Part I

Item 1. Business.

Introduction

Candela Corporation (“Candela” or the “Company”) is a pioneer in the development and commercialization of advanced aesthetic laser and light-based systems that allow physicians and personal care practitioners to treat a wide variety of cosmetic and medical conditions including:

· permanent hair reduction on all skin types;

· skin rejuvenation, skin tightening and wrinkle reduction;

· vascular lesions such as rosacea, facial spider veins, leg veins, port wine stains, angiomas and hemangiomas;

· all-color tattoo removal;
skin resurfacing
scars, stretch marks and warts;

· removal of benign pigmented lesions such as sun spots, age spots, freckles, and Nevus of Ota/Ito;

· acne and acne scars;

· sebaceous hyperplasia;

· beard bumps (PFB);

· psoriasis; and,

· other cosmetic skin treatments.

Since our founding 37 years ago, we have continuously developed and enhanced applications for laser and light-based technology. In the mid-1980’s we began developing laser technology for medical applications, and since that time have shipped approximately 12,000 systems to over 70 countries. Since the early 1990’s we have focused our organizational resources on developing laser and light-based technology for use solely in cosmetic and aesthetic applications. Below is a sampling of Candela’s innovations in the laser and light-based technologies market:

· first laser system based on selective photothermolysis to treat cutaneous vascular lesions with minimal skin injury;

· first laser system to treat vascular lesions approved by the FDA for use on children;

· first Q-switched alexandrite laser for pigmented lesions and tattoos;

· first effective pulsed dye laser treatment of hemangiomas, scars and warts;

· first multi-wavelength long-pulse dye laser for treatment of leg telangiectasia (spider veins);

· first laser with a clearance for non-invasive treatment of acne and acne scars;

· first hair removal laser with integrated Dynamic Cooling Device (“DCD”);

· first pulsed dye laser with DCD for wrinkles;

· first DCD for epidermal protection in vascular lesion treatment;

· first to introduce “laser-pumped-laser” hand-piece technology for expended pigmented lesion and tattoo removal treatments (for which we have applied for a patent); and,

· first pain reduction device for aesthetic lasers and intense pulse light (“IPL”) systems.

Candela’s current product line offers comprehensive and technologically sophisticated cosmetic and aesthetic lasers and light-based systems used by physicians and personal care practitioners to treat a wide variety of cosmetic and medical conditions. Candela’s product line includes the following innovative products:

· GentleMax™—Multi-wavelength technology integrated aesthetic treatment workstation.

· AlexTriVantage™—The total tattoo and pigmented lesion solution using multi-wavelength technology in conjunction with our “laser-pumped-laser” hand piece technology.

· SmoothPeel™—Erbium: YAG laser—The simple choice for superior skin resurfacing.

· Serenity™—Revolutionary Pneumatic Skin Flattening™ (PSF™) technology that improves efficacy and safety while significantly reducing the pain associated with laser and IPL treatments.

· GentleLASE® family of lasers provides the highest power, speed, efficacy and ease-of-use in permanent hair reduction, vascular lesions, wrinkle reduction and the treatment of pigmented lesions.

· The GentleYAG® family of lasers provides fast, effective permanent hair reduction for every skin type including tanned or dark skin, treatment of pseudofolliculitis barbae (“PFB”), leg and facial veins, and skin tightening.

· The Vbeam® Perfecta, Platinum and Aesthetica family of lasers—Gold standard pulsed dye technology eliminates pigmentation, vascular lesions including port wine stain birthmarks, rosacea, leg and facial veins, skin rejuvenation by wrinkle reduction, scars, warts, psoriasis and hemangiomas.

· The Smoothbeam® diode laser, for treatment of acne and acne scars, sebaceous hyperplasia and non-ablative dermal remodeling of wrinkles.

The growth in the market for using aesthetic laser and light-based products is currently a worldwide phenomenon being driven by an increase in discretionary income of aging baby-boomers, which continues to create new opportunities for Candela. This market demographic places a premium on good health and personal appearance, and has demonstrated a willingness to pay for health and cosmetic products and services. In addition, continuous growth in the popularity of laser and light-based treatments among the general population is also spurring demand for Candela’s products. Last year, according to The American Society for Aesthetic Plastic Surgery, Americans spent an estimated $12.2 billion on approximately 11.5 million cosmetic procedures. In particular, lasers and light-based systems are proving an attractive alternative for eliminating unwanted hair. Laser hair-removal procedures were the second most frequent cosmetic procedure performed last year, second only to Botox injections.

Candela is dedicated to developing safe and effective products. Our aesthetic laser and light-based systems are further distinguished by being among the fastest, smallest and most affordable in their respective markets. We believe that we have the largest market share because of these product attributes and we are committed to continual innovation as we meet the needs of our markets.

Candela was incorporated in Massachusetts on October 22, 1970 and subsequently reincorporated in Delaware on July 1, 1985.

Industry Overview

Lasers and light-based devices use the unique characteristics of light to achieve precise and efficacious therapeutic effects, often in a non-invasive manner. The precise color, concentration, and controllability of different types of light provide for the delivery of a wide range of specialized treatments. First introduced in the 1960’s, the use of lasers for medical applications grew rapidly in the 1990’s as technical advances

made medical lasers more effective and reliable. Medical lasers and light-based devices are today used for numerous types of procedures falling into four broad categories: ophthalmic surgery, aesthetic and cosmetic procedures, general surgery, and dental procedures. Candela competes solely within the growing market for lasers and light-based devices for performing aesthetic and cosmetic procedures including:

· removal of unwanted hair;

· treatment of rosacea, facial veins and leg veins, red birthmarks, scars, stretch marks, and warts;

· facial rejuvenation and skin tightening to reduce the appearance of fine lines and wrinkles;

· removal of pigmented lesions such as sun spots, age spots, and freckles;

· treatment of acne and acne scars;

· treatment of psoriasis;

· treatment of Nevus of Ota and melasma;

· tattoo removal; and,

· skin resurfacing.

Lasers produce intense bursts of highly focused light to treat skin tissues. A laser’s wavelength (color), energy level, spot size and pulse width (exposure time) are optimized for the specific treatment. Light-based devices commonly referred to as intense pulsed light, feature a broad range of wavelength of light designed to target vascular and pigmentary targets for facial rejuvenation procedures. Hair removal and the treatment of various leg vein malformations require the deepest laser penetration for successful treatment while scars and red birthmarks (port wine stains and hemangiomas) require less laser penetration. Pigmented lesions such as sun spots, age spots and tattoos are typically surface conditions that require the least amount of penetration. Different conditions may require the use of different types of lasers or light-based devices with specific power requirements and optimized operating parameters. An active aesthetic practice addressing a broad range of cosmetic procedures may need multiple lasers and light-based devices.

We believe the aesthetic and cosmetic laser industry is now in an era of broad-based growth. The major factors converging to drive this growth are:

· medical practitioners desire to drive additional revenue into their practices due to the increasing reduction in insurance reimbursement;

· the discretionary income of aging baby boomers;

· the increased general acceptance of aesthetic and cosmetic laser treatments; and,

· the development of technology that allows for new, effective, pain free and economic procedures for conditions with large patient populations.

Aesthetic and cosmetic device vendors, who are able to deliver lasers and light-based systems that are efficacious, cost effective, reliable, and easy to use, will be well positioned to take advantage of such broad-based industry growth.

Managed care and reimbursement restrictions in the United States, and similar constraints outside the United States, such as socialized medicine, are motivating practitioners to emphasize aesthetic and cosmetic procedures that are delivered on a private, fee-for-service basis. While cosmetic procedures were once the domain of plastic surgeons and dermatologists, reimbursement reductions coupled with the reliable revenue stream from private-pay procedures have piqued the interest of other specialties,

including general practitioners, family care practitioners, obstetricians and gynecologists, and general and vascular surgeons.

Key technical developments required for the broader cosmetic laser and light-based treatment markets relate to ease-of-use, speed, lower costs, safety, and effective elimination of undesirable side effects. These factors are critical for broader segments of practitioners who wish to build aesthetic and cosmetic laser and light-based treatment practices. These factors are also important for minimizing the disruption of a patient’s normal routine and for building demand for procedures addressing very large patient populations.

Business Strategy

Candela believes that a convergence of price, performance and technology is occurring in the aesthetic and cosmetic laser industry, driving market expansion. We believe we have the necessary infrastructure in place to capitalize on this expansion. Candela’s objective is to continue to be the leading provider of aesthetic and cosmetic lasers and light-based devices by using its proprietary technology and expertise in light and tissue interaction, as well as by developing market-oriented products that utilize related technologies. Our business strategy is focused on the following goals:

· increase penetration of our traditional customer base;

· expand beyond our traditional customer base;

· reduce product costs;

· expand our direct domestic distribution channels;

· expand our international distribution channels;

· introduce new technologies that improve current treatment procedures and outcomes and provide our customers with unique differentiation;

· develop home use products that enable consumers to leverage the advantages of light based technologies at home; and,

· continue investing in research and development to develop new applications that are efficacious, cost-effective, reliable and easy to use and have a high return on investment for our customers.

Increase Penetration of Our Traditional Customer Base. Our traditional customer base consists of dermatologists and plastic and cosmetic surgeons. We believe that the affordability of our products will enable us to penetrate further into the dermatologist, plastic and cosmetic surgeon markets. We believe that affordability has been a major obstacle preventing non-traditional practitioners from purchasing a laser or light-based system. As competition for patients among practitioner’s increases, those practitioners with aesthetic and cosmetic laser and light-based systems will be able to differentiate themselves.

Expand beyond our traditional customer base. As reimbursement rates dropped over the past several years, many primary care physicians (family and general practice, and obstetrics and gynecology physicians) have begun to seek new services to offer to their patients. Cosmetic laser and light-based procedures represent an ideal new service that is appealing to their patients, and adds a new “cash-pay” revenue stream to their practice. Cosmetic laser and light-based procedures are safe and easy to perform. As more primary care physicians realize that these procedures are safe and easy to perform, awareness of cosmetic laser and light-based procedures will continue to grow.

Reduce Product Costs. We apply bottom-up engineering, focusing on each component to improve the performance of each device while reducing its size, complexity, and cost. We believe our approach leads to

devices with fewer parts and greater manufacturing efficiency, resulting in lower production costs. This enables us to offer more reliable products at more affordable prices.

Expand Our Direct Domestic Distribution Channels. North America presently is the largest single geographic market for our products. We continue to upgrade our United States direct and indirect sales forces to better address the needs of our traditional core markets.

Expand Our International Distribution Channels. Outside of the Unites States, we continue to strengthen our long-standing positions in Europe and Japan and are seeking to expand our markets in Asia-Pacific and Latin America. We currently have direct sales offices in Madrid, Lisbon, Rome, Frankfurt, Paris, Osaka, Fukuoka, Nagoya, Tokyo and direct representation in China. Over the past year we increased the number and improved the quality of our international independent distributor channel.

Introduce New Technologies that Improve Current Treatment Procedures. As the market for non-invasive cosmetic procedures continues to expand Candela has a strong focus on how to improve existing treatments to enable our customers to improve results and the overall experience for their customers. For example, reducing the pain associated with many procedures while maintaining or improving efficacy is an area where Candela is committed to delivering new solutions. The recent introduction of the Serenity™ device, utilizing PSF™ technology for the reduction of pain during laser and light based procedures continues to be developed to expand the application range as well as the number of machines with which it can be adapted to work with. This offers our customers a key differentiator in their market.

Develop Home Use Products. Candela has recently formed a dedicated Home Use product division to leverage initiatives that have been underway for medical office use within our research and development organization. We are currently expanding our efforts in a number of aesthetic and medical aesthetic application areas.

Continue Investing in Research & Development. We believe that continued investment in research and development is necessary to maintain our position as leader in the aesthetic laser and light-based device market. Our research and development approach is to develop high quality, reliable, and affordable products that address our existing markets and also allow us to expand into larger, growing markets. In support of this approach, our research and development staff works closely with our marketing and operations teams to identify new clinical applications that serve our markets. We have numerous research and development arrangements with leading physicians, hospitals and academic laboratories in the United States and throughout the world. In a parallel effort, our research and development and engineering teams continue to optimize our existing products by adding new technologies, increasing the speed of treatment and ease of use for our customers as well as reduce the overall size of our products.

The Market for Aesthetic and Cosmetic Laser and Light-Based Systems

Our traditional customer base for aesthetic and cosmetic devices consists of dermatologists and plastic and cosmetic surgeons. In addition, other practitioner groups are emerging as potential customers, including general and family practitioners, obstetricians, gynecologists, and general and vascular surgeons. In the United States, according to the American Medical Association and various professional societies, there are approximately 12,000 dermatologists, 8,000 plastic and cosmetic surgeons and 11,000 ear, nose and throat specialists. Practitioners in other specialties that are beginning to buy aesthetic and cosmetic laser and light-based systems include 70,000 general and family practitioners, 35,000 obstetricians and gynecologists, and 28,000 general and vascular surgeons. In addition, the aesthetic and cosmetic laser and light-based system market includes non-medical practitioners, notably electrologists, of which there are an estimated 6,000 in the United States and approximately 4,000 med spa owners in the United States.

The end markets for cosmetic procedures encompass broad and growing patient groups, including aging “baby boomers” as well as younger age groups. Baby boomers were approximately 80 million,

representing approximately 29% of the total United States population. This large population group has exhibited a strong demand for aesthetic and cosmetic procedures. We believe that as the cost of treatments decreases and the popularity of cosmetic procedures such as hair removal increases, the target market for these procedures will expand beyond the baby boomers to include a broad range of women and men aged 17 to 65. Demographic factors similar to the United States underlie the growth of the aesthetic and cosmetic market outside of the United States as well.

Hair Removal. We believe that the great majority of the 108 million women over the age of 16 in the United States employ one or more techniques for temporary hair removal from various parts of the body. Also, a growing number of men are removing hair by means other than their daily shaving routine. A number of techniques are used to pull hair from the follicle including waxing, depilatories, and tweezing. In the waxing process, a lotion, generally beeswax-based, is spread on the area to be treated and is then rapidly peeled off, pulling out the entrapped hairs. Depilatories employ rotating spring coils or slotted rubber rolls to trap and pull out the hairs. Tweezing involves removing individual hairs with a pair of tweezers. Pulling hair from the follicle produces temporary results, but is often painful and may cause skin irritation. Depilatory creams, which contain chemicals to dissolve hair, frequently leave a temporary unpleasant odor and may also cause skin irritation. Shaving is the most widely used method of hair removal, especially for legs and underarms but produces the shortest-term results. Hair bleaches do not remove hair, but instead lighten the color of hair so that it is less visible. A principal drawback of all of these methods is that they require frequent treatment.

