnings                              | ** ** | **30,124**              | ** **  | **26,023**             | ** ** |
| Accumulated other comprehensive income            | ** ** | **553**                 | ** **  | **428**                | ** ** |
| Total stockholders’ equity                   | ** ** | **71,496**              | ** **  | **66,769**             | ** ** |
| Total liabilities and stockholders’ equity   | ** ** | **$**                   | **108,098** | ** **             | **$**      | **100,479** | ** ** |

 

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

 

3

----

 

**CANDELACORPORATION**

**Consolidated Statements of Operations**

(in thousands, except per sharedata)

(unaudited)

 
| ** **                                                                                                                                                                                          | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                                          | ** ** | **April 2,  2005**         | ** ** | **March 27,  2004**       | ** ** | **April 2,  2005** | ** ** | **March 27,  2004** | ** ** |
| **Revenue**                                                                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers and other products**                                                                                                                                                                       | ** ** | **$**                           | **28,483** | ** **                     | **$**      | **23,509** | ** ** | **$** | **70,365** | ** ** | **$** | **58,769** | ** ** |
| **Product-related service**                                                                                                                                                                         | ** ** | **6,199**                       | ** ** | **4,141**                      | ** ** | **14,912** | ** ** | **11,465** | ** ** |
| **Total revenue**                                                                                                                                                                                   | ** ** | **34,682**                      | ** ** | **27,650**                     | ** ** | **85,277** | ** ** | **70,234** | ** ** |
| **Cost of sales**                                                                                                                                                                                   | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers and other products**                                                                                                                                                                       | ** ** | **13,005**                      | ** ** | **11,399**                     | ** ** | **30,391** | ** ** | **28,555** | ** ** |
| **Product-related service**                                                                                                                                                                         | ** ** | **4,947**                       | ** ** | **2,273**                      | ** ** | **12,139** | ** ** | **6,142** | ** ** |
| **Litigation related charges**                                                                                                                                                                      | ** ** | **4,829**                       | ** ** | **—**                     | ** ** | **4,829** | ** ** | **—** | ** ** |
| **Total cost of sales**                                                                                                                                                                             | ** ** | **22,781**                      | ** ** | **13,672**                     | ** ** | **47,359** | ** ** | **34,697** | ** ** |
| **Gross profit**                                                                                                                                                                                    | ** ** | **11,901**                      | ** ** | **13,978**                     | ** ** | **37,918** | ** ** | **35,537** | ** ** |
| **Operating expenses:**                                                                                                                                                                             | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selling, general and administrative**                                                                                                                                                             | ** ** | **11,281**                      | ** ** | **9,572**                      | ** ** | **27,938** | ** ** | **22,793** | ** ** |
| **Research and development**                                                                                                                                                                        | ** ** | **1,910**                       | ** ** | **1,460**                      | ** ** | **4,866** | ** ** | **3,951** | ** ** |
| **Litigation related charges**                                                                                                                                                                      | ** ** | **773**                         | ** ** | **—**                     | ** ** | **773** | ** ** | **—** | ** ** |
| **Total operating expenses**                                                                                                                                                                        | ** ** | **13,964**                      | ** ** | **11,032**                     | ** ** | **33,577** | ** ** | **26,744** | ** ** |
| ** **                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income (loss) from operations**                                                                                                                                                                   | ** ** | **(2,063**                      | **)**      | **2,946**                      | ** ** | **4,341** | ** ** | **8,793** | ** ** |
| **Other income (expense):**                                                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Interest income**                                                                                                                                                                                 | ** ** | **162**                         | ** ** | **73**                         | ** ** | **399** | ** ** | **228** | ** ** |
| **Interest expense**                                                                                                                                                                                | ** ** | **—**                      | ** ** | **(6**                         | **)**      | **—** | ** ** | **(13** | **)** |
| **Other income (expense), net**                                                                                                                                                                     | ** ** | **(93**                         | **)**      | **(14**                        | **)**      | **25** | ** ** | **398** | ** ** |
| **Total other income**                                                                                                                                                                              | ** ** | **69**                          | ** ** | **53**                         | ** ** | **424** | ** ** | **613** | ** ** |
| **Income (loss) from continuing operations  before income taxes**                                                                                                                                   | ** ** | **(1,994**                      | **)**      | **2,999**                      | ** ** | **4,765** | ** ** | **9,406** | ** ** |
| ** **                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Benefit (Provision) for income taxes**                                                                                                                                                            | ** ** | **638**                         | ** ** | **(1,039**                     | **)**      | **(1,525** | **)** | **(3,215** | **)** |
| ** **                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income (loss) from continuing operations**                                                                                                                                                        | ** ** | **(1,356**                      | **)**      | **1,960**                      | ** ** | **3,240** | ** ** | **6,191** | ** ** |
| **Discontinued operations:**                                                                                                                                                                        | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Loss from discontinued Skin Care Center  operations of $473 less income tax benefit of $175**                                                                                                     | ** ** | **—**                      | ** ** | **—**                     | ** ** | **—** | ** ** | **(298** | **)** |
| **Gain (loss) on closure of skin care center  including revision of leasehold obligations of $1,374 and provision of  $(3,348) less income tax expense of $(515) and income tax benefit of $1,253** | ** ** | **—**                      | ** ** | **—**                     | ** ** | **859** | ** ** | **(2,095** | **)** |
| **Net (loss) income**                                                                                                                                                                               | ** ** | **$**                           | **(1,356** | **)**                          | **$**      | **1,960** | ** ** | **$** | **4,099** | ** ** | **$** | **3,798** | ** ** |
| **Net income (loss) per share of common stock**                                                                                                                                                     | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income (loss) from continuing operations**                                                                                                                                                        | ** ** | **$**                           | **(.06**   | **)**                          | **$**      | **.09** | ** ** | **$** | **.14** | ** ** | **$** | **.28** | ** ** |
| **Gain (loss) from discontinued operations**                                                                                                                                                        | ** ** | **—**                      | ** ** | **—**                     | ** ** | **.04** | ** ** | **(.11** | **)** |
| **Net income**                                                                                                                                                                                      | ** ** | **$**                           | **(.06**   | **)**                          | **$**      | **.09** | ** ** | **$** | **.18** | ** ** | **$** | **.17** | ** ** |
| **Diluted:**                                                                                                                                                                                        | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Income from continuing operations**                                                                                                                                                               | ** ** | **$**                           | **(.06**   | **)**                          | **$**      | **.09** | ** ** | **$** | **.14** | ** ** | **$** | **.27** | ** ** |
| **Gain (loss) from discontinued operations**                                                                                                                                                        | ** ** | **—**                      | ** ** | **—**                     | ** ** | **.04** | ** ** | **(.10** | **)** |
| **Net income**                                                                                                                                                                                      | ** ** | **$**                           | **(.06**   | **)**                          | **$**      | **.09** | ** ** | **$** | **.18** | ** ** | **$** | **.17** | ** ** |
| ** **                                                                                                                                                                                          | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic weighted average shares outstanding**                                                                                                                                                       | ** ** | **22,408**                      | ** ** | **22,150**                     | ** ** | **22,366** | ** ** | **21,759** | ** ** |
| **Diluted weighted average shares outstanding**                                                                                                                                                     | ** ** | **22,408**                      | ** ** | **23,016**                     | ** ** | **23,062** | ** ** | **22,601** | ** ** |