Before the advent of laser and light-based hair removal, electrolysis was the only method available for the long-term removal of body hair. The success rate for electrolysis is variable depending upon the skill of the electrologist and always requires a series of treatments. Electrolysis is time-consuming, expensive and sometimes painful. There is also some risk of skin blemishes and a rising concern relating to needle infection. Because electrolysis requires that each hair follicle be treated separately and can only treat visible hair follicles, the treatment of an area as small as an upper lip may require numerous visits at an aggregate cost of up to $1,000. The American Electrology Association estimates that approximately one million people per year undergo electrology procedures. Although we believe the large majority of all electrolysis treatments are for facial hair, the neck, breasts and bikini line are also treated. Because hair follicles are disabled one at a time, electrolysis is rarely used to remove hair from large areas such as the back, chest, abdomen, and legs. We believe laser and light-based systems enable the practitioner to address a potentially larger market than electrolysis by treating a larger area of the body more quickly and with improved results.

We believe the market for laser and light-based hair removal is growing as the customer compares laser and light-based treatments to other hair removal methods that are currently available. The benefits of a laser and light-based system treatment include:

· significantly reduced procedure time and number of treatments;

· significantly longer-term cosmetic improvement;

· treatment of larger areas in each treatment session;

· less discomfort during and immediately following procedures;

· reduced risk of scarring and infection; and,

· non-invasive procedures.

Vascular Lesions. Benign vascular lesions are abnormal, generally enlarged and sometimes proliferating blood vessels that appear on the surface of the skin as splotches, dots, bulges, and spider shapes in a variety of colors ranging from red to purple. Different types of benign vascular lesions include the following:

· stretch marks and scars;

· varicose veins, which are large veins greater than 1mm in diameter and often bulge above the skin surface;

· rosacea, which is the dilation of capillaries in the cheeks, nose, forehead and chin;

· telangiectasias, more commonly referred to as spider veins, appearing on the face and other parts of the body;

· leg telangiectasias, which are smaller spider veins up to 1mm in diameter appearing as single strands;

· port wine stains, which are vascular birthmarks characterized by a red or purple discoloration of the skin; and,

· hemangiomas, which are protuberances that consist of dilated vessels, which often appear on newborns within one month of birth.

Pigmented Lesions/Tattoos. Benign pigmented lesions can be both epidermal, on the outer layer of skin, and dermal, on the innermost layer of skin, natural or man-made (tattoos) and can constitute a significant cosmetic problem to those who have them. There has been significant increase in recent years in the number of people getting tattoos. This growth is expected to result in a compounded annual growth rate of 16.8% for the Tattoo Removal Laser market between 2006 and 2010.

Skin Rejuvenation. Skin rejuvenation is one of the fastest growing segments of the aesthetic laser and light-based system market. A significant percentage of the population suffers from fine lines and wrinkles or older looking skin as a result of the normal aging process. This is the primary group of candidates for non-ablative laser and skin tightening treatments. While the market for skin rejuvenation is greatest in the United States, significant opportunities abound in international markets where there is an aging demographic, such as Japan, or a high prevalence of photo-damaged skin, such as Australia and Latin America.

Acne. Patients have expressed dissatisfaction with existing therapies for acne and acne scarring. These therapies include the following: drug therapy, dermabrasion, ablation, excision, chemical peeling and injections of filler materials. These therapies have minimal efficacy, a significant side-effect profile, require long recovery periods and, in most cases, do not meet patient expectations. For many of these patients, laser treatment can represent a better treatment alternative. Laser therapy can effectively target the sebaceous gland which is the root cause of acne.

Acne Scars. The majority of existing acne scar patients that initially seek traditional treatments decide not to undertake a procedure due to the side-effects and social down-time. A more acceptable alternative for acne scar treatment is laser therapy. In the treatment of acne scars, the laser initiates deposition of new collagen to raise depressions in the skin, reducing the appearance of acne scars. Over a series of treatments, new collagen can fill in and soften the appearance of acne scars.

Psoriasis. The National Psoriasis Foundation estimates that psoriasis afflicts more than seven million Americans and that between 150,000 and 260,000 new cases are diagnosed each year.

Skin Resurfacing. In calendar 2006, there were approximately 575,000 skin resurfacing procedures performed in the U.S., most using non-ablative skin resurfacing technologies. In addition to these

procedures there were also approximately 560,000 chemical peels and 995,000 microdermabrasion procedures conducted in the U.S, respectively.

Candela’s Products

We research, develop, manufacture, market, sell, distribute, and service laser and light-based systems used to perform procedures addressing patients’ aesthetic, medical and cosmetic concerns. We offer a comprehensive range of products based on proprietary technologies. Our products focus on the major aesthetic and cosmetic laser and light-based applications including:

· hair removal;

· non-invasive treatment of facial and leg veins and other benign vascular lesions;

· treatment of rosacea;

· removal of benign pigmented lesions such as age spots and sun spots;

· treatment of scars and stretch marks;

· wrinkle reduction;

· treatment of acne and acne scars;

· treatment of psoriasis;

· all-color tattoo removal;

· skin resurfacing; and, and,

· other skin treatments.

Our objective is to remain the leading provider of aesthetic and cosmetic lasers by continually striving to develop smaller, faster, and less expensive devices. Candela has been, and continues to be, a pioneer in the laser industry. From the start, our mission has been to lead the way in the development of innovative laser products which include:

Dynamic Cooling Device. The DCD cools the top layer of the skin, while leaving the targeted underlying hair follicle, vein or other structure at normal temperature. As a result, higher levels of laser energy can be delivered during treatment, while minimizing thermal injury, pain, and the inconvenience associated with anesthetics. The design of the hand-held DCD enables the practitioner to clearly see the area being treated, and the combined efficiency of the lasers and DCD reduces the risks of over treatment. The DCD delivers just the right amount of cooling quickly and consistently. Currently, DCD is available as an option on several Candela laser systems.

GentleMax™

· Integrated aesthetic treatment workstation with multiple wavelength capability;

· The fastest and most powerful Nd:YAG 1064 laser and 755 nm laser in one;

· Superior results in less time and in fewer treatments;

· Touch-screen technology for user-friendly interface;

· Unlimited potential with complete treatment versatility offering unmatched permanent hair reduction to skin tightening and skin rejuvenation to treating leg and facial veins- as many as 36 different applications;

· Offers a choice of skin cooling options—from chilled air technology to Candela’s integrated and patented Dynamic Cooling Device (DCD) that utilizes bursts of cryogen before and after the laser pulse to offer unparalleled patient comfort.

SmoothPeel™

· Erbium:YAG laser for precise and predictable peels without the chemicals;

· Superior ablative characteristics for skin;

· Offering patients multiple treatment options from simple freshening to a peel comparable to a glycolic acid peel with just a few days of downtime.

AlexTriVantage™

· The total all-color tattoo and pigmented lesion solution;

· New laser-pumped laser hand pieces (patent pending) offer a unique and elegant design;

· Effective removal of even the most difficult tattoo colors;

· New long pulse mode offers advanced rejuvenation treatments for a wider variety of pigmented lesions;

· Candela’s fastest, gentlest, most powerful q-switched alexandrite laser;

· Touch-screen technology for user friendly interface.

Serenity™

· Revolutionary PSF™ technology for pain reduction in laser and IPL treatments;

· Improves efficacy and safety during laser and light-based hair removal treatments;

· Works with all laser and light based devices.

GentleLASE® Family. The GentleLASE® system is a high-energy, long-pulse solid-state laser that generates laser light in the near infrared wavelength range. It is used for both hair removal, pigmented lesions, and large (1mm or larger) leg and facial veins. The technology incorporated in the GentleLASE® uses intense pulsed light energy directed through an Alexandrite rod, which achieves selective heating while keeping the temperature of the skin below its damage threshold. The longer Alexandrite laser wavelength gives the GentleLASE a higher melanin absorption coefficient and enables the GentleLASE® to penetrate skin surfaces deeper than most other hair removal lasers. The GentleLASE continues to feature an (18mm) spot size, the industry’s largest. The GentleLASE® was recently redesigned into a smaller, more transportable configuration and re-introduced with new advanced features including additional spot sizes, longer delivery systems and faster repetition rates (Hz rates).

The other system comprising the GentleLASE® family of lasers is the GentleLASE Limited Edition™, our most affordable hair removal laser. The GentleLASE LE™ features fewer options than its namesake, including fewer spot sizes and reduced fluences, but GentleLASE® performance advantages: speed, efficacy and ease-of-use, remain the same regardless of the configuration.

GentleYAG® Family. The GentleYAG® system is a high-energy, long-pulse Nd:YAG laser that is used to remove unwanted hair in all skin types, eliminate leg and facial veins and provide for skin rejuvenation, including wrinkle reduction and skin tightening. The technology incorporated in the GentleYAG® uses intense pulsed light energy directed through an Nd:YAG (Neodymium: Yttrium Aluminum Garnet) rod, which targets selected chromospheres to achieve localized heating while

maintaining skin temperature below its damage threshold in conjunction with DCD epidermal cooling. Like the GentleLASE® laser, the GentleYAG® also supports an 18mm spot size, the industries largest.

Other members of the GentleYAG® family of lasers include the GentleYAG® HR (for hair removal only), the GentleYAG® VR (for leg & facial veins) and the GentleYAG® SRT (for skin rejuvenation and tightening). All of these models are upgradeable to provide additional treatment options.

GentleMAX. The GentleMAX is Candela’s newest product offering and combines the treatment capabilities of both the GentleLASE and GentleYAG lasers described above. The GentleMAX not only incorporates 755 nm and 1064 nm treatment options into a single workstation, it does so without loss of any specifications found on the single wavelength GentleLASE & GentleYAG lasers. The GentleMAX can also act as a platform for current and future component upgrades, including the SmoothPeel skin resurfacing laser, further expanding the GentleMAX’s range of applications.

The GentleMAX can be configured with delivery systems incorporating DCD or air cooling and is also available in upgradeable, single wavelength and Limited Edition models, giving the GentleMAX an almost unlimited number of configurations in which it can be purchased.

Pneumatic Skin Flattening (PSF™). PSF™ technology, which provides pain reduction on almost any laser or light-based hair removal system, and also eliminates the need for other epidermal protection technologies, has been introduced initially as the Serenity™. The Serenity™ device offers several different configurations of hand pieces and adaptors that allow PSF™ to be used with, again, almost any laser or IPL device on the market today.

Vbeam® Family. The Vbeam® system delivers the safety and efficacy of the clinically proven pulsed dye laser (PDL) while minimizing the problematic side effects of postoperative bruising, commonly referred to as purpura. Each member of the Vbeam® family features Candela’s patented Dynamic Cooling Device that increases patient comfort while providing epidermal protection.

The Vbeam® Family has recently been upgraded to feature a smaller, more streamlined design as well as an improved user interface designed to accommodate the wide range of users in today’s market. The new design also features three individual, upgradeable models designed to meet the needs of almost any growing practice. The Aesthetica is specifically designed for skin rejuvenation, the Platinum for vascular lesions, and the Perfecta, which treats a wide range of vascular lesions, as well as providing comprehensive skin rejuvenation treatments. Additional indications treated by the Vbeam® family include: facial spider veins, leg telangiectasias, hemangiomas, poikiloderma, rosacea, scars, warts, stretch marks, vulvodynia, acne, port wine stains and other vascular abnormalities present in adults to infants.

ALEXLAZR™system. The ALEXLAZR™ is a short-pulse solid-state laser, which emits near-infrared, 755 nm light for the non-invasive removal of epidermal pigmentation such as sun spots, tattoo pigments and dermal pigmented lesions such as Nevus of Ota, a bluish colored, non-vascular, pigmented lesion, generally found among persons of Asian descent. The ALEXLAZR™ has a fiber optic delivery system that produces an even beam distribution without hot spots. Its wavelength maximizes beam penetration, providing gentle treatments with effective results on deeper pigments and is effective in the removal of tattoo pigments, optimally targeting the green, blue and black pigmented inks.

The AlexTriVantage introduces and incorporates “laser-pumped-laser” technology to further expand its pigmented lesion and tattoo removal treatment capabilities. This new technology allows for 532 and 1064 nm q-switched energies to also be generated from the 755 nm laser devices through additional hand pieces containing the Nd:YAG and KTP crystals capable of emitting these wavelengths. These new wavelengths allow for the treatment of all tattoo colors, tattoo removal on darker skin types and the expanded removal of epidermal and dermal pigmented lesions.

Smoothbeam® system. Introduced in March 2001, the Smoothbeam® diode laser heats collagen in the upper dermis, stimulating new collagen deposition for the improvement of wrinkles, sebaceous hyperplasia and acne scars. The system is small, easily portable and available in two unique colors to ideally complement the practice environment. The Smoothbeam® laser employs laser light at 1450 nm to heat the dermis, sebaceous glands, and associated structures within the dermis in combination with Candela’s patented DCD cooling to cool and protect the epidermis. The thermal injury alters the structure of the sebaceous glands, the root cause of acne lesions, resulting in more effective and longer-lasting acne clearance.

SmoothPeel. The SmoothPeel laser is an Erbium:YAG laser offering skin resurfacing treatments more precise than chemical peels and offering superior results compared to the more commonly delivered microdermabrasion treatment.

Sales and Distribution

We market and sell our products worldwide. Executives in North America, Latin America, Japan, Asia-Pacific, Europe and the Middle East manage our marketing, selling and service activities through a combination of direct personnel and a network of independent distributors.

The mix of direct sales and distributor sales varies by region. Generally, our distributors enter into 2-3 year exclusive agreements during which they typically agree not to sell our competitors’ products. Our sales strategy is to choose the most productive and practicable distribution channel within each of our geographic markets.

We sell products in the United States primarily through our direct sales force to our traditional customer base of dermatologists and plastic and cosmetic surgeons. Candela’s products are distributed to our non-traditional markets through an exclusive arrangement with McKesson’s Medical Surgical Division. McKesson has 450 dedicated sales representatives that showcase a wide range of products to family and general practice, and obstetrics and gynecology, physicians.

Outside the United States, we sell our products in Europe, Japan, Latin America, the Middle East, and Asia-Pacific through direct sales offices and distribution relationships. We have a total of 131 employees in our direct sales offices in Madrid, Lisbon, Rome, Frankfurt, Paris, Tokyo, Nagoya, Fukuoka, Osaka, and Netanya. We also have established distribution relationships in China, Europe, Japan, Africa, Latin America, and the Middle East. Outside the United States, we are utilizing 59 distributors. Refer to Note 11 of our Consolidated Financial Statements for additional financial information about segments and geographical areas.

The following chart shows data relating to Candela’s international activities during each of the last three fiscal years by geographic region. Revenue generated from regions other than the United States includes sales from our German, Spanish, Italian, French, Japanese, Israeli, and Australian subsidiaries, as well as sales shipped directly to international locations from the United States.

	June 30,		July 1,		July 2,
Revenues:	2007		2006		2005
	(in thousands)
United States and Canada	$	64,885	$	69,330	$	57,517
Japan and Asia-Pacific	29,950		30,175		29,229
Europe	42,356		34,618		30,659
Latin America & all others	11,366		15,343		6,496
	$	148,557	$	149,466	$	123,901

Service and Support

Candela believes that quick and effective delivery of service is important to our customers. Our principal service center and parts depot is located at our Wayland, Massachusetts headquarters. Parts depots are also located at our sales offices in Japan, Spain, Portugal, Italy, Germany, and France. Independent distributors also maintain parts depots.

We also believe a highly trained and qualified service staff is important to product reliability. Distributors and subsidiaries have the primary responsibility of servicing systems within their territories. Their service personnel are required to attend formal training to become authorized. We provide service training in Asia, Europe and the United States. In addition, we have service and technical support staff in each of our markets worldwide.

Post-warranty product maintenance and repair provides an additional recurring source of revenue. Customers may elect to purchase a service contract or purchase service on a time-and-materials basis. Candela’s service contracts offer a range of service levels and options, including additional clinical support. The contract terms generally run in 12 or 24-month intervals (See Item 8).

Candela emphasizes education and support of its customers. Periodic device calibration/verification, coupled with the continuous training of our service providers, helps to ensure product reliability. We extend prompt and courteous technical and clinical support to our customers when needed.

Manufacturing and Raw Materials

We design, assemble, and test our branded products at our Wayland, Massachusetts and Netanya, Israel facilities. Ensuring adequate and flexible production capacity, applying lean manufacturing techniques, continually reducing costs, and maintaining superior product quality are top priorities of our manufacturing organization. We achieve our goals by:

· working closely with the research and development organization, including significant early involvement in product design;

· continually improving our just-in-time manufacturing and inventory processes;

· effectively managing and working closely with a limited number of the most qualified suppliers; and,

· applying the latest cell manufacturing techniques.

Our facility has ISO 13485 certification and has established and is maintaining a quality system that meets the requirements of ISO 13485:2003 and CAN/CSA-ISO 13485. The ISO 13485 certification provides guidelines for the quality of company systems associated with the design, development, production, servicing and distribution of medical lasers and accessories. ISO 13485 standards are European quality requirements and CAN/CSA-ISO 13485 is a Canadian quality requirement, all specifically relating to the design of medical devices.

Our products are manufactured with standard components and subassemblies supplied by third party manufacturers to our specifications. We purchase certain components and subassemblies from a limited number of suppliers.

If our suppliers are unable to meet our requirements on a timely basis, our production could be interrupted until we obtain an alternative source of supply. To date, we have not experienced significant delays in obtaining dyes, optical and electro-optical components, electronic components, Alexandrite rods and other raw materials for our products. We believe that over time alternative component and subassembly manufacturers and suppliers can be identified if our current third party manufacturers and suppliers fail to fulfill our requirements.

Research and Development

We believe that our advanced research and engineering activities are crucial to maintaining and enhancing our business, and we are currently conducting research on a number of applications. We believe that our in-house research and development (R&D) staff has demonstrated its ability to develop innovative new products that meet evolving market needs. Our core competencies include:

· applied laser physics and technology;

· tissue optics;

· photochemistry;

· light-tissue interaction;

· clinical research;

· aesthetic laser applications;

· engineering and design of medical laser devices; and,

· collaborative research with leading academic and medical institutions.

As we discover new technologies or applications with commercial potential, we assemble a team to develop the new product or application in cooperation with leading physicians and medical and research institutions. In the United States in particular, we must receive United States Federal Drug Administration (“FDA”) clearance before marketing new products or applications.

Our research and development team works with our operations group to design our products for ease of manufacturing and assembly and with our marketing group to create and respond to market opportunities. We believe this interaction between functional groups facilitates the introduction of new products with the right balance of features, clinical benefits, performance, quality, and cost. Historically, our research and development effort has relied primarily on internal development building on our core technologies. In addition to our acquisition of Inolase during fiscal 2007, which has permitted us to expand our internal R&D capabilities, we have engaged the services of several independent engineering and development firms to assist in the acceleration of new product development.

In addition, Candela conducts joint research with physicians affiliated with various medical and research institutions. One example of technology developed through joint research is our Dynamic Cooling Device which was developed in conjunction with the Beckman Laser Institute at the University of California, Irvine. We anticipate continuing joint research and licensing arrangements with reputable medical research institutions in future periods.

Our expenditures on research and development are set forth in Item 7.

Backlog

While we did maintain a significant backlog of recently introduced products at June 30, 2007, we typically have not had, and do not anticipate having, significant backlog in the future. Accordingly, we do not believe that our backlog at any particular date is necessarily an accurate predictor of revenue for any succeeding period.

Customers

Our sales are not dependent on any single customer or distributor, and we continue to expand our distribution channel worldwide through direct and indirect sales forces. We experience some seasonal

reduction of our product sales in our first fiscal quarter due to the summer holiday schedule of physicians and their patients.

Competition

Competition in the aesthetic and cosmetic laser industry is intense and technological developments are expected to continue at a rapid pace. Although there are several manufacturers of aesthetic and cosmetic lasers, we believe Candela is one of only a few companies that offer a broad range of technologies and products able to address multiple clinical applications. Unlike Candela, few of our competitors focus exclusively on the cosmetic and aesthetic laser market and several rely on a single technology which can be limiting. We compete on the basis of proprietary technology, product features, performance, service, price, and reputation. Some of our competitors have greater financial, marketing, and technical resources than we do. Moreover, some competitors have developed, and others may attempt to develop, products with applications similar to ours. We believe that many factors will affect our competitive position in the future, including our ability to:

· develop and manufacture new products that meet the needs of our markets;

· respond to competitive developments and technological changes;

· manufacture our products at lower cost;

· retain a highly qualified research and engineering staff;

· provide sales and service to a worldwide customer base;

· maintain and improve product reliability.

Proprietary Rights

We have numerous patents and have a number of patent applications pending to protect our rights in certain technical aspects of our hair removal, wrinkle removal, acne treatment, benign vascular lesion, pigmented lesion, and other laser systems.

In addition to our portfolio of issued patents and patent applications, we license patented technology from third parties. We use our patented Dynamic Cooling Device (“DCD”) under a license agreement to patent rights owned by the Regents of the University of California (“Regents”).

In August 2000, we obtained exclusive license rights to the DCD (subject to certain limited license rights of Cool Touch, Inc. [“Cool Touch”]) in the following fields of use:

· procedures that involve skin resurfacing and rejuvenation,

· vascular skin lesions, and,

· laser hair removal.

Cool Touch obtained a license to the DCD on a co-exclusive basis with Candela, in certain narrower fields of use. Cool Touch is restricted in its ability to assign its license rights to certain existing competitors of Candela. Candela is entitled to one-half of all royalty income payable to the Regents from Cool Touch. Under the agreement, Candela no longer is required by the Regents to negotiate sublicenses to third parties. However, Candela is entitled to one-half of all royalties due from any other entity that licenses the DCD technology from the Regents in other fields of use.

We rely primarily on a combination of patent, copyright, and trademark laws to establish and protect our proprietary rights. We also rely on trade secret laws, confidentiality procedures, and licensing arrangements to establish and protect our technology rights. In addition, we seek to protect our

proprietary rights by using confidentiality agreements with employees, consultants, advisors, and others. We cannot be certain that these agreements will adequately protect our proprietary rights in the event of any unauthorized use or disclosure, that our employees, consultants, advisors, or others will maintain the confidentiality of such proprietary information, or that our competitors will not otherwise learn about or independently develop such proprietary information.

Despite our efforts to protect our intellectual property, unauthorized third parties may attempt to copy aspects of our products, to violate our patents, or to obtain and use our proprietary information. In addition, the laws of some foreign countries do not protect our intellectual property to the same extent as do the laws of the United States The loss of any material patent, trademark, trade name, trade secret, or copyright could hurt our business, results of operations, and financial condition.

We believe that our products do not infringe the rights of third parties, although one party is presently asserting that our products infringe its patents (see Item 3). We cannot be certain that third parties will not assert infringement claims against us in the future or that any such assertion will not result in costly litigation or require us to obtain a license to third party intellectual property. In addition, we cannot be certain that such licenses will be available on reasonable terms or at all, which could hurt our business, results of operations, and financial condition.

Government Regulation

FDA’s Premarket Clearance and Approval (“PMA”) Requirements. Unless an exemption applies, each medical device that we wish to market in the U.S. must receive either “510(k) clearance” or PMA in advance from the FDA pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s 510(k) clearance process usually takes from three to twelve months, but it can last longer. The process of obtaining PMA approval is much more costly, lengthy, and uncertain and generally takes from one to three years or even longer. We cannot be sure that 510(k) clearance or PMA approval will ever be obtained for any product we propose to market.

The FDA decides whether a device must undergo either the 510(k) clearance or PMA approval process based upon statutory criteria. These criteria include the level of risk that the agency perceives is associated with the device and a determination whether the product is a type of device that is similar to devices that are already legally marketed. Devices deemed to pose relatively less risk are placed in either class I or II, which requires the manufacturer to submit a pre-market notification requesting 510(k) clearance, unless an exemption applies. The pre-market notification must demonstrate that the proposed device is “substantially equivalent” in intended use and in safety and effectiveness to a legally marketed “predicate device” that is either in class I, class II, or is a “pre-amendment” class III device (i.e., one that was in commercial distribution before May 28, 1976) for which the FDA has not yet decided to require PMA approval.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance. The FDA requires each manufacturer to make this determination in the first instance, but the FDA can review any such decision. If the FDA disagrees with a manufacturer’s decision not to seek a new 510(k) clearance, the agency may retroactively require the manufacturer to submit a pre-market notification requiring 510(k) clearance. The FDA also can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance is obtained. We have modified some of our 510(k) cleared devices but have determined that, in our view, new 510(k) clearances are not required. We cannot be certain that the FDA would agree with any of our decisions not to seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for any modification, we also may be required to cease marketing and/or recall the modified device until we obtain a new 510(k) clearance.

Devices deemed by the FDA to pose the greatest risk such as life-sustaining, life-supporting, or implantable devices, or deemed not substantially equivalent to a legally marketed predicate device, are placed in class III. Such devices are required to undergo the PMA approval process in which the manufacturer must prove the safety and effectiveness of the device to the FDA’s satisfaction. A PMA application must provide extensive pre-clinical and clinical trial data and also information about the device and its components regarding, among other things, manufacturing, labeling, and promotion. After approval of a PMA, a new PMA or PMA supplement is required in the event of a modification to the device, it’s labeling, or its manufacturing process.

A clinical trial may be required in support of a 510(k) submission or PMA application. Such trials generally require an Investigational Device Exemption (“IDE”) application approved in advance by the FDA for a limited number of patients, unless the product is deemed a non-significant risk device eligible for more abbreviated IDE requirements. The IDE application must be supported by appropriate data, such as animal and laboratory testing results. Clinical trials may begin once the IDE application is approved by the FDA and the appropriate institutional review boards are at the clinical trial sites.

To date, the FDA has deemed our products to be class II devices eligible for the 510(k) clearance process. We believe that most of our products in development will receive similar treatment. However, we cannot be certain that the FDA will not deem one or more of our future products to be a class III device and impose the more burdensome PMA approval process.

Pervasive and Continuing FDA Regulation. A host of regulatory requirements apply to marketed devices such as our laser and light-based products, including labeling regulations, the Quality System Regulation (which requires manufacturers to follow design, testing, control, documentation, and other quality assurance procedures), the Medical Device Reporting regulation (which requires that manufacturers report to the FDA certain types of adverse events involving their products), and the FDA’s general prohibition against promoting products for unapproved or “off label” uses. Our Class II devices can have special controls such as performance standards, post-market surveillance, patient registries, and FDA guidelines that do not apply to class I devices. Unanticipated changes in existing regulatory requirements or adoption of new requirements could hurt our business, financial condition, and results of operations.

We are subject to inspection and market surveillance by the FDA for compliance with regulatory requirements. If the FDA finds that we have failed to comply with applicable requirements, the agency can institute a wide variety of enforcement actions. The FDA sometimes issues a public warning letter but also may pursue more drastic remedies, such as refusing our requests for 510(k) clearance or PMA approval of new products, withdrawing product approvals already granted to us, requiring us to recall products, or asking a court to require us to pay civil penalties or criminal fines, adhere to operating restrictions, or close down our operations. Ultimately, criminal prosecution is available to the FDA as punishment for egregious offenses. Any FDA enforcement action against us could hurt our business, financial condition, and results of operation.

Other United States Regulation. We also must comply with numerous federal, state, and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control, and hazardous substance disposal. We cannot be sure that we will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not hurt our business, financial condition, and results of operations.

Foreign Regulation. International sales are subject to foreign government regulation, the requirements of which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ. Companies are now required to obtain the CE Mark prior to sale of certain medical devices

within the European Union. During this process, the sponsor must demonstrate compliance with ISO manufacturing and quality requirements.

Candela and its products may also be subject to other federal, state, local, or foreign regulations relating to health and safety, environmental matters, quality assurance, and the like. To date, Candela’s compliance with laws that regulate the discharge of materials into the environment or otherwise relate to the protection of the environment has not had a material effect on its ongoing operations. Candela has not made any material expenditure for environmental control facilities. However, we cannot be certain that we will not be required to incur significant costs to comply with such laws and regulations in the future.