 

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

 

4

----

 

**CANDELACORPORATION**

**Consolidated Statements of Cash Flows**

(in thousands)

(unaudited)

 
| ** **                                                                                               | ** ** | **For the nine months ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                               | ** ** | **April 2,  2005**        | ** ** | **March 27,  2004** | ** ** |
| **Cash flows from operating activities:**                                                                | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Net income**                                                                                           | ** ** | **$**                          | **4,099**  | ** ** | **$** | **3,798** | ** ** |
| **Adjustments to reconcile net income to net  cash  provided by (used for) operating  activities:** | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **(Revision of) provision for disposal of  discontinued operations**                                     | ** ** | **(1,374**                     | **)**      | **2,095** | ** ** |
| **Depreciation and amortization**                                                                        | ** ** | **556**                        | ** ** | **471** | ** ** |
| **Provision for bad debts**                                                                              | ** ** | **908**                        | ** ** | **754** | ** ** |
| **Effect  of exchange rate changes on foreign currency  denominated assets and liabilities**        | ** ** | **(35**                        | **)**      | **15** | ** ** |
| **Increase (decrease) in cash from working  capital:**                                                   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Accounts receivable**                                                                                  | ** ** | **(632**                       | **)**      | **(5,549** | **)** |
| **Notes receivable**                                                                                     | ** ** | **(571**                       | **)**      | **596** | ** ** |
| **Inventories**                                                                                          | ** ** | **976**                        | ** ** | **(4,430** | **)** |
| **Other current assets**                                                                                 | ** ** | **1,072**                      | ** ** | **(827** | **)** |
| **Other assets**                                                                                         | ** ** | **373**                        | ** ** | **(278** | **)** |
| **Accounts payable**                                                                                     | ** ** | **2,268**                      | ** ** | **(503** | **)** |
| **Accrued payroll and related expenses**                                                                 | ** ** | **(1,540**                     | **)**      | **(960** | **)** |
| **Deferred revenue**                                                                                     | ** ** | **1,598**                      | ** ** | **408** | ** ** |
| **Accrued warranty costs**                                                                               | ** ** | **98**                         | ** ** | **1,226** | ** ** |
| **Income taxes payable**                                                                                 | ** ** | **229**                        | ** ** | **(665** | **)** |
| **Long term portion of deferred revenue**                                                                | ** ** | **1,146**                      | ** ** | **(693** | **)** |
| **Loss from discontinued operations**                                                                    | ** ** | **—**                     | ** ** | **298** | ** ** |
| **Other accrued liabilities**                                                                            | ** ** | **710**                        | ** ** | **1,111** | ** ** |
| **Change in restricted cash**                                                                            | ** ** | **32**                         | ** ** | **—** | ** ** |
| **Net cash provided by (used for) operating  activities**                                                | ** ** | **9,913**                      | ** ** | **(3,133** | **)** |
| ** **                                                                                               | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash flows from investing activities:**                                                                | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Purchases of property and equipment**                                                                  | ** ** | **(553**                       | **)**      | **(193** | **)** |
| **Net cash used for investing activities**                                                               | ** ** | **(553**                       | **)**      | **(193** | **)** |
| ** **                                                                                               | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Cash flows from financing activities:**                                                                | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Proceeds from the issuance of common stock**                                                           | ** ** | **501**                        | ** ** | **3,277** | ** ** |
| **Net cash provided by financing activities**                                                            | ** ** | **501**                        | ** ** | **3,277** | ** ** |
| ** **                                                                                               | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Effect of exchange rates on cash and cash  equivalents**                                               | ** ** | **302**                        | ** ** | **314** | ** ** |
| ** **                                                                                               | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Net increase in cash and cash equivalents**                                                            | ** ** | **10,163**                     | ** ** | **265** | ** ** |
| **Cash and cash equivalents at beginning of  period**                                                    | ** ** | **37,139**                     | ** ** | **31,870** | ** ** |
| **Cash and cash equivalents at end of period**                                                           | ** ** | **$**                          | **47,302** | ** ** | **$** | **32,135** | ** ** |

* *

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

 

5

----

* *

Candela Corporation

Notes to Consolidated Financial Statements

 

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

 

The accompanying unaudited consolidatedfinancial statements and notes do not include all of the disclosures made inthe Annual Report on Form 10-K of Candela Corporation (the “Company”,or “Candela”) for fiscal year 2004, which should be read in conjunction withthese financial statements.  Thefinancial information included herein is unaudited, with the exception of theconsolidated balance sheet as of July 3, 2004, which was derived from theaudited consolidated balance sheet dated July 3, 2004. 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 thethree and nine-month periods ended April 2, 2005 are not necessarilyindicative of the results to be expected for the full year.