Product Liability and Warranties

Our products are generally covered by a standard warranty, with an option to purchase extended warranty contracts at the time of product sale or service contracts after the time of sale. We maintain a reserve based on anticipated standard warranty claims. We believe such reserves to be adequate, but in the event of a major product problem or recall, such reserves may be inadequate to cover all costs, and such an event could have a material adverse effect on our business, financial condition, and results of operations.

Our business involves the inherent risk of product liability claims. We believe that we maintain appropriate product liability insurance with respect to our products. We cannot be certain that with respect to our current or future products, such insurance coverage will continue to be available on terms acceptable to us or that such coverage will be adequate for liabilities that may actually be incurred.

The Skin Care Centers

In 1996, we began an effort to own and operate skin care centers offering cosmetic laser treatments utilizing our equipment along with other cosmetic services traditionally offered by high-end spas. We pursued this strategy by purchasing a spa in Boston, Massachusetts in 1996, and opening a new facility in Scottsdale, Arizona in 1997. We subsequently decided to discontinue our skin care center efforts. We closed our Scottsdale facility in 1997 and the Boston facility in 2003.

Applied Optronics

In 2003, Candela acquired substantially all of the assets of Applied Optronics, the diode division of Schwartz Electro-Optics, Inc. Applied Optronics was a leading manufacturer of high-powered, pulsed and CW diode lasers, and was a component supplier to the OEM market that serves a variety of industries including the military, medical, industrial, research and robotics fields. Applied Optronics was the lead supplier of the diodes for our Smoothbeam® diode laser system. The Applied Optronics division of Candela, located in South Plainfield, New Jersey, generates revenue from diode sales to third-party customers.

Inolase

On March 6, 2007, we acquired Inolase (2002) Ltd. (“Inolase”) a non-public company engaged in the development and manufacture of proprietary pneumatic skin flattening PSF devices for the aesthetic light-based treatment industry as well as the development of intellectual property related to medical devices and light sources. It is now a wholly owned subsidiary of Candela which continues to engage in commerce under the name Inolase. This operation which includes research and development, sales and marketing, and manufacturing (including ISO 13485 certification) is located in Netanya, Israel.

Employees

As of June 30, 2007, we employed 386 employees, 255 in the United States and 131 internationally. None of our employees are subject to collective bargaining agreements.

Available Information

Access to our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed with or furnished to the Securities and Exchange Commission may be obtained through the Investor Relations section of our website at www.candelalaser.com/ir_corp.asp as soon as reasonably practical after we electronically file or furnish these reports. We do not charge for access to and viewing of these reports. Information on our Investor Relations page and on our website is not part of this Annual Report on Form 10-K or any of our other securities filings unless specifically incorporated herein by reference. In addition, our filings with the Securities and Exchange Commission may be accessed through the Securities and Exchange Commission’s Electronic Data Gathering, Analysis and Retrieval system at www.sec.gov. All statements made in any of our securities filings, including all forward-looking statements or information, are made as of the date of the document in which the statement is included, and we do not assume or undertake any obligation to update any of those statements or documents unless we are required to do so by law.

Forward-looking and Cautionary Statements

Certain statements contained in this Annual Report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“Reform Act”). We may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, Candela’s representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,” “projects,” and similar expressions, may identify such forward-looking statements. Such forward looking statements include but are not limited to: that we have the necessary infrastructure in place to capitalize on expansion; the affordability of our products will allow for expansion; that we can lower production costs; or that the market will expand beyond baby boomers. Candela assumes no obligation to update or revise any forward-looking statements. In accordance with the Reform Act, set forth under Item 1A “Risk Factors”, are cautionary statements that accompany those forward-looking statements. Readers should carefully review such cautionary statements as they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and from historical trends. Those cautionary statements are not exclusive and are in addition to other factors discussed elsewhere in this Annual Report, in Candela’s filings with the Securities and Exchange Commission, or in materials incorporated therein by reference.

Candela GentleLASE, Vbeam, GentleYAG and Smoothbeam are registered trademarks and GentleMax, AlexTriVantage, SmoothPeel, and the Candela flame are trademarks of Candela Corporation. Dynamic Cooling Device, DCD, Serenity, Pneumatic Skin Flattening, and PSF are trademarks.

Item 1A. Risk Factors.

The following important factors, among others, could cause our actual operating results to differ materially from those indicated or suggested by forward-looking statements made in this Form 10-K or presented elsewhere by management from time to time.

Unfavorable results in our intellectual property litigation with Palomar Medical Technologies may result in significant decline to our stock price.

On August 9, 2006, one of our competitors, Palomar Medical Technologies (“Palomar”), alleged that the manufacture, use and sale of our products for laser hair removal infringe a certain United States patent. Public announcements concerning this litigation that are unfavorable to us may result in significant declines in our stock price. An adverse ruling or judgment in this matter could cause our stock price to decline significantly.

Litigation with Palomar will be expensive and protracted, and our intellectual property position may be weakened as a result of an adverse ruling or judgment. Whether or not we are successful in the pending lawsuits, litigation consumes substantial amounts of our financial resources and diverts management’s attention away from our core business. See Item 3—“Legal Proceedings.”

Because we derive more than half of our revenue from international sales, including approximately 20% of our revenue from Japan and the Asia-Pacific marketplace in fiscal 2007, we are susceptible to currency fluctuations, negative economic changes taking place in Japan and the Asia-Pacific marketplace, and other risks associated with conducting business overseas.

We sell more than half of our products and services outside the United States. International sales, consisting of sales from our subsidiaries in Germany, Spain, Italy, France, Japan, Israel, and Australia, and sales shipped directly to international locations from the United States, accounted for approximately 56% of our revenue for fiscal year 2007, and we expect that they will continue to be significant. As a result, a major part of our revenues and operating results could be adversely affected by risks associated with international sales. In particular, significant fluctuations in the exchange rates between the United States dollar and foreign currencies could cause us to lower our prices and thus reduce our profitability, or could cause prospective customers to push out orders to later dates because of the increased relative cost of our products in the aftermath of a currency devaluation or currency fluctuation. Other risks associated with international sales that we currently face or have faced in the past include:

· longer payment cycles common in foreign markets;

· failure to obtain or significant delays in obtaining necessary import or foreign regulatory approvals for our products; and,

· difficulties in staffing and managing our foreign operations.

The failure to obtain Alexandrite rods for the GentleLASE® system from our sole supplier would impair our ability to manufacture and sell the GentleLASE® system.

We use Alexandrite rods to manufacture the GentleLASE® system, which accounts for a significant portion of our total revenues. We depend exclusively on our contract manufacturer to supply these rods, for which no alternative supplier meeting our quality standards exists. We cannot be certain that our contract manufacturer will be able to meet our future requirements at current prices or at all. To date, we have been able to obtain adequate supplies of Alexandrite rods in a timely manner, but any extended interruption in our supplies could hurt our results.

Disappointing quarterly revenue or operating results could cause the price of our common stock to fall.

Our quarterly revenue and operating results are difficult to predict and may swing sharply from quarter to quarter. Historically, our first fiscal quarter has typically had the least amount of revenue in any quarter of our fiscal year. The results of the first quarter are directly impacted by the seasonality of the purchasing cycle.

If our quarterly revenue or operating results fall below the expectations of investors or public market analysts, the price of our common stock could fall substantially. Our quarterly revenue is difficult to forecast for many reasons, some of which are outside of our control, including the following:

Market supply and demand

· potential increases in the level and intensity of price competition between our competitors and us;

· potential decrease in demand for our products; and,

· possible delays in market acceptance of our new products.

Customer behavior

· changes in or extensions of our customers’ budgeting and purchasing cycles; and,

· changes in the timing of product sales in anticipation of new product introductions or enhancements by us or our competitors.

Company operations

· absence of significant product backlogs;

· our effectiveness in our manufacturing process;

· unsatisfactory performance of our distribution channels, service providers, or customer support organizations; and,

· timing of any acquisitions and related costs.

Our failure to respond to rapid changes in technology and intense competition in the laser industry could make our lasers obsolete.

The aesthetic and cosmetic laser equipment industry is subject to rapid and substantial technological development and product innovations. To be successful, we must be responsive to new developments in laser technology and new applications of existing technology. Our financial condition and operating results could be hurt if our products fail to compete favorably in response to such technological developments, or we are not agile in responding to competitors’ new product introductions or product price reductions. In addition, we compete against numerous companies offering products similar to ours, some of which have greater financial, marketing, and technical resources than we do. We cannot be sure that we will be able to compete successfully with these companies and our failure to do so could hurt our business, financial condition, and results of operations.

Like other companies in our industry, we are subject to a regulatory review process and our failure to receive necessary government clearances or approvals could affect our ability to sell our products and remain competitive.

The types of medical devices that we seek to market in the United States generally must receive either “510(k) clearance” or “PMA approval” in advance from the United States Food and Drug Administration (FDA) pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s 510(k) clearance process usually takes from three to twelve months, but it can last longer. The process of obtaining PMA approval is

much more costly and uncertain and generally takes from one to three years or even longer. To date, the FDA has deemed our products eligible for the 510(k) clearance process. We believe that most of our products in development will receive similar treatment. However, we cannot be sure that the FDA will not impose the more burdensome PMA approval process upon one or more of our future products, nor can we be sure that 510(k) clearance or PMA approval will ever be obtained for any product we propose to market.

Many foreign countries in which we market or may market our products have regulatory bodies and restrictions similar to those of the FDA. We cannot be certain that we will be able to obtain (or continue to obtain) any such government approvals or successfully comply with any such foreign regulations in a timely and cost-effective manner, if at all, and our failure to do so could adversely affect our ability to sell our products.

We have modified some of our products without FDA clearance. The FDA could retroactively decide the modifications were improper and require us to cease marketing and/or recall the modified products.

Any modification to one of our 510(k) cleared devices that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance. The FDA requires every manufacturer to make this determination in the first instance, but the FDA can review any such decision. We have modified some of our marketed devices, but we believe that new 510(k) clearances are not required. We cannot be certain that the FDA would agree with any of our decisions not to seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for any modification, we also may be required to cease marketing and/or recall the modified device until we obtain a new 510(k) clearance.

Achieving complete compliance with FDA regulations is difficult, and if we fail to comply, we could be subject to FDA enforcement action.

We are subject to inspection and market surveillance by the FDA to determine compliance with regulatory requirements. The FDA’s regulatory scheme is complex, especially the Quality System Regulation (“QSR”), which requires manufacturers to follow elaborate design, testing, control, documentation, and other quality assurance procedures. This complexity makes complete compliance difficult to achieve. Also, the determination as to whether a QSR violation has occurred is often subjective. If the FDA finds that we have failed to comply with the QSR or other applicable requirements, the agency can institute a wide variety of enforcement actions, including a public warning letter or other stronger remedies, such as:

· fines, injunctions, and civil penalties against us;

· recall or seizure of our products;

· operating restrictions, partial suspension, or total shutdown of our production;

· refusing our requests for 510(k) clearance or PMA approval of new products;

· withdrawing product approvals already granted; and,

· criminal prosecution.

We may also be subject to state regulations. State regulations, and changes to state regulations, may prevent sales to particular end users or may restrict use of the products to particular end users or under particular supervision which may decrease revenues or prevent growth of revenues.

Our products may also be subject to state regulations. Federal regulation allows our products to be sold to and used by licensed practitioners as determined on a state-by-state basis which complicates monitoring compliance. As a result, in some states non-physicians may purchase and operate our products.

In most states, it is within a physician’s discretion to determine whom they can supervise in the operation of our products and the level of supervision. However, some states have specific regulations as to appropriate supervision and who may be supervised. A state could disagree with our decision to sell to a particular type of end user or change regulations to prevent sales to particular types of end users or change regulations as to supervision requirements. In several states applicable regulations are in flux. Thus, state regulations and changes to state regulations may decrease revenues or prevent growth of revenues.

Claims by others that our products infringe their patents or other intellectual property rights could prevent us from manufacturing and selling some of our products or require us to incur substantial costs from litigation or development of non-infringing technology.

Our industry has been characterized by frequent litigation regarding patent and other intellectual property rights. Patent applications are maintained in secrecy in the United States until such patents are issued and are maintained in secrecy for a period of time outside the United States. Accordingly, we can conduct only limited searches to determine whether our technology infringes any patents or patent applications of others. Any claims of patent infringement would be time-consuming and could:

· result in costly litigation;

· divert our technical and management personnel;

· cause product shipment delays;

· require us to develop non-infringing technology; and,

· require us to enter into royalty or licensing agreements.

Although patent and intellectual property disputes in the laser industry have often been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and often require the payment of ongoing royalties, which could hurt our gross margins. In addition, we cannot be sure that the necessary licenses would be available to us on satisfactory terms, or that we could redesign our products or processes to avoid infringement, if necessary. Accordingly, an adverse determination in a judicial or administrative proceeding, or the failure to obtain necessary licenses, could prevent us from manufacturing and selling some of our products, which could hurt our business, results of operations, and financial condition. On the other hand, we may have to start costly and time consuming litigation in order to enforce our patents, to protect trade secrets, and know-how owned by us or to determine the enforceability, scope, and validity of the proprietary rights of others.

We could incur substantial costs as a result of product liability claims.

There are various risks of physical injury to the patient when using our lasers for aesthetic and cosmetic treatments. Injuries often result in product liability or other claims being brought against the practitioner utilizing the device and us. The costs and management time we would have to spend in defending or settling any such claims, or the payment of any award in connection with such claims, could hurt our business, results of operations, and financial condition. Although we maintain product liability insurance, we cannot be certain that our policy will provide sufficient coverage for any claim or claims that may arise, or that we will be able to maintain such insurance coverage on favorable economic terms.

We may be unable to attract and retain management and other personnel we need to succeed.

The loss of any of our senior management or other key research, development, sales, and marketing personnel, particularly if lost to competitors, could hurt our future operating results. Our future success will depend in large part upon our ability to attract, retain, and motivate highly skilled employees. We cannot be certain that we will attract, retain, and motivate sufficient numbers of such personnel.

Our failure to manage future acquisitions and joint ventures effectively may divert management attention from our core business and cause us to incur additional debt, liabilities or costs.

We may acquire businesses, products, and technologies that complement or expand our business. We may also consider joint ventures and other collaborative projects. We may not be able to:

· identify appropriate acquisition or joint venture candidates;

· successfully negotiate, finance, or integrate any businesses, products, or technologies that we acquire; and,

· successfully manage any joint ventures or collaborations.

Furthermore, the integration of any acquisition or joint venture may divert management time and resources. If we fail to manage these acquisitions or joint ventures effectively, we may incur debts or other liabilities or costs that could harm our operating results or financial condition. While we from time to time evaluate potential acquisitions of businesses, products, and technologies, consider joint ventures and other collaborative projects, and anticipate continuing to make these evaluations, we have no present understandings, commitments, or agreements with respect to any acquisitions or joint ventures.

We face risks associated with product warranties.

We could incur substantial costs as a result of product failures for which we are responsible under warranty obligations.

The expense and potential unavailability of insurance coverage for our customers could adversely affect our ability to sell our products and negatively impact our financial condition.

Some of our customers and prospective customers have had difficulty in procuring or maintaining liability insurance to cover their operation and use of our products. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using our products and, industry-wide, potential customers may opt against purchasing laser and other light-based products due to the cost of or inability to procure insurance coverage.

Failure to maintain effective internal control over financial reporting could have a material adverse effect on our business, operating results and stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include a report by our management on our internal control over financial reporting. Such report must contain an assessment by management of the effectiveness of our internal control over financial reporting as of the end of our fiscal year and a statement as to whether or not such internal control is effective.

Effective internal controls are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. If we cannot provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our brand and operating results could be harmed. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls cannot provide absolute assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that the control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed, and we could fail to meet our reporting obligations, which could have a material adverse effect on our business.

Our efforts to comply with Section 404 have resulted in, and are likely to continue to result in, significant costs, the commitment of time and operational resources and the diversion of management’s attention.

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

We lease two facilities totaling approximately 38,000 square feet for our operations in Wayland, Massachusetts, which is located approximately 20 miles west of Boston. The leases on these facilities expire March 2008. We also lease a 12,000 square foot facility in South Plainfield, New Jersey for our diode operation. This lease ends on October 31, 2008. Candela’s management believes that its current facilities are suitable and adequate for our near-term needs.

Candela’s subsidiaries currently lease the following facilities:

· Candela Skin Care Center of Boston, Inc., 20,728 square feet located in Boston, MA. The lease on this facility is for a period of 15 years, and commenced on June 1, 1994. Future rent payments have been accounted for in our restructuring reserve.

· Candela KK.—We lease 4 offices in Japan in Tokyo, Osaka, Nagoya, and Fukuoka. These leases expire between September 30, 2007 and May 31, 2009.

· Candela Iberica, S.A.. We lease two locations in Lisbon, Portugal and Madrid, Spain. These leases expire on September 29, 2008 and December 31, 2008, respectively.

· Candela Deutschland GmbH. The lease on this facility in Neu Isenberg, Germany expires on August 31, 2011.

· Candela France SARL. The lease on this facility in Villebou Sur Yvette, France expires on May 1, 2011.

· Candela Italia. The lease on this facility in Formello, Italy expires on March 31, 2011.

· Inolase. The lease on this facility in Netanya, Israel expires on April 30, 2010.

Item 3. Legal Proceedings.

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

· On August 9, 2006, Palomar filed suit against the Company in the United States District Court for the District of Massachusetts, asserting willful infringement by the Company of U.S. Patent No. 5,735,844. Palomar seeks compensatory and treble damages, as well as attorneys’ fees and injunctive relief. In November, 2006, the Company answered the complaint by denying Palomar’s allegations and asserting a variety of affirmative defenses and counterclaims against Palomar. This response included a counterclaim by the Company against Palomar seeking a declaratory judgment that United States patent No. 5,595,568 (“the ‘568 Patent”) is either invalid, or products manufactured by the Company do not infringe the ‘568 Patent, or both. In November, 2006, Palomar filed an answer denying the Company’s counterclaim. In February, 2007, Palomar moved to amend its Complaint to add The General Hospital Corporation as a party, to add a claim for infringement by Candela of the ‘568 patent, and to allege that additional Candela products infringe the ‘568 Patent. Palomar’s motion to amend its Complaint was granted in August of 2007. In February of 2007, Candela moved to amend its Answer and Counterclaims to add allegations of

inequitable conduct, double-patenting and violation of Mass. Gen. Laws Ch. 93A by Palomar. The Company’s motion to amend its complaint was granted in March of 2007. Palomar filed a general denial response to Candela’s Amended Answer and Counterclaim in March of 2007. In August of 2007, the parties had a Markman hearing before the U.S. District Court Judge presiding over the above-described legal proceeding. In a Markman hearing, the Court interprets the definition of the disputed claim term of a patent. The parties are presently in the midst of pre-trial fact discovery which shall end on December 31, 2007.

· On August 10, 2006, the Company filed suit against Palomar in the United States District Court for the District of Massachusetts, asserting willful infringement by Palomar of U.S. Patent Nos. 6,659,999, 5,312,395, and 6,743,222. The Company seeks compensatory and treble damages for the patent infringement, as well as attorneys’ fees and an injunction against Palomar to prevent Palomar’s continuing infringement. The Company served its complaint on Palomar in August, 2006. In October, 2006, the Company amended the Company’s suit against Palomar by removing from the suit allegations that Palomar infringes Patent 6,659,999. In October, 2006, Palomar answered the Company’s amended complaint by denying the Company’s allegations and asserting an affirmative defense of inequitable conduct with respect to the ‘395 patent. In addition, Palomar filed a demand for a declaratory judgment seeking a judicial determination that Palomar products either do not infringe the ‘395 and ‘222 patents or that such patents are invalid. In November, 2006, the Company answered the counterclaim by denying Palomar’s allegations. The parties are in the midst of pre-trial fact discovery.

· In December, 2006, the Company filed suit against Palomar in the United States District Court for the Eastern District of Texas, Lufkin Division, asserting that Palomar infringes one or more claims of United States patents Nos: 5,810,801, 6,659,999 and 6,120,497. The Company seeks compensatory and treble damages for past infringement, as well as attorneys’ fees and an injunction against Palomar from future infringement. In January, 2007, Palomar answered the complaint by denying the Company’s allegations and filing a declaratory judgment motion seeking a court ruling that it does not infringe such patents and/or that such patents are invalid. In addition, Palomar filed a motion to transfer the case to the United States District Court for the District of Massachusetts. In February, 2007, the Company added Massachusetts General Hospital as a party to its action. The Court denied Palomar’s motion to transfer the case to Massachusetts. The parties are in the midst of pre-trial fact discovery.

While the Company intends to vigorously contest Palomar’s allegations, and to pursue its own claims against Palomar, each lawsuit is inherently uncertain and unpredictable as to its ultimate outcome. An adverse outcome in Palomar’s suit against the Company would materially hurt the Company’s business, financial condition, results of operations and cash flows. In contrast, an adverse outcome in either of the two lawsuits which the Company has initiated against Palomar would not likely have a material adverse effect on the business or financial condition of the Company.

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

Not applicable.

Part II

Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters and Issuer Purchases of Equity Securities.

Candela’s common stock trades on The NASDAQ National Market under the symbol “CLZR.”

At September 11, 2007, there were approximately 322 holders of record of our common stock and the closing sale price of our common stock was $7.34.

Market Price of Common Stock

The following table sets forth quarterly high and low sales prices of the common stock for the indicated fiscal periods:

	High		Low
Fiscal 2006
First Quarter	$	11.62	$	9.50
Second Quarter	15.47		8.99
Third Quarter	22.81		14.35
Fourth Quarter	24.08		14.10
Fiscal 2007
First Quarter	$	16.70	$	9.91
Second Quarter	14.67		10.37
Third Quarter	12.86		9.38
Fourth Quarter	12.82		10.34

Repurchase of our Equity Securities

Stock repurchases during the three-month period ended June 30, 2007 are as follows:

						Announced Plan or Program
Fiscal Period	Total Shares Purchased		Average Paid per Share			Total Shares Purchased		Dollar Value of Shares That May Yet be Purchased
								(in thousands)
April 1, 2007 to April 28, 2007		—		—			—
April 29, 2007 to May 26, 2007		—		—			—
May 27, 2007 to June 30, 2007		105,200		$	11.31		105,200
Total		105,200					105,200		$	16,115

Dividend Policy

We have never paid a cash dividend and have no present intention to pay cash dividends in the foreseeable future. We intend to retain any future earnings for use in our business.

Securities Authorized for Issuance under Equity Compensation Plans

See Part III, Item 12 for information regarding securities authorized for issuance under equity compensation plans.

Item 6. Selected Consolidated Financial Data.

The table set forth below contains certain consolidated financial data for each of the last five fiscal years of Candela. This data should be read in conjunction with the detailed information, financial statements and related notes, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.

	For the Year Ended
Consolidated Statement of Operations Data:	June 30, 2007		July 1, 2006			July 2, 2005			July 3, 2004			June 28, 2003
	(in thousands, except per share data)
Revenue:
Lasers and other products	$	113,225	$	121,838		$	102,323		$	87,965		$	68,072
Product-related service	35,332		27,628			21,578			16,473			10,579
Total revenue	148,557		149,466			123,901			104,438			78,651
Cost of sales:
Lasers and other products	49,303		54,748			45,235			36,413			30,641
Product related service	24,191		20,869			17,918			14,860			7,992
Litigation related charges	—		—			4,829			—			—
Total cost of sales	73,494		75,617			67,982			51,273			38,633
Gross profit:	75,063		73,849			55,919			53,165			40,018
Operating expenses:
Selling, general and administrative	53,562		44,297			40,165			33,978			24,519
Research and development	18,146		8,879			6,890			5,302			4,545
Litigation related charges	—		—			773			—			—
Total operating expenses	71,708		53,176			47,828			39,280			29,064
Income from operations:	3,355		20,673			8,091			13,885			10,954
Other income (expense):
Interest income	2,719		1,748			640			308			651
Other income (expense), net	3,725		(19		)	(73		)	905			(262		)
Total other income	6,444		1,729			567			1,213			389
Income from continuing operations before income tax:	9,799		22,402			8,658			15,098			11,343
Provision for income taxes	3,543		7,468			2,194			4,586			3,516
Income from continuing operations	6,256		14,934			6,464			10,512			7,827
Discontinued operations:
Loss from discontinued skin care center operations of $473 and $1,468, net of income tax benefit of $175 and $455, in 2004 and 2003, respectively	—		—			—			(298		)	(1,013		)
Gain (loss) on disposal of skin care center, including revision of leasehold obligations of $1,374 and provision for operating losses of $(3,348) less income tax of $(515) and income tax benefit of $1,253 in 2005 and 2004, respectively	—		—			859			(2,095		)	—
Net income	$	6,256	$	14,934		$	7,323		$	8,119		$	6,814
Net income per share of common stock
Basic:
Income from continuing operations	$	0.27	$	0.65		$	0.29		$	0.48		$	0.39
Income (loss) from discontinued operations	—		—			0.04			(0.11		)	(0.05		)
Net income	$	0.27	$	0.65		$	0.33		$	0.37		$	0.34
Diluted:
Income from continuing operations	$	0.27	$	0.62		$	0.28		$	0.46		$	0.38
Income (loss) from discontinued operations	—		—			0.04			(0.10		)	(0.05		)
Net income	$	0.27	$	0.62		$	0.32		$	0.36		$	0.33
Basic weighted average shares outstanding	23,086		23,017			22,388			21,902			20,083
Diluted weighted average shares outstanding	23,525		23,948			23,073			22,712			20,645

	For the Year Ended
Consolidated Balance Sheet Data, in thousands:	June 30, 2007		July 1, 2006		July 2, 2005		July 3, 2004		June 28, 2003
Cash, restricted cash, and cash equivalents	$	27,200	$	40,360	$	56,383	$	37,139	$	31,813
Marketable securities	11,773		27,332		—		—		—
Marketable securities (long-term portion)	12,260		11,953		—		—		—
Working capital	66,774		81,910		70,378		61,387		47,307
Total assets	150,230		149,656		116,816		100,479		80,501
Long-term debt	—		—		—		—		—
Total stockholders’ equity	101,510		100,012		74,339		66,769		53,348

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

All statements, trend analysis and other information contained in the following discussion relative to markets for our products and trends in revenue, gross margins and anticipated expense levels, as well as other statements including words such as “anticipate”, “believe”, “plan”, “estimate”, “expect”, and “intend” and other similar expressions, constitute forward-looking statements. These forward-looking statements are subject to business and economic risks and uncertainties, and our actual results of operations may differ materially from those contained in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Item1A. “Risk Factors” as well as other risks and uncertainties referenced in this Annual Report on Form 10-K.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, receivables valuation, valuation of investments, inventory valuation, depreciable lives of fixed assets, valuation of goodwill and acquired intangibles, income taxes, stock-based compensation, and accrued warranties. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies and the related judgments and estimates affect the preparation of our consolidated financial statements.

Revenue Recognition. We generally recognize revenue upon shipment of product to customers and the fulfillment of all contractual terms and conditions, pursuant to the guidance provided by SAB No. 104, “Revenue Recognition”. Credit is not extended to customers and revenue is not recognized until collectibility is reasonably assured. Revenue from the sale of service contracts is deferred and recognized on a straight-line basis over the contract period. Revenue from service administered by us that is not covered by a service contract is recognized as the services are provided. In certain instances, we may sell products together with extended warranties or maintenance contracts. The revenue recognized per element is determined by allocating the total sales price to each element, based on the relative fair values in accordance with Emerging Issues Task Force (EITF) 00-21, “Revenue Arrangements with Multiple Deliverables”. Separately priced extended warranty and maintenance products are accounted for over the life of the contract. Unearned revenue is reported on the balance sheet as deferred revenue.