 

**2.****                           ****Litigation Related Charges**

 

On February 17th 2005, an arbitratorissued an interim decision in the dispute concerning Candela’s royaltyobligations under its Amended and Restated License Agreement with The Regentsof the University of California (the “Regents”). In connection with thisinterim decision the Company recognized charges of approximately $5.6 millionduring the third fiscal quarter of 2005. These charges consist of thesettlement of prior year royalty claims made by the Regents against the Companyof approximately $3.4 million, royalty claims for the Company’s first andsecond fiscal quarters of 2005 of approximately $0.5 and $0.9 million,respectively, and $0.8 million in attorney fees, interest, and professionalcosts as reimbursement of those charges to the Regents as required by theaforementioned license agreement. The royalty charges have been listed as aseparate line under cost of goods sold on the accompanying income statement.All other charges have been listed as a separate line within operatingexpenses. The arbitrator will issue a final decision with actual damages afterhe reviews further post-arbitration submissions by the parties as to the finalcalculation of damages. The Company presently expects that, based on the chargesthat it has already recorded in connection with the interim judgment, thatthere will not likely be any material additional charges related to this matterin future periods.

 

**3.****                            DiscontinuedOperations**

 

On September 27, 2003 management initiated aplan to close its only remaining skin care center. The closure is accounted foras a discontinued operation in accordance with Statement of FinancialAccounting Standards (“SFAS”) 144 “*Accounting for theImpairment or Disposal of Long-Lived Assets*” and SFAS 146 “*Accounting for Costs Associated with Exit or Disposal Activities*”.As a result, in the fiscal quarter ended September 27, 2003, the Companyrecorded a $2,095 charge for the accrual of $3,000 of future occupancy costs,primarily relating to future lease payments for the Boston facility, and $348of severance obligations and other related costs of closure, net of anticipatedtax benefits of $1,253. Approximately 45 positions have been eliminated as aresult of this restructuring plan, all 45 employees have been terminated.

 

During the three-month period ended October 2,2004, the landlord for the Boston facility secured a sublease for thatproperty.  The Company was not able todetermine the future economic benefit of the sublease at that time. Thesublessee commenced making payments to the landlord during December of2004.  As a result of these and futurepayments scheduled under the sublease, the Company revised the estimated futurecosts associated with the Boston facility and, in the quarter ended January 1,2005, reversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublesseepayments of $1,703, net of legal and other fees of approximately $329 andincome taxes of approximately $515, and was recognized in the three-monthperiod ended January 1, 2005.

 

6

----

 

**3.****                            DiscontinuedOperations, continued.**

 

The following table reflects the combinedrestructuring charges incurred in the nine month period ended April 2,2005:

 
| **(in thousands)**                                                | ** ** | **Leasehold  Improvements  and Fixed  Assets** | ** ** | **Facility  Costs** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------|------------|---------------------|------------|-----------|------------|
| **Balance at July 3, 2004**                                  | ** ** | **$**                                          | **197**    | ** **          | **$**      | **2,809** | ** ** | **$** | **3,006** | ** ** |
| **Reduction of reserve due to cash payments**                     | ** ** | ** **                                     | ** ** | **415**             | ** ** | **415**   | ** ** |
| **Non-cash amortization relating to the  Scottsdale reserve**     | ** ** | **75**                                         | ** ** | **—**          | ** ** | **75**    | ** ** |
| **Reduction of reserve due to revision of  leasehold obligation** | ** ** | **—**                                     | ** ** | **1,374**           | ** ** | **1,374** | ** ** |
| **Balance at April 2, 2005**                                      | ** ** | **$**                                          | **122**    | ** **          | **$**      | **1,020** | ** ** | **$** | **1,142** | ** ** |

 

At April 2, 2005, the discontinued segment hada net liability of approximately $1.9 million consisting primarily of theaforementioned reserve of $1.1 million and deferred gift certificate revenue of$0.8 million. Revenues for discontinued operations for the quarter ended September 27,2003 were approximately $0.4million. There have been no subsequent revenues.

 

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

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement No. 123R, “Share-Based Payment” (“FAS 123R”). FAS 123R is arevision of FASB Statement No. 123, “Accounting for Stock-BasedCompensation” (“FAS 123”). The Company is required to adopt the provisions ofFAS123R as of the beginning of its first fiscal quarter of 2006, beginning July 3,2005. This statement establishes standards for and requires the recognition ofthe cost of employment-related services settled in share-based payment. Theadoption of the provisions of FAS 123R will have a material impact on theCompany’s consolidated financial statements.

 

Currentlyand until the adoption of FAS 123R, the Company follows the provisions of FAS123. The provisions of FAS 123 allow companies to either expense the estimatedfair value of stock options or to continue to follow the intrinsic value methodset forth in Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB 25”), but disclose the pro forma effects onnet income (loss) had the fair value of the options been expensed. Candelahas elected 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. Forawards that 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

----

 