Allowance for Doubtful Accounts. Our policy is to maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Credit limits are established through a process of reviewing the financial history and stability of each customer. Where appropriate, we obtain

credit rating reports and financial statements of customers when determining or modifying their credit limits. We regularly evaluate the collectibility of our trade receivable balances based on a combination of factors. When a customer’s account balance becomes past due, we initiate dialogue with the customer to determine the cause. If it is determined that the customer will be unable to meet its financial obligation to us, such as in the case of a bankruptcy filing, deterioration in the customer’s operating results or financial position or other material events impacting their business, we record a specific allowance to reduce the related receivable to the amount we expect to recover given all information presently available. We will also provide a general reserve based on the aging of the accounts and notes receivable based on historical experiences of write-offs.

As of June 30, 2007, our accounts receivable balance of $38.5 million is reported net of allowances for doubtful accounts of $1.4 million. We believe our reported allowances at June 30, 2007, are adequate. If the financial conditions of those customers were to deteriorate, however, resulting in their inability to make payments, we may need to record additional allowances that would result in additional selling, general and administrative expenses being recorded for the period in which such determination is made.

Inventory Reserves. As a designer and manufacturer of high technology equipment, we are exposed to a number of economic and industry factors that could result in portions of our inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, technological changes in our markets, our ability to meet changing customer requirements, competitive pressures in products and prices, and the availability of key components from our suppliers. Our policy is to establish inventory reserves when conditions exist that suggest that our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand for our products and market conditions. We regularly evaluate the ability to realize the value of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, product end of life dates, estimated current and future market values and new product introductions. Purchasing requirements and alternative usage avenues are explored within these processes to mitigate inventory exposure. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value. As of June 30, 2007, our inventory of $21.4 million is stated net of inventory reserves of $2.1 million. If actual demand for our products deteriorates, or market conditions are less favorable than those that we project, additional inventory reserves may be required.

Fair Value of Financial Instruments. Carrying amounts of the financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to the short term nature of these instruments. Held-to-maturity marketable securities, which are generally comprised of short-duration certificates of deposit or government-backed bonds, are valued at amortized cost which approximates market value. Available-for-sale securities are marked-to-market on a quarterly basis and the associated unrealized gain or loss is reflected as a component of other comprehensive income (loss), net of tax.

Product Warranties. Our products are sold with warranty provisions that require us to remedy deficiencies in quality or performance of our products over a specified period of time at no cost to our customers. Our policy is to establish warranty reserves at levels that represent our estimate of the costs that will be incurred to fulfill those warranty requirements at the time that revenue is recognized. We believe that our recorded liability at June 30, 2007, is adequate to cover our future cost of materials, labor and overhead for the servicing of our products sold through that date. If actual product failures or material or service delivery costs differ from our estimates, our warranty liability would need to be revised accordingly.

Stock based compensation. Effective July 3, 2005, we implemented the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 revised (“SFAS No. 123R”) and Staff Accounting Bulletin 107 (“SAB 107”) for all share-based compensation that was not vested as of July 2, 2005. We adopted SFAS No. 123R using a modified prospective application, as permitted under SFAS

No. 123R. Accordingly, prior period amounts have not been restated. Under this application, we were required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

The fair value of each option/stock appreciation rights (“SARs”) award is estimated on the date of grant using the Black-Scholes option-pricing model incorporating various assumptions. Expected volatility is determined using both current and historical implied volatilities of the underlying stock which is obtained from public data sources. The expected life of the options is based on historical observations adjusted for the estimated exercise dates of unexercised options/SARs. Additionally, separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The average risk-free interest rate is based on the U.S. treasury security rate with a term to maturity that approximates the option’s expected life as of the grant date. The forfeiture rate is based on historical experience as well as future expectations. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Prior to July 3, 2005, we followed the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”. The provisions of SFAS No. 123 allowed companies to either expense the estimated fair value of stock options or to continue to follow the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), but disclose the pro forma effects on net income (loss) had the fair value of the options been expensed. We elected to apply APB 25 in accounting for its stock option incentive plans.

In accordance with APB 25 and related interpretations, compensation expense for stock options is recognized in income based on the excess, if any, of the quoted market price of the stock at the grant date of the award or other measurement date over the amount an employee must pay to acquire the stock. Generally, the exercise price for stock options granted to employees equals or exceeds the fair market value of the common stock at the date of grant, thereby resulting in no recognition of compensation expense. For awards that generated compensation expense as defined under APB 25, the Company calculated the amount of compensation expense and recognized the expense over the vesting period of the award.

Contingencies. We are subject to proceedings, lawsuits and other claims. We assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of reserves required, if any, for these contingencies is made after careful analysis of each individual issue. The required reserves may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters. We record charges for the costs we anticipate incurring in connection with litigation and claims against us when we can reasonably estimate these costs.

Restructuring. We record restructuring charges incurred in connection with consolidation or relocation of operations, exited business lines, or shutdowns of specific sites. These restructuring charges, which reflect our commitment to a termination or exit plan that will begin within twelve months, are based on estimates of the expected costs associated with site closure, legal matters, contract terminations, or other costs directly related to the restructuring. If the actual cost incurred exceeds the estimated cost, an additional charge to earnings will result. If the actual cost is less than the estimated cost, a credit to earnings will be recognized.

Taxes. In accordance with SFAS No. 109, “Accounting for Income Taxes,” we recognize deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax basis of assets and liabilities, calculated using enacted tax rates for the year in which the differences are expected to be reflected in the tax return. Realization is dependent on the generation of

sufficient taxable income in future years. Management continually evaluates the need for a valuation allowance for deferred tax assets based on the probability of realization determined by expectations for future taxable income and other factors. Although realization is not assured, based on available evidence, management believes it is more likely than not that the full amount of the net deferred tax asset will be realized. However, the amount realizable could be reduced if estimates of future taxable income are reduced.

Overview

We research, develop, manufacture, market, sell, distribute, and service lasers and light-based products used to perform aesthetic and cosmetic procedures. We sell our lasers and light-based products principally to medical practitioners. Candela markets its products directly and through a network of distributors to end users. Our traditional customer base includes plastic and cosmetic surgeons and dermatologists. More recently, we have expanded our sales to a broader group of practitioners consisting of general practitioners and certain specialists including obstetricians, gynecologists, and general and vascular surgeons. We derive our revenue from the sale of lasers, light-based devices, and other products, and product-related services.

We sell products worldwide through our direct sales force and independent distributors.

We assemble substantially all of our products in our Wayland, Massachusetts and Netanya, Israel facilities in the quarter in which they are shipped, and backlog has not been significant. We experience some seasonal reduction of our product sales in our first fiscal quarter due to the summer holiday schedule of physicians and their patients.

Our products are generally covered by a standard warranty, with an option to purchase extended warranty contracts at the time of product sale or service contracts after the time of sale. Distributor sales generally include a parts warranty only. The anticipated cost associated with the standard warranty coverage is accrued at the time of shipment as a cost of sales. Any costs associated with product installation are also recognized as costs of sales. Both such anticipated and actual costs have no associated revenue and therefore reduce the gross profit from product-related service revenue.

Product-related service revenue consists of revenue from maintenance and repair services and the sale of spare parts and consumables. We derive revenue from extended service contracts, which are typically for a 12 or 24-month period, and the revenue is initially deferred and recognized over the life of the service contract. In addition, we provide on-site service worldwide on a time-and-materials basis directly or through our distributors.

International revenue, consisting of sales from our subsidiaries in Germany, France, Italy, Spain, Japan, Israel, and Australia, and sales consisting of products shipped from the United States directly to international locations from the United States during the fiscal years ended June 30, 2007, July 1, 2006, and July 2, 2005 represented 56%, 54%, and 54% of total sales, respectively.

Our fiscal year consists of the 52 or 53-week period ending on the Saturday closest to June 30 of each year. The years ended June 30, 2007, July 1, 2006, and July 2, 2005 contained 52 weeks each, respectively.

Results of Operations

The following tables set forth selected financial data for the periods indicated, expressed as a percentage of total revenue.

	For the Year Ended
	June 30,			July 1,		July 2,
	2007			2006		2005
Revenue Mix:
Lasers and other products		76.2	%	81.5	%	82.6	%
Product-related services		23.8	%	18.5	%	17.4	%
Total revenue		100.0	%	100.0	%	100.0	%
Gross profit:
Lasers and other product		43.0	%	44.9	%	46.1	%
Product-related services		7.5	%	4.5	%	2.9	%
Litigation-related charges		0.0	%	0.0	%	-3.9	%
Total gross profit		50.5	%	49.4	%	45.1	%
Operating expenses:
Research and development		12.2	%	5.9	%	5.6	%
Selling, general & administrative		36.0	%	29.7	%	32.4	%
Litigation-related charges		0.0	%	0.0	%	0.6	%
Total operating expenses		48.2	%	35.6	%	38.6	%
Income from operations		2.3	%	13.8	%	6.5	%
Other income, net		4.3	%	1.2	%	0.5	%
Income before income taxes		6.6	%	15.0	%	7.0	%
Provision for income taxes		2.4	%	5.0	%	1.8	%
Net income		4.2	%	10.0	%	5.2	%

Fiscal Year Ended June 30, 2007 Compared to Fiscal Year Ended July 1, 2006

Revenue. Revenue for the year ended June 30, 2007 was $148.6 million as compared to $149.5 million in the prior fiscal year. The slight decrease is primarily related to a decrease in volume of our legacy products and the inability to ship all the announced new products.

International revenue increased approximately $3.5 million over the prior year and accounted for approximately 56% of total revenue for fiscal 2007 as compared to approximately 54% for fiscal 2006. This $3.5 million increase, was net of an approximate $4.2 million decreases in sales in Latin America, which represents approximately a 28% decrease in sales for that region. Sales in Europe increased approximately 22%, representing a $7.7 million increase in Europe as compared to the fiscal 2006.

Product-related service revenue increased approximately 28% to $35.3 million in fiscal 2007 from $27.6 million in fiscal 2006. This increase was consistent with the increase in systems sold over the past few years and increase in renewal contracts.

Gross Profit. Gross profit increased approximately $1.2 million to $75.1 million, or 50.5% of revenue, in fiscal 2007 from $73.8 million, or 49.4% of revenue, in fiscal 2006. The increase in gross profit was primarily driven by improvements in the overall product-related service area. These improvements were the result of the staffing efficiencies that were achieved through the world-wide service organization and the increased service contracts.

Research and Development Expense. Research and development spending increased approximately $9.2 million to $18.1 million in fiscal 2007 as compared to $8.9 million for fiscal 2006. The increase was attributable primarily to $6.3 million of higher outsourced project-related work utilized to expedite the completion of the new product introduction cycle, $1.1 million of increased project materials expenditures related to the same, and $0.9 million related to increased personnel expenses including share-based compensation. As a percentage of revenue, research and development expenses were approximately 12.2% and 5.9% for fiscal 2007 and 2006, respectively.

Selling, General and Administrative Expense. Selling, general and administrative expense increased to approximately $53.6 million or 36.0% of revenue during fiscal 2007 as compared to $44.3 million or 30% during fiscal 2006. Of the $9.3 million increase, $3.9 million was due to higher personnel expense for increased headcount, higher commission expense due to increased commissionable revenue, and stock-based compensation. The increase is also attributable to a $0.8 million increase in marketing-related expenses such as customer-related work-shops, advertising, trade shows, and an increase of $2.9 million due to an increase in legal and professional fees.

Other Income/Expense. Total other income increased approximately $4.7 million for the fiscal 2007 to $6.4 million, from approximately $1.7 million for the fiscal 2006. This increase is primarily attributable to the recognition of a $3.5 million gain on the exchange of common stock of Solx Inc. for cash and common stock of Occulogix Inc. (NasdaqGM: OCCX). The gain was a result of the acquisition of Solx Inc., a privately-held company, by Occulogix Inc., a publicly traded company. The Company held 19.99% of the outstanding common stock of Solx Inc. on an as-converted basis, prior to the merger. As a result of the acquisition of Solx, Inc., the Company received approximately $1.0 million in cash plus approximately 1.3 million shares of common stock in Occulogix Inc.

Income Taxes. The provision for income taxes results from a combination of activities of both the domestic and foreign subsidiaries. The Company recorded a 36.2% effective tax rate for the year ended June 30, 2007 compared to a 33% effective tax rate for the year ended July 1, 2006. The provision for income taxes for the year ended July 1, 2006, includes a tax provision calculated for taxable income generated at the foreign subsidiaries at rates below that of the United States statutory tax rate.

Fiscal Year Ended July 1, 2006 Compared to Fiscal Year Ended July 2, 2005

Revenue. Total revenue increased $25.6 million or 20.6% to $149.5 million in fiscal 2006 from $123.9 million in fiscal 2005. Increases in unit sales accounted for the increase. The increase was due primarily to strong growth for the GentleLASE® systems, GentleYAG® systems and the introduction of the newer Vbeam® models. The increase is also attributable to the exclusive arrangement with McKesson’s Medical Surgical Division in 2006.

International revenue increased $13.8 million over the prior year and accounted for 56% of total revenue for fiscal 2006 in comparison to 54% for fiscal 2005. Of the $13.8 million increase, approximately $8.8 million was related to increases in sales to Latin America, which represents a 136% increase in that region. Sales in Europe increased approximately 13%, representing a $4 million increase in Europe compared to 2005. The large growth internationally resulted from our sales force expansion and distributor networks and new product introductions.

Product-related service revenue increased 28% to $27.6 million in fiscal 2006 from $21.6 million in fiscal 2005. This increase was consistent with the increase in systems sold over the past few years and increase in renewal contracts.

Gross Profit. Gross profit increased approximately $17.9 million to $73.8 million or 49% of revenue in fiscal 2006 from $55.9 million, or 45% of revenue in fiscal 2005, as a direct result of the increase in revenue. Excluding the Regents litigation-related charges, gross profit would have increased $13.1 million from $60.7 million, or 49% of revenue compared to fiscal 2005. As a percentage of revenue, 2006 gross

profit is comparable to prior year excluding the Regents litigation-related charges incurred in 2005 which related to the proceeding against the Regents.

Research and Development Expense. Research and development spending increased $2 million to $8.9 million compared to $6.9 million for fiscal year 2005. This increase was primarily attributable to $1.3 million of higher personnel expense due primarily to increased headcount, stock-based compensation and $0.7 million of other research and development related costs. As a percentage of revenue, research and development expenses were approximately 6% for 2006 and 2005.

Selling, General and Administrative Expense. Selling, general and administrative expense increased to $44.3 million or 30% of revenue during fiscal 2006 compared to $40.2 million or 32% during fiscal 2005. Of the $4.1 million increase, $2.3 million was due to higher personnel expense for increased headcount, higher commission expense due to increased revenue, and stock-based compensation. The increase is also attributable to a $1 million increase in marketing-related expenses such as customer-related work-shops, advertising, trade shows, and an increase of $1 million due to an increase in legal and audit fees, excluding the litigation related charges for 2005 offset by a decrease in bad debt expense of approximately $0.4 million.

Other Income/Expense. Total other income increased $1.2 million for the fiscal year 2006 to $1.7 million, from $0.6 million for the fiscal year 2005. This increase is related primarily to interest earned from the increase in our cash and cash equivalents, marketable securities and long-term investments and an increase in interest rates.

Income Taxes. The provision for income taxes results from a combination of activities of both the domestic and foreign subsidiaries. We recorded a 33% effective tax rate for the year ended July 1, 2006 compared to a 25.3% effective tax rate for the year ended July 2, 2005. During the year ended July 2, 2005, the Company recorded a benefit for the utilization of deferred tax assets which was not applicable during the current fiscal year ended 2006.

Discontinued Operations

On September 27, 2003 management initiated a plan to close its only remaining skin care center. The closure is accounted for as a discontinued operation in accordance with Statement of Financial Accounting Standards (“SFAS”) 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” and SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities”. As a result, in fiscal year 2004, we recorded a $2.1 million charge for the accrual of $3.0 million of future occupancy costs, primarily relating to future lease payments for the Boston facility, and $0.4 million of severance obligations and other related costs of closure, net of anticipated tax benefits of $1.3 million.

During fiscal year 2005, the landlord for the Boston facility secured a sublease for that property. The sub-lessee commenced making payments to the landlord during December of 2004. As a result of these and future payments scheduled under the sublease, we revised the estimated future costs associated with the Boston facility and, in the fiscal year 2005, reversed approximately $0.9 million of the restructuring reserve. This reversal represents the aforementioned anticipated economic benefit due to sub-lessee payments of $1.7 million, net of legal and other fees of approximately $0.3 million and income taxes of approximately $0.5 million.

Liquidity and Capital Resources

Our cash and cash equivalents, and marketable securities at June 30, 2007 totaled approximately $51.2 million compared to approximately $79.6 million at July 1, 2006. We continue to have no long-term debt. We believe that the combination of existing cash and cash equivalents, and marketable securities on hand, along with cash to be generated by future operations and amounts available under our line of credit, will be sufficient to meet our ongoing operating and capital expenditure requirements for the foreseeable

future. However, we cannot be sure that we will not require additional capital beyond the amounts currently forecasted by us, nor that any such required additional capital will be available on reasonable terms, if at all, as it becomes required.

Cash used by operating activities amounted to $7.7 million for fiscal 2007 as compared to cash provided by operations of $14.4 million for fiscal 2006. This decrease in cash provided by operating activities was due to: (a) a decrease in year-over-year net income of approximately $8.6 million; (b) a year-over-year increase in inventory of approximately $4.7 million due to the inability to ship new products at year end; and, (c) a year-over-year increase in accounts receivable of approximately $4.7 million due primarily to increases in international receivables that typically have slightly longer payment terms.

Cash provided by investing activities amounted to approximately $2.5 million for fiscal 2007 as compared to cash used by investing activities of approximately $40.0 million for fiscal 2006. This increase in cash provided by investing activities reflects the net maturities of held-to-maturity investments offset by our cash acquisition of Inolase.

Cash used by financing activities amounted to approximately $8.4 million for the fiscal year 2007 as compared to cash provided by financing activities of approximately $8.9 million for fiscal 2006. The decrease is primarily the result of the Company repurchasing its own equity shares under the previously announced repurchase program.

Debt Instruments and Related Covenants

We maintain a renewable $10,000,000 revolving credit agreement with a major bank with interest at the bank’s base rate of LIBOR plus 2.25%. Any borrowings outstanding under the line of credit are due on demand or according to a payment schedule established at the time funds are borrowed. The line of credit is unsecured. The agreement contains restrictive covenants limiting the establishment of new liens, and the purchase of margin stock. No amounts were outstanding under the line of credit as of June 30, 2007 or July 1, 2006.

Off-Balance Sheet Arrangements

Our only off-balance sheet arrangements consist of non-cancelable operating leases entered into in the ordinary course of business and the license agreement with the Regents. The table below in the next section titled “Contractual Obligations” shows the amounts of our operating lease commitments and purchase commitments payable by year. For liquidity purposes, we choose to lease our facilities and automobiles instead of purchasing them.

Contractual Obligations

In August 2000 Candela obtained exclusive license rights to the DCD, subject to certain limited license rights of Cool Touch, Inc. (“Cool Touch”), in the following fields of use: procedures that involve skin resurfacing and rejuvenation, vascular skin lesions, and laser hair removal. Cool Touch, a subsidiary of New Star Technology, Inc. obtained a license to the DCD on a co-exclusive basis with Candela, in certain narrower fields of use. Cool Touch is restricted in its ability to assign its license rights to certain existing competitors of Candela. Candela is entitled to one-half of all royalty income payable to the Regents from Cool Touch. Under the amended agreement, Candela no longer is required by the Regents to negotiate sublicenses to third parties. However, Candela is entitled to one-half of all royalties due from any other entity that licenses the DCD technology from the Regents in other fields of use.

We recognized royalty expense of $9.2 million and $2.6 million for fiscal 2005 and 2004, respectively, based on the license agreement with the Regents. Included in the fiscal 2005 expense of $9.2 million is $4.8 million of expense for the third quarter charge taken related to the Regents arbitration decision. Of

that $4.8 million, $1.3 million related to fiscal 2005, $3.0 million related to fiscal 2004 and 0.5 million related to prior years.

Effective July 3, 2005, we amended certain portions of our agreement with the Regents whereby for the annual license fee of $0.3 million, our royalty obligation will be reduced to 3% from its prior level of 6%. The annual fee of $0.3 million was paid by a lump sum of $3.0 million and is being amortized over the remaining life of the patent agreement, which as of June 30, 2007 was approximately five years. This reduced royalty rate and the amortization of the annual license fee payment is reflected in our financial statements as of June 30, 2007. The unamortized portion of the license fee payment is reflected in prepaid licenses in the June 30, 2007 balance sheet. We recognized royalty expense associated with this patent of approximately $3.4 million for fiscal year 2007.

Outstanding contractual obligations are reflected in the following table:

	Total		Less than 1 year			1-3 years			3-5 years			After 5 years
	(in thousands)
Royalty commitments	$	4,250		$	1,000		$	2,000		$	500		$	750
Operating leases	3,065			1,690			1,182			193			—
Total contractual obligations	$	7,315		$	2,690		$	3,182		$	693		$	750

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value and requires unrealized gains and losses on items for which the fair value option has been elected to be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently in the process of evaluating the impact of SFAS No. 159 on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This statement is effective for our fiscal year 2008. We are currently assessing the potential impact that the adoption of SFAS No. 157 will have on our financial statements; the impact is not expected to be material.

In September 2006, the FASB issued Emerging Issues Task Force Issue (“EITF”), No. 06-1, Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF No. 06-1 requires that we provide disclosures regarding the nature of arrangements in which we provide consideration to manufacturers or resellers of equipment necessary for an end-customer to receive service from us, including the amounts recognized in the Consolidated Statements of Income. This EITF is effective for our fiscal year 2008. We do not expect the adoption of EITF No. 06-1 to have a material impact on our consolidated financial statements.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (FIN No. 48). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification,

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

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140. This standard permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; requires evaluation of interests in securitized financial assets; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and eliminates the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This standard is effective for all financial instruments acquired or issued for fiscal years beginning after September 15, 2006. We do not believe that adoption of SFAS No. 155 will have a material effect on our financial position or results of operations.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB No. 108 is effective for our fiscal year 2007 annual financial statements. The adoption of SAB No. 108 did not have a significant impact on our financial statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

We have cash equivalents and marketable securities that primarily consist of money market mutual funds, certificates of deposit, US government securities and fixed income corporate securities. The majority of these investments have maturities within one to five years. We believe that our exposure to interest rate risk is minimal due to the term and type of our investments and those fluctuations in interest rates would not have a material adverse effect on our results of operations.

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

We had three forward exchange contracts outstanding serving as a hedge of our Euro-denominated intercompany receivables in the notional amount of approximately 3.1 million Euros at June 30, 2007. These contracts serve as hedges of a substantial portion of our Euro-denominated intercompany balances. The fair value of the foreign currency derivative contract outstanding at June 30, 2007 was approximately $4.2 million resulting in an unrealized gain of approximately $9 thousand. Any gains and losses on the fair value of the derivative contract would be largely offset by losses and gains on the underlying transaction.

CANDELA CORPORATION
Consolidated Balance Sheets
(in thousands, except per share data)

	June 30,			July 1,
	2007			2006
Assets
Current assets:
Cash and cash equivalents	$	27,152		$	40,194
Restricted cash	48			166
Marketable securities	11,773			27,332
Accounts receivable, net of allowance for doubtful accounts of $1,412 and $1,831 at June 30 and July 1, respectively	38,455			34,273
Notes receivable	1,025			1,611
Inventories, net	21,368			16,666
Other current assets	7,136			5,084
Total current assets	106,957			125,326
Property and equipment, net	3,479			3,302
Deferred tax assets, long-term	6,146			5,294
Goodwill	10,997			—
Acquired intangible assets, net of amortization of $662 at June 30	8,151			—
Marketable securities, long-term	12,260			11,953
Other assets	2,240			3,781
Total assets	$	150,230		$	149,656
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	6,922		$	15,968
Accrued payroll and related expenses	5,344			5,728
Accrued warranty costs, current	5,486			5,868
Income taxes payable	—			933
Sales tax payable	1,161			854
Royalties payable	459			764
Other accrued liabilities	9,554			3,672
Deferred revenue, current	10,000			8,342
Current liabilities of discontinued operations	1,257			1,287
Total current liabilities	40,183			43,416
Deferred tax liability, long-term	2,659			480
Accrued warranty costs, long-term	2,127			3,761
Deferred revenue, long-term	3,751			1,987
Total liabilities	48,720			49,644
Commitments and contingencies
Stockholders’ equity:
Common stock, $.01 par value, 60,000,000 shares authorized; 26,082,000 and 25,914,000 issued at June 30 and July 1, respectively	261			259
Treasury stock, 3,125,000 and 2,250,000 common shares at June 30 and July 1, respectively, at cost	(22,458		)	(12,997		)
Additional paid-in capital	69,466			64,234
Accumulated earnings	54,536			48,280
Accumulated other comprehensive (loss) income	(295		)	236
Total stockholders’ equity	101,510			100,012
Total liabilities and stockholders’ equity	150,230			$	149,656

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

CANDELA CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the years ended June 30, 2007, July 1, 2006 and July 2, 2005

	2007			2006			2005
	(in thousands, except per share data)
Revenue
Lasers and other products	$	113,225		$	121,838		$	102,323
Product-related service	35,332			27,628			21,578
Total revenue	148,557			149,466			123,901
Cost of sales
Lasers and other products	49,303			54,748			45,235
Product-related service	24,191			20,869			17,918
Litigation related charges	—			—			4,829
Total cost of sales	73,494			75,617			67,982
Gross profit	75,063			73,849			55,919
Operating expenses:
Selling, general and administrative	53,562			44,297			40,165
Research and development	18,146			8,879			6,890
Litigation related charges	—			—			773
Total operating expenses	71,708			53,176			47,828
Income from operations	3,355			20,673			8,091
Other income (expense):
Interest income	2,719			1,748			640
Other income (expense), net	3,725			(19		)	(73		)
Total other income	6,444			1,729			567
Income from continuing operations before income taxes	9,799			22,402			8,658
Provision for income taxes	3,543			7,468			2,194
Income from continuing operations	6,256			14,934			6,464
Discontinued operations:
Gain on disposal of skin care center, including revision of leasehold obligations, of $1,374 net of income tax expense of ($515)	—			—			859
Net income	$	6,256		$	14,934		$	7,323
Net income per share of common stock
Basic:
Income from continuing operations	$	0.27		$	0.65		$	0.29
Gain from discontinued operations	—			—			0.04
Net income	$	0.27		$	0.65		$	0.33
Diluted:
Income from continuing operations	$	0.27		$	0.62		$	0.28
Gain from discontinued operations	—			—			0.04
Net income	$	0.27		$	0.62		$	0.32
Weighted average shares outstanding:
Basic	23,086			23,017			22,388
Diluted	23,525			23,948			23,073
Net income	$	6,256		$	14,934		$	7,323
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment	246			521			(713		)
Unrealized loss on available-for-sales securities, net of tax	(777		)	—			—
Comprehensive income	$	5,725		$	15,455		$	6,610

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

CANDELA CORPORATION
Consolidated Statements of Stockholders’ Equity
For the years ended June 30, 2007, July 1, 2006, and July 2, 2005

																		Accumulated
						Additional												Other
	Common Stock					Paid-in			Treasury Stock						Accumulated			Comprehensive
	Shares		Amount			Capital			Shares			Amount			Earnings			Income (Loss)				Total
	(In thousands)
Balance July 3, 2004		24,567		$	246		$	53,069		(2,250	)	$	(12,997	)		$	26,023		$	428		$	66,769
Sale of common stock under stock plans		197		2			958															960
Net income																7,323						7,323
Currency translation adjustment																			(713		)	(713		)
Balance July 2, 2005		24,764		248			54,027			(2,250	)	(12,997		)		33,346			(285		)	74,339
Sale of common stock under stock plans		1,150		11			8,111															8,122
Net income																14,934						14,934
Stock-based compensation expense							1,285															1,285
Tax beneifit of stock exercise							811															811
Currency translation adjustment																			521			521
Balance July 1, 2006		25,914		259			64,234			(2,250	)	(12,997		)		48,280			236			100,012
Sale of common stock under stock plans		168		2			841															843
Treasury stock activity—purchase of shares										(875	)	(9,461		)								(9,461		)
Net income																6,256						6,256
Stock-based compensation expense							4,125															4,125
Tax beneifit of stock exercise							266															266
Unrealized loss on available-for-sales securities, net of tax																			(777		)	(777		)
Currency translation adjustment																			246			246
Balance June 30, 2007		26,082		$	261		$	69,466		(3,125	)	$	(22,458	)		$	54,536		$	(295	)	$	101,510