**4.****                            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 changed tothe pro forma amounts indicated below:

 
| ** **                                                                                                                                         | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|
| **(in thousands, excepts per share data)**                                                                                                         | ** ** | **April 2,  2005**         | ** ** | **March 27,  2004**       | ** ** | **April 2,  2005** | ** ** | **March 27,  2004** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net (loss) income , as reported**                                                                                                                | ** ** | **$**                           | **(1,356** | **)**                          | **$**      | **1,960** | ** ** | **$** | **4,099** | ** ** | **$** | **3,798** | ** ** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Add: stock-based employee compensation  expense included in reported net income (loss), 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** | ** ** | **(118**                        | **)**      | **(969**                       | **)**      | **(407** | **)** | **(731** | **)** |
| ** **                                                                                                                                         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Pro forma net income (loss)**                                                                                                                    | ** ** | **$**                           | **(1,474** | **)**                          | **$**      | **991** | ** ** | **$** | **3,692** | ** ** | **$** | **3,067** | ** ** |
| **Net income (loss) per share of common stock**                                                                                                    | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic - as reported**                                                                                                                            | ** ** | **$**                           | **(0.06**  | **)**                          | **$**      | **0.09** | ** ** | **$** | **0.18** | ** ** | **$** | **0.17** | ** ** |
| **Basic - pro forma**                                                                                                                              | ** ** | **$**                           | **(0.07**  | **)**                          | **$**      | **0.04** | ** ** | **$** | **0.17** | ** ** | **$** | **0.14** | ** ** |
| **Diluted - as reported**                                                                                                                          | ** ** | **$**                           | **(0.06**  | **)**                          | **$**      | **0.09** | ** ** | **$** | **0.18** | ** ** | **$** | **0.17** | ** ** |
| **Diluted - pro forma**                                                                                                                            | ** ** | **$**                           | **(0.06**  | **)**                          | **$**      | **0.04** | ** ** | **$** | **0.16** | ** ** | **$** | **0.14** | ** ** |

 

Incomputing this pro-forma amount, the Company has used the Black-Scholes pricingmodel using the following assumptions for options granted in fiscal years 2005and 2004:

 
| ** **                                      | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| **Risk-free interest rate**                     | ** ** | **4.25**   | **%**      | **4.25**   | **%**      |
| **Estimated volatility**                        | ** ** | **77**     | **%**      | **76**     | **%**      |
| **Expected life for stock options (yrs)**       | ** ** | **2.99**   | ** ** | **2.99**   | ** ** |
| **Expected life for stock purchase plan (yrs)** | ** ** | **0.5**    | ** ** | **0.5**    | ** ** |
| **Expected dividends**                          | ** ** | **—** | ** ** | **—** | ** ** |

 

**5.****                            EarningsPer Share**

 

Basic earnings per share is computed bydividing net income by the weighted average number of shares of common stockoutstanding for the period and, if there are dilutive securities, dilutedearnings per share is computed by including common stock equivalentsoutstanding for the period in the denominator.

 

8

----

 

**5.****                            EarningsPer Share, continued.**

 

Common stock equivalents include sharesissuable upon the exercise of stock options or warrants, net of shares assumedto have been purchased with the proceeds, using the treasury stock method.

 
| ** **                                                                               | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|
| **(in thousands, except per share  data)**                                               | ** ** | **April 2,  2005**         | ** ** | **March 27,  2004**       | ** ** | **April 2,  2005** | ** ** | **March 27,  2004** | ** ** |
| ** **                                                                               | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic shares used in the calculation of  earnings per share**                          | ** ** | **22,408**                      | ** ** | **22,150**                     | ** ** | **22,366** | ** ** | **21,759** | ** ** |
| ** **                                                                               | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Effect of dilutive securities:**                                                       | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Stock options**                                                                        | ** ** | **—**                      | ** ** | **866**                        | ** ** | **696** | ** ** | **842** | ** ** |
| **Stock warrants**                                                                       | ** ** | **—**                      | ** ** | **—**                     | ** ** | **—** | ** ** | **—** | ** ** |
| ** **                                                                               | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Diluted shares used in the calculation of  earnings per share**                        | ** ** | **22,408**                      | ** ** | **23,016**                     | ** ** | **23,062** | ** ** | **22,601** | ** ** |
| ** **                                                                               | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per share effect of dilutive securities on  income (loss) from continuing operations** | ** ** | **$**                           | **.00**    | ** **                     | **$**      | **.00** | ** ** | **$** | **.00** | ** ** | **$** | **.01** | ** ** |
| ** **                                                                               | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Per share effect of dilutive securities on  net income (loss)**                        | ** ** | **$**                           | **.00**    | ** **                     | **$**      | **.00** | ** ** | **$** | **.00** | ** ** | **$** | **.00** | ** ** |

 

During the nine month period ended April 2,2005, options to purchase 360,265 shares of common stock were excluded from thecalculation of diluted earnings per share because the exercise price of suchoptions was greater than the average market price of the common stock for theperiod.  During the three month periodended April 2, 2005, options to purchase 1,015,038 shares of common stockwere excluded from the calculation of diluted earnings per share since theireffect would be anti-dilutive due to the Company’s net loss for the period.During the three and nine month periods ended March 27, 2004, options topurchase 217,625 and 125,518 shares of common stock, respectively, wereexcluded from the calculation of diluted earnings per share because theexercise price of such options was greater than the average market price of thecommon stock for the period.

 

**6.****                           ****Comprehensive Income**

 

Componentsof comprehensive income (loss) include net income (loss) and certaintransactions that have generally been reported in the consolidated statement ofstockholders’ equity.

 
| ** **                                  | ** ** | **For the three months ended:** | ** ** | **For the nine months ended:** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|
| **(in thousands)**                          | ** ** | **April 2,  2005**         | ** ** | **March 27,  2004**       | ** ** | **April 2,  2005** | ** ** | **March 27,  2004** | ** ** |
| **Net income (loss)**                       | ** ** | **$**                           | **(1,356** | **)**                          | **$**      | **1,960** | ** ** | **$** | **4,099** | ** ** | **$** | **3,798** | ** ** |
| **Foreign currency translation adjustment** | ** ** | **(898**                        | **)**      | **(58**                        | **)**      | **125** | ** ** | **637** | ** ** |
| **Total comprehensive income (loss)**       | ** ** | **$**                           | **(2,254** | **)**                          | **$**      | **1,902** | ** ** | **$** | **4,224** | ** ** | **$** | **4,435** | ** ** |

 

9

----

 

**7.****                            Inventories**

 
| **(in thousands)**  | ** ** | **April 2,  2005** | ** ** | **July 3,  2004** | ** ** |
|---------------------|------------|-------------------------|------------|------------------------|------------|
| ** **          | ** ** | ** **              | ** ** | ** **             | ** ** |
| **Raw materials**   | ** ** | **$**                   | **2,918**  | ** **             | **$**      | **4,833** | ** ** |
| **Work in process** | ** ** | **70**                  | ** ** | **556**                | ** ** |
| **Finished goods**  | ** ** | **9,827**               | ** ** | **8,182**              | ** ** |
| ** **          | ** ** | **$**                   | **12,815** | ** **             | **$**      | **13,571** | ** ** |

 

**8.****                            SegmentInformation**

 

The Company operates in one industry segment:the design, manufacture, sale, and service of medical devices and relatedequipment. The results in this segment have been presented in the ConsolidatedStatements of Operations for the appropriate periods.

 

**9.         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 thenine-month period ended April 2, 2005:

 
| **(in thousands)**                             | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------|------------|
| **Beginning balance July 3, 2004**        | ** ** | **$**      | **8,257**  | ** ** |
| **Plus accruals related to new sales**         | ** ** | **4,196**  | ** ** |
| **Less amortization of prior period accruals** | ** ** | **4,513**  | ** ** |
| **Ending balance on April 2, 2005**       | ** ** | **$**      | **7,940**  | ** ** |

 

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

 

10

----

 

**9.         Guarantees,continued.**

 

The followingtable reflects changes in the Company’s deferred revenue account during thenine-month period ended April 2, 2005:

 
| **(in thousands)**                              | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|------------|------------|
| **Beginning balance July 3, 2004**         | ** ** | **$**      | **4,055**  | ** ** |
| **Plus deferral of new service contract sales** | ** ** | **7,015**  | ** ** |
| **Less recognition of deferred revenue**        | ** ** | **3,792**  | ** ** |
| **Ending balance on April 2, 2005**        | ** ** | **$**      | **7,278**  | ** ** |

 

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

 

**10.****                    ****Commitments and Contingencies**

 

The Company has received demands for payment ofbankruptcy preference claims relating to payments the Company received in theordinary course of business prior to the bankruptcy of DVI Strategic PartnerGroup (DVI). The Company is in the process of researching the claims, but feelsthat no preferential treatment was bestowed upon it during the months leadingup to the aforementioned bankruptcy, and accordingly believes the demand iswithout merit.

 

From time to time, the Company is a party to variouslegal proceedings incidental to its business. Except for the bankruptcy preference claims in the DVI matter, theCompany believes that none of the legal proceedings that are presently pending,if adversely decided to the Company, will have a material adverse effect uponits financial position, results of operations, or liquidity.

 

11

----

 

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

 

**Critical Accounting Policies**

 

****This discussion and analysis of our financial condition andresults of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. We evaluate our estimates and judgments onan on-going basis, including those related to revenue recognition, bad debts,inventories, warranty obligations, contingencies, restructurings and incometaxes. We base our estimates and judgments on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying value of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates and judgmentsunder different assumptions or conditions. A discussion of our criticalaccounting policies and the related estimates and judgments affecting thepreparation of our consolidated financial statements is included in our AnnualReport on Form 10-K for fiscal year 2004.****

 

12

----

 

**Results of Operations**

 

***Revenue.***

 

Revenue source by geographic region is reflected in the followingtable:

 
| ** **          | ** ** | **For the three months ended:** | ** ** |
|---------------------|------------|---------------------------------|------------|
| **(in thousands)**  | ** ** | **April 2, 2005**          | ** ** | **March 27, 2004** | ** ** | **Change** | ** ** |
| ** **          | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US revenue**      | ** ** | **$**                           | **15,073** | ** ** | **43** | **%** | **$** | **12,975** | ** ** | **47** | **%** | **$** | **2,098** | ** ** | **16** | **%** |
| **Foreign revenue** | ** ** | **19,609**                      | ** ** | **57** | **%** | **14,675** | ** ** | **53** | **%** | **4,934** | ** ** | **34** | **%** |
| ** **          | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**   | ** ** | **$**                           | **34,682** | ** ** | **100** | **%** | **$** | **27,650** | ** ** | **100** | **%** | **$** | **7,032** | ** ** | **25** | **%** |

 

 
| ** **          | ** ** | **For the nine months ended:** | ** ** |
|---------------------|------------|--------------------------------|------------|
| ** **          | ** ** | **April 2, 2005**         | ** ** | **March 27, 2004** | ** ** | **Change** | ** ** |
| ** **          | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **US revenue**      | ** ** | **$**                          | **37,653** | ** ** | **44** | **%** | **$** | **32,069** | ** ** | **46** | **%** | **$** | **5,584** | ** ** | **17** | **%** |
| **Foreign revenue** | ** ** | **47,624**                     | ** ** | **56** | **%** | **38,165** | ** ** | **54** | **%** | **9,459** | ** ** | **25** | **%** |
| ** **          | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**   | ** ** | **$**                          | **85,277** | ** ** | **100** | **%** | **$** | **70,234** | ** ** | **100** | **%** | **$** | **15,043** | ** ** | **21** | **%** |

 

ConsolidatedOverview

 

Consolidatedrevenue increased $7.0 and $15.0 million, to $34.7 and $85.3 million for thethree and nine-month periods, respectively, ended April 2, 2005, ascompared to the three and nine-month periods ended March 27, 2004. Theincrease was due primarily to uniform increase in demand for our products andproduct-related service on a worldwide basis, coupled with our continuedexpansion into newer markets.

 

Foreignrevenue increased 34% or $4.9 million for the three-month period ended April 2,2005, as compared to the three-month period ended March 27, 2004. Revenuein South America, Europe and Asia increased approximately $2.1, $1.7 and $1.1million, respectively as compared to the same period in the prior year.

 

Foreignrevenue increased 25% or $9.5 million for the nine-month period ended April 2,2005, as compared to the nine-month period ended March 27, 2004.Year-to-date foreign revenue increased across all countries.  Year-to-date revenue in Europe increasedapproximately $3.9 million accounting for 26% of this comparative increasewhile revenue in South America increased over 500 percent, accounting forapproximately $3.6 million or 24% of the year over year comparative increase.Increases in Asia totaled approximately $2.0 million or approximately 13% ofthe year-to-date, period over period increase.

 

USrevenue increased by $2.1 and $5.6 million, respectively, for the three andnine month periods ended April 2, 2005, as compared to the same periodsduring the prior fiscal year. This increase was generally uniform over all USsales territories.

 

13

----

 

Revenue source by type is reflected in the following table:

 
| ** **                    | ** ** | **For the three months ended:** | ** ** |
|-------------------------------|------------|---------------------------------|------------|
| **(in thousands)**            | ** ** | **April 2, 2005**          | ** ** | **March 27, 2004** | ** ** | **Change** | ** ** |
| **Revenue**                   | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers and other products** | ** ** | **$**                           | **28,483** | ** ** | **82** | **%** | **$** | **23,509** | ** ** | **85** | **%** | **$** | **4,974** | ** ** | **21** | **%** |
| **Product-related service**   | ** ** | **6,199**                       | ** ** | **18** | **%** | **4,141** | ** ** | **15** | **%** | **2,058** | ** ** | **50** | **%** |
| ** **                    | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**             | ** ** | **$**                           | **34,682** | ** ** | **100** | **%** | **$** | **27,650** | ** ** | **100** | **%** | **$** | **7,032** | ** ** | **25** | **%** |

 
| ** **                    | ** ** | **For the nine months ended:** | ** ** |
|-------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **April 2, 2005**         | ** ** | **March 27, 2004** | ** ** | **Change** | ** ** |
| **Revenue**                   | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Lasers and other products** | ** ** | **$**                          | **70,365** | ** ** | **83** | **%** | **$** | **58,769** | ** ** | **84** | **%** | **$** | **11,591** | ** ** | **20** | **%** |
| **Product-related service**   | ** ** | **14,912**                     | ** ** | **17** | **%** | **11,465** | ** ** | **16** | **%** | **3,452** | ** ** | **30** | **%** |
| ** **                    | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total revenue**             | ** ** | **$**                          | **85,277** | ** ** | **100** | **%** | **$** | **70,234** | ** ** | **100** | **%** | **$** | **15,043** | ** ** | **21** | **%** |

 

Laser and other product revenue increasedapproximately $5.0 million for the three month period ended April 2, 2005,as compared to the three month period ended March 27, 2004. Revenues fromsales of our GentleLaseTM product line increased approximately $2.4 millionduring this period to account for almost 50% of this incremental increase.  In addition, the EllipseTM product line launched during the quarteraccounted for $0.9 million in incremental revenue while the GentleYagTM,AlexTM, and VBeamTM product lines added revenue increases of $0.9 million, $0.7million, $0.6 million respectively. These increases were partially offset by areduction in revenue from sales of the SmoothbeamTM product line.

 

Product-related service increased $2.1 millionduring the third fiscal quarter as compared to the same period in the prioryear. This increase was primarily due to the growing size of our installed baseand the larger number of service contracts associated with that base. Inaddition, several foreign distributors made larger than normal consumablepurchases during the quarter.

 

Laser and other product revenue increasedapproximately $11.6 million for the nine month period ended April 2, 2005,compared to the nine month period ended March 27, 2004. This year overyear increase was driven primarily by the introduction of the GentleYagTMproduct line which was launched during the third quarter of fiscal 2004 and theintroduction of the EllipseTM product line during the third quarter of fiscal2005. These two product lines accounted for approximately $10.7 million and$0.9 million, respectively, of the increase. The legacy product lines had mixed results but together did notincrementally add to the period over period increase.

 

Product-related service increased $3.5 millionfor the nine month period ended April 2, 2005, compared to the nine monthperiod ended March 27, 2004. This increase was primarily due to thegrowing size of our installed base and the larger number of service contractsassociated with that base.

 

***Litigation Related Charges.  ***On February 17th 2005, anarbitrator issued an interim decision in the dispute concerning our royaltyobligations under our Amended and Restated License Agreement with The Regentsof the University of California (the “Regents”). In connection with thisinterim decision we recognized charges of approximately $5.6 million during thecurrent fiscal quarter. These charges consist of the settlement of prior yearroyalty claims made by the Regents against the Company of approximately $3.4million, royalty claims for our first and second fiscal quarters of 2005 ofapproximately $0.5 and $0.9 million, respectively, and $0.8 million in attorneyfees, interest, and professional costs as reimbursement of those charges to theRegents as required by the aforementioned license agreement. The royaltycharges have been listed as a separate line under cost of goods sold. All othercharges have been listed as a separate line within operating expenses. The arbitratorwill issue a final decision with actual damages after he reviews furtherpost-arbitration submissions by the parties as to the final calculation ofdamages. The Company presently expects that, based on the charges that it hasalready recorded in connection with the interim judgment, that there will notlikely be any material additional charges related to this matter in futureperiods. As a result of the arbitrator's interim ruling, Candela will incurroyalty obligations to the Regents on future sales of the DCD at a higherroyalty rate than it has recognized on DCD sales over the past few years.

 

14

----

 

***Gross Profit. ***Excludinglitigation-related charges, gross profit increased approximately $2.8 millionor 20% for the three month period ended April 2, 2005, compared to thesame period in the prior fiscal year. As a percentage of revenue, gross profitexcluding litigation-related charges decreased approximately 2.3% during thecurrent quarter as compared to the same period in the prior fiscal year. Thisis primarily due to the new method by which the company calculates its royaltyexpense associated with the DCD cooling device licensed from a third party andcarried as an accessory on some of the Company’s laser systems. Gross profitincreased approximately $7.2 million or 20% for the nine month period ended April 2,2005, compared to the same period one year earlier.  The overall increases in gross profitexcluding litigation-related charges result principally from the increase insales volume.

 

***Selling, General and AdministrativeExpense. ***Selling,general and administrative expenses increased to approximately $11.3 millionfor the three-month period ended April 2, 2005 from approximately $9.6million for the three-month period ended March 27, 2004. The increase wasprimarily due to an increase in the provision for doubtful accounts ofapproximately $0.8 million, increased marketing program spending ofapproximately $0.6 million, and increased audit, legal and professional fees ofapproximately $0.3 million, owing to the recently completed arbitration caseand the ongoing Sarbanes Oxley compliance testing.  As a percentage of quarterly revenue,selling, general and administrative expenses decreased to 32% from 34% ofrevenues for the same respective period in the prior year. For the nine-monthperiod ended April 2, 2005, selling, general and administrative expensesincreased to approximately $27.9 million from approximately $22.8 million forthe nine-month period ended March 27, 2004. The increase in selling,general and administrative expenses is due primarily from the aforementionedincrease in the provision for doubtful accounts, increased legal expense due tothe recently completed arbitration case, employee related costs in the salesdepartment and increased marketing expense on a period over period basis. As apercentage of revenue, current year selling, general and administrativeexpenses remained stable as compared to the same nine-month period one yearearlier, increasing slightly to 32.8% from 32.5% of revenues.

 

***Research and Development Expense.***    Research and development spending increasedto $1.9 million for the three-month period ended April 2, 2005 from $1.5for the three-month period ended March 27, 2004 due primarily to anincrease in the number of active projects and an increase in employee costs.Spending in this area increased to $4.9 million for the nine-month period endedApril 2, 2005 from $4.0 for the nine-month period ended March 27, 2004due primarily to the aforementioned increase in project spending and anincrease in employee-related costs.

 

***Other Income/Expense. ***Net other incomefor the period and year to date did not change substantially from the prioryear and principally represents interest income on cash holdings.

 

***Income Taxes.***The provision for income taxes results from a combination of activities of boththe domestic and foreign subsidiaries of the Company.  Excluding discontinued operations, werecorded a 32% effective tax rate for the three-month period ended April 2,2005, which brought our nine-month effective tax rate to approximately32%.  This compares to the three-monthperiod ended March 27, 2004, in which we recorded a 34% effective rate,which brought our nine-month effective tax rate to approximately 32%.  The provision for income taxes differs fromthe U.S. statutory rate as a result of tax provisions calculated for incomegenerated by foreign subsidiaries at a rate that differs from the U.S.statutory rate.

 

15

----

 

**Discontinued Operations**

 

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 three months ended October 2, 2004 and all priorfinancial statements have been restated to reflect skin care center operationsas discontinued.  During the three-monthperiod ended October 2, 2004, the landlord for the Boston facility secureda sublease for that property.  TheCompany was not able to determine the future economic benefit of the subleaseat that time. The sublessee commenced making payments to the landlord during December of2004.  As a result of these and futurepayments scheduled under the sublease, the Company revised the estimated futurecosts associated with the Boston facility and, in the quarter ended January 1,2005, reversed approximately $859 of the restructuring reserve. This reversalrepresents the aforementioned anticipated economic benefit due to sublesseepayments of $1,703, net of legal and other fees of approximately $329 andincome taxes of approximately $515, and was recognized in the three-monthperiod ended January 1, 2005.

 

The Company believes that the size of the remaining accrual issufficient to cover all future leasehold expenses for the remainder of thelease term. These expenses could potentially increase if the sublessee were notto honor its obligation.

 

**Liquidity and Capital Resources**

 

Cash provided by operating activities amounted to $9.9 million for thenine months ended April 2, 2005, in comparison to cash used in operatingactivities of $3.1 million for the same period in the prior year. This increasein cash provided by operating activities primarily reflects collection ofoutstanding accounts receivable and increased inventory turns. Cash used byinvesting activities reflected the purchase of vans to better equip our salesforce during the nine months ended April 2, 2005, compared to the sameperiod in the prior year.  Cash providedby financing activities amounted to $0.5 million for the nine-months ended April 2,2005 in comparison to cash provided of $3.3 million for the same period duringthe prior year.  The decrease reflects areduction in proceeds for the issuance of stock by the corporation, primarilyto employees under the existing stock option plan.

 

Our outstanding contractual obligations as of April 2, 2005, arereflected 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** | ** ** | **$**     | **2,647**  | ** **                        | **$**      | **1,005**                 | ** ** | **$**                     | **1,273**  | ** **                            | **$**      | **274** | ** ** | **$** | **95** | ** ** |
|                      |            |           |            |                                   |            |                           |            |                           |            |                                       |            |  |  |  |  |  |

 

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 payment schedule establishedat the time funds are borrowed.  The lineof credit is unsecured.  The agreementcontains restrictive covenants limiting the establishment of new liens, and thepurchase of margin stock.  No amountswere outstanding under the line of credit as of April 2, 2005.

 

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.

 

16

----

 

**CautionaryStatements**

 

This Quarterly Report on Form 10-Q contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995.  Forward-looking statements arenot promises or guarantees and are subject to risks and uncertainties thatcould cause our actual results to differ materially from thoseanticipated.  Such statements may relateto, among other things, the future of the industry, product development,business strategy (including the possibility of future acquisitions),anticipated operational and capital expenditure levels, continued acceptanceand growth of our products, and dependence on significant customers andsuppliers.  Forward-looking statementsmay also include, without limitation, any statement relating to future events,conditions or circumstances or using words such as or similar to:  anticipate; believe; continue; could;estimate; expect; intend; plan; predict; project; may; or will.  The risks and uncertainties that may affectforward-looking statements and/or our business include, among others, thosediscussed in “Cautionary Statements” in our Annual Report filed on Form 10-Kfor the fiscal year ended July 3, 2004, as well as other risks anduncertainties referenced in this Quarterly Report.  These risks and uncertainties include, butare not limited to, the following:

 

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

 

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

 

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

 

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

 

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

 

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

 

•                  Claimsby others that our products infringe their patents or other intellectualproperty rights, or that the patents which we own or have licensed rights toare invalid, could prevent us from manufacturing and selling some of 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.

 

17

----

 

#### **CautionaryStatements, continued**

 

We caution readers not to place unduereliance upon any forward-looking statements, which speak only as of the datemade.  We expressly disclaim anyobligation or undertaking to release publicly any updates or revisions to anysuch statements to reflect any change in our expectations or any change inevents, conditions or circumstances on which any such statement is based.

 

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

 

Wehave foreign subsidiaries in Japan, Spain, France and Germany.  Approximately 56% of our revenues for thenine months ended April 2, 2005 were from operations outside the UnitedStates.  These subsidiaries transactbusiness in both local and foreigncurrency.  Therefore, we are exposed toforeign currency exchange risks and fluctuations in foreign currencies, whichcould adversely impact our results and financial condition.  However, sales from the United States madedirectly to customers or distributors in foreign countries are invoiced in U.S.dollars and are not exposed to foreign currency risk.

 

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

 

We have cash 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. Anevaluation was performed under the supervision and with the participation ofmembers of our management, including our Chief Executive Officer and our ChiefFinancial Officer, of the effectiveness of the design and operation of our “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934 Rule 13a-15(e))as of April 2, 2005 (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) Changesto internal control over financial reporting. There were no changes in our internal control over financial reportingduring the fiscal quarter ended April 2, 2005 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

18

----

 

**CANDELA CORPORATION**

 

**Part II. Other Information**

 

# **Item 1 - Legal Proceedings**

 

TheCompany has an Amended and Restated License Agreement (the “License”)with the Regents pursuant to which the Company licenses certain patent rightsto its dynamic cooling device (“DCD”) from the Regents.  The Company sells its DCD as a component partof its Smoothbeam® laser system and as an accessory to its other lasersystems.  In April of 2004, the Regents issueda notice of default under the License, asserting, among other things, that theCompany was in breach of the License for the alleged failure to make requiredroyalty payments and to make required disclosures.  The Regents’ April notice asserted that thetotal underpaid royalties, interest and other charges for the period fromAugust of 2000 through September 2003 are $1,128,000.  The Regents issued a subsequent notice ofdefault, dated June 30, 2004, relating to the quarterly periods ended December27, 2003 and March 27, 2004, for which the Regents asserted that the Companyunderpaid additional royalties amounting to $1,350,000.  The Regents issued a subsequent notice ofdefault, dated September 10, 2004, relating to the quarterly period ended July3, 2004, for which the Regents asserted that the Company underpaid additional royaltiesamounting to $990,000.

 

Under the License, disputes are to be settled by binding arbitrationthrough a mutually acceptable single arbitrator.  On June 14, 2004, the Company filed a Demandfor Arbitration to adjudicate the differing interpretations of the License heldby the Company and the Regents.  On July8, 2004, the Regents filed their response and counterclaim for breach ofcontract and declaratory relief.  Candeladeposited approximately $1.0 million in June of 2004, and an additional $1.0and $1.4 million in August and December, respectively, of 2004, into an escrowfund to be paid in whole or in part to the Company or the Regents as determinedby the arbitrator.

 

On February 17th, 2005, the arbitrator issued an interim decision inthe dispute concerning our royalty obligations under our Amended and RestatedLicense Agreement with the Regents.  Thearbitrator found in favor of the Regents as to the primary issue in thedispute, finding that we are obligated to pay royalties on the good faith listprices of our Sclero, SPTL, GentleLASE and GentleYAG laser systems when thosesystems are sold with DCDs, and not just on the good faith list prices of theDCDs for sale with those systems.  Thearbitrator denied the Regents’ request for the right to declare a forfeiture ofour license with the Regents.  Inconnection with this interim decision we recognized charges of approximately$5.6 million during the current fiscal quarter. These charges consist of the settlement of prior year royalty claimsmade by the Regents against the Company of approximately $3.4 million, royaltyclaims for our first and second fiscal quarters of 2005 of approxmately $0.5and $0.9 million, respectively, and $0.8 million in attorney fees, interest,and professional costs as reimbursement of those charges to the Regents asrequired by the aforementioned license agreement.  The royalty charges have been listed as aseperate line under cost of goods sold. All other charges have been listed as a separate line within operatingexpenses.  The arbitrator will issue afinal decision with actual damages after he reviews further post-arbitrationsubmissions by the parties as to the final calculation of damages.  The Company presently expects that, based onthe charges that it has already recorded in connection with the interim judgment,that there will not likely be any material additional charges related to thismatter in future periods.  As a result ofthe arbitrator’s interim ruling, Candela will incur royalty obligations to the Regentson future sales of DCD at a higher royalty rate than it has recognized on DCDsales over the past few years.

 

The Company has received demands for payment of bankruptcy preferenceclaims relating to payments the Company received in the ordinary course ofbusiness prior to the bankruptcy of DVI Strategic Partner Group (DVI).  The Company is in the process of researchingthe claims, but feels that no preferential treatment was bestowed upon itduring the months leading up to the aforementioned bankruptcy, and accordinglybelieves the demand is without merit.

 

Fromtime to time, the Company is a party to various legal proceedings incidental toits business.  Except for the bankruptcypreference claims in the DVI matter, the Company believes that none of thelegal proceedings that are presently pending, if adversely decided to theCompany, will have a material adverse effect upon its financial position,results of operations, or liquidity.

 

**ITEM 6 - Exhibits**

 

(a)                                  Exhibits

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

 

19

----

 

**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:  May 9, 2005 | /s/ F.  Paul Broyer |                                                                              |
|                    |                     | F. Paul  Broyer                                                                   |
|                    |                     | (Senior Vice  President, Finance and Administration  and Chief Financial Officer) |
|                         |                          |                                                                                   |  |  |

 

20

----

 

**CandelaCorporation**

 

**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 |

 

21

----