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

CANDELA CORPORATION
Consolidated Statements of Cash Flows
For the years ended June 30, 2007, July 1, 2006, and July 2, 2005

	2007			2006			2005
Cash flows from operating activities:
Net income	$	6,256		$	14,934		$	7,323
Adjustments to reconcile net income to net cash (used by) provided by operating activities:
(Gain) loss of disposal of discontinued operations	—			—			(859		)
Gain on exchange of stock	(3,540		)	—			—
Share-based compensation expense	4,125			1,285			—
Depreciation and amortization	1,631			571			755
Provision (benefit) for bad debts	989			1,241			573
Provision for deferred taxes	45			(2,399		)	233
Change in restricted cash	118			33			58
Other non-cash items	(144		)	95			(180		)
Increase (decrease) in cash from working capital, net of acquisitions:	—
Accounts receivable	(4,943		)	(681		)	(1,801		)
Notes receivable	586			(844		)	(19		)
Inventories	(4,702		)	(3,561		)	719
Other current assets	(266		)	75			1,335
Other assets	(977		)	(2,684		)	427
Accounts payable	(10,376		)	3,593			4,760
Accrued payroll and related expenses	(438		)	882			(567		)
Deferred revenue	3,422			2,243			2,731
Accrued warranty costs	(2,016		)	620			2,091
Income taxes payable	(2,921		)	(779		)	(303		)
Other accrued liabilities	5,732			(238		)	1,698
Net cash (used by) provided by operating activities	(7,419		)	14,386			18,974
Cash flows from investing activities:
Purchases of property and equipment	(763		)	(715		)	(635		)
Maturities of held-to-maturity marketable securities	37,014			4,369			—
Cash proceeds from exchange of stock	994			—			—
Purchases of held-to-maturity marketable securities	(17,706		)	(43,654		)	—
Acquisition of business, net of cash acquired	(15,986		)	—			—
Acquisition of intangible assets	(1,380		)	—			—
Net cash provided by (used by) investing activities	2,173			(40,000		)	(635		)
Cash flows from financing activities:
Proceeds from the issuance of common stock	843			8,122			960
Purchase of treasury stock	(9,461		)	—			—
Benefits of tax effects from exercise of stock options	266			811
Net cash (used by) provided by financing activities	(8,352		)	8,933			960
Effect of exchange rates on cash and cash equivalents	556			492			(55		)
Net (decrease) increase in cash and cash equivalents	(13,042		)	(16,189		)	19,244
Cash and cash equivalents at beginning of period	40,194			56,383			37,139
Cash and cash equivalents at end of period	$	27,152		$	40,194		$	56,383
Cash paid during the year for:
Interest	$	—		$	—		$	—
Income taxes	5,451			9,834			2,269
Noncash investing and financing activities:
Stock acquired on exchange of Solx, Inc. investment	$	2,546		$	—		$	—

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

Notes to Consolidated Financial Statements

1. Description of Business and Summary of Significant Accounting Policies

Description of Business. Candela Corporation (“the Company” or “Candela”) is involved in the development and commercialization of advanced aesthetic laser systems that allow physicians and personal care practitioners to treat a wide variety of cosmetic and medical conditions.

Basis of Consolidations. The financial statements include the accounts of the Company and its subsidiaries. Intercompany transactions and balances have been eliminated. Investments in which we are not able to exercise significant influence over the investee are accounted for under the cost method.

Reclassifications. Certain prior period amounts have been reclassified to conform to the current period presentation. There was no impact on operating income.

The following table details the affect of the reclassification on the July 1, 2006 balance sheet to conform to the June 30, 2007 presentation relative to deferred tax assets and liabilities. Due to the immaterial nature of the current portion of deferred tax assets, they are included as a component of “Other current assets” on our consolidated balance sheets for June 30, 2007 and July 1, 2006, respectively.

(in thousands)	July 1, 2006 Originally Reported			Reclassification				July 1, 2006 Reclassified
Other current assets		$	1,756		$	3,328			$	5,084
Deferred tax assets, long-term		8,142			(2,848		)		5,294
Deferred tax liability, long-term		—			(480		)		(480		)
Net fiscal year 2006 reclassification					$	—

Fiscal Years. The Company’s fiscal year ends on the Saturday nearest June 30. The years ended June 30, 2007, July 1, 2006 and July 2, 2005 each contain 52 weeks.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, receivables valuation, valuation of investments, inventory valuation, depreciable lives of fixed assets, valuation of goodwill and acquired intangibles, income taxes, stock-based compensation, and accrued warranties. Actual results could differ materially from those estimates.

Cash and Cash Equivalents. The Company considers all highly liquid instruments with original maturities of three months or less to be cash equivalents. Substantially all cash and cash equivalents were invested in short duration certificates of deposit and overnight repurchase agreements with major financial institutions. These are valued at amortized cost which approximates market value.

Marketable Securities. The Company accounts for marketable securities in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). SFAS 115 establishes the accounting and reporting requirements for all debt securities and for investments in equity securities that have readily determinable fair values. All marketable securities must be classified as one of the following: held-to-maturity, available-for-sale, or trading. The Company classifies substantially all of its marketable securities as held-to-maturity as the Company has the intent and ability to hold them to maturity. Held-to-maturity debt securities are reported at amortized cost which approximates fair value. The Company classifies its investment in Occulogix, Inc, (Note 15) as available-for-sale. As such, this investment is marked-to-market on a quarterly basis and the associated unrealized gain or loss is reflected as a component of other comprehensive income (loss), net of tax.

Current held-to-maturity marketable securities include investments that are expected to mature in more than three months and up to twelve months. Long-term investments have remaining maturities of one to three years. Unrealized gains and losses related to the marketable securities are not considered a permanent decline in the market value of such securities.

Accounts Receivable and Notes Receivable. The Company’s trade accounts receivable and notes receivable are primarily from sales to end users, leasing companies, and distributors servicing the medical device market, and reflect a broad domestic and international customer base. The Company does not require collateral and has not historically experienced significant credit losses related to receivables from individual customers or groups of customers in any particular industry or geographic area.

The Company’s policy is to maintain reserves for potential losses resulting from the inability of our customers to make required payments. These reserves are charged to bad debts expense. The Company determines the adequacy of this allowance by regularly reviewing the aging of its accounts and notes receivable and evaluating the individual customer’s balances considering the customer’s financial condition, historical experience credit history and current economic conditions. Credit assessments are established through a process of reviewing the financial history and stability of each customer prior to inception of the sale. Where appropriate, the Company will obtain credit rating reports and financial statements of customers when determining or modifying their credit limits. When a customer’s account balance becomes past due, the Company will initiate dialogue with the customer to determine the cause. If it is determined that the customer will be unable to meet its financial obligation, such as in the case of a bankruptcy filing, deterioration in the customer’s operating results or financial position or other material events impacting their business, the Company will record an allowance to reduce the related receivable to the amount the Company expects to recover given all information presently available. The Company will also provide a general reserve based on the aging of the accounts and notes receivable based on historical experiences of write-offs.

Derivative Instruments and Hedging Activity. The Company enters into financial instruments to reduce its exposure to fluctuations in foreign exchange rates by creating offsetting positions through the use of foreign currency forward contracts. The Company recognizes all derivative instruments as either assets or liabilities in the statements of financial position and measures those instruments at fair value. Changes to the fair value of derivative contracts that do not qualify for hedge accounting are reported in earnings in the period of the change. For derivatives that qualify for hedge accounting, changes in the fair value of the derivatives are either recorded in shareholders’ equity as a component of other comprehensive income or are recognized currently in earnings, along with an offsetting adjustment against the basis of the item being hedged.

The Company’s foreign currency forward contracts may involve elements of credit and market risk in excess of the amounts recognized in the financial statements. The Company monitors its positions and the credit quality of counter-parties, consisting primarily of major financial institutions, and does not anticipate nonperformance by any counter-party. The Company does not use derivative financial instruments for trading or speculative purposes, nor is the Company a party to leveraged derivatives.

Inventories. Inventories are stated at the lower of cost (first-in, first-out method) or market, using a standard costing system which includes material, labor and manufacturing overhead Standard costs are

monitored and updated as necessary, to reflect the changes in raw material costs and labor and overhead rates.

As a designer and manufacturer of high technology equipment, the Company is exposed to a number of economic and industry factors that could result in portions of inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, technological changes in markets, the Company’s ability to meet changing customer requirements, competitive pressures in products and prices, and the availability of key components from suppliers. The Company’s policy is to establish inventory reserves when conditions exist that suggest inventory may be in excess of anticipated demand or is obsolete based upon assumptions about future demand for the Company’s products and market conditions. The Company regularly evaluates the ability to realize the value of inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, product end of life dates, estimated current and future market values and new product introductions. Purchasing requirements and alternative usage avenues are explored within these processes to mitigate inventory exposure. When recorded, the reserves are intended to reduce the carrying value of inventory to its net realizable value. Inventory of $21.4 million as of June 30, 2007 and $16.7 million as of July 1, 2006 is stated net of inventory reserves of $2.1 million and $0.6 million, respectively. If actual demand for the Company’s products deteriorates, or market conditions are less favorable than those projected, additional inventory reserves may be required.

Property and Equipment. Purchased property and equipment is recorded at cost. Laser systems used for testing are capitalized at cost. Repairs and maintenance costs are expensed as incurred. Leasehold improvements are amortized over the shorter of the useful life or the life of the related lease. Depreciation is provided using the straight-line method over the estimated useful lives as follows:

	Estimated Life or Number of Years
Leasehold improvements		2 to 15
Office furniture, computer and other equipment		2 to 10

Prepaid license fees. Prepaid license fees are amortized over the term of the related contract (see Note 8).

Goodwill, Acquired Intangible Assets and Long-Lived Assets. Goodwill is the amount by which the cost of acquired net assets in a business acquisition exceeded the fair values of net identifiable assets on the date of our purchase.

Intangible assets with indefinite useful lives, including goodwill, are evaluated for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Factors we consider important, on an overall company basis that could trigger an impairment review include significant underperformance relative to historical or projected future operating results, significant changes in our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period and a reduction of our market capitalization relative to net book value. To conduct these tests of goodwill and indefinite-lived intangible assets, the fair value of the reporting unit is compared to its carrying value. If the reporting unit’s carrying value exceeds its fair value, we record an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value. We estimate the fair values of our reporting units using discounted cash flow valuation models.

Long-lived assets primarily include property and equipment and intangible assets with finite lives. In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we periodically review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of those assets are no

longer appropriate. Each impairment test is based on a comparison of the undiscounted cash flows to the recorded value of the asset. If impairment is indicated, the asset is written down to its estimated fair value based on a discounted cash flow analysis.

Goodwill and acquired intangible assets consist of the following:

(in thousands)	June 30, 2007				July 1, 2006
Goodwill		$	10,997			$	—
Intangible assets with finite lives:
Patents		$	2,804			$	—
Developed technology		6,009				—
		8,813				—
Less: accumulated amortization		(662		)		—
		$	8,151			$	—

Amortization expense on acquired intangible assets was approximately $0.7 million for the fiscal year ended 2007. There was no amortization expense associated with acquired intangible assets in the fiscal year ended 2006 or 2005, respectively.

Amortization expense associated with acquired intangibles is expected to be approximately $1.7 million for each of the fiscal years ended 2008 through 2012, inclusive.

Revenue Recognition.

Product sales—The Company generally recognizes revenue upon shipment of product to customers and the fulfillment of all contractual terms and conditions, pursuant to the guidance provided by Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). SAB 104 requires that at the time revenue is recognized persuasive evidence of an arrangement exists; delivery has occurred or services rendered; the fee is fixed and determinable; and collectibility is reasonably assured. Circumstances which generally preclude the immediate recognition of revenue include shipping terms of FOB destination. In these instances, revenue is deferred until adequate documentation is obtained to ensure that the delivery criteria have been fulfilled. The Company provides for the estimated cost to repair or replace products under warranty at the time of sale. Unearned revenue is reported on the balance sheet as deferred income.

Service—Revenue from the sale of service contracts is deferred and recognized on a straight-line basis over the contract period. Revenue from service administered by the Company that is not covered by a service contract is recognized as the services are provided.

Multiple-element arrangements—In certain instances, the Company may sell products together with extended warranties or maintenance contracts. The revenue recognized per element is determined by allocating the total sales price to each element, based on the relative fair values in accordance with Emerging Issues Task Force (EITF) 00-21, “Revenue Arrangements with Multiple Deliverables”. Revenue for extended warranty and maintenance contracts are recognized on a straight line basis over the life of the contract. Unearned revenues are reported on the balance sheet as deferred revenue.

Product Warranty Costs. The Company’s products generally carry a standard warranty. The Company maintains a reserve based on anticipated warranty claims at the time product revenue is recognized. Factors that affect the Company’s product warranty liability include the number of installed units, the anticipated cost of warranty repairs and historical and anticipated rates of warranty claims.

Research and Development Costs. Research and development costs are expensed as incurred.

Advertising Costs. Advertising costs are expensed as incurred and are included as a component of selling, general and administrative expenses in the accompanying Consolidated Statements of Income and Comprehensive Income. Advertising costs were approximately $0.7 million for the fiscal year ended 2007 and $0.9 million for each of the fiscal years 2006 and 2005, respectively.

Shipping and handling costs. The Company reports shipping and handling costs in both sales and the related costs as cost of sales to the extent they are billed to customers. In all other instances they are reflected as a component of cost of sales.

Stock-based compensation. Effective July 3, 2005, the Company implemented the fair value recognition provisions of SFAS 123 revised (“SFAS 123R”) and Staff Accounting Bulletin 107 (“SAB 107”) for all share-based compensation. The Company adopted SFAS 123R using a modified prospective application, as permitted under SFAS 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

The application of SFAS 123R and SAB 107 during the years ended June 30, 2007 and July 1, 2006 resulted in the recognition of share-based compensation expense of $4.1 million and $1.2 million, respectively, attributable to stock options/stock appreciation rights (“SARs”) and $35 thousand and $56 thousand, respectively, attributable to the employee stock purchase plan.

This expense was divided between operating expense cost centers based upon the functional responsibilities of the individual holding the respective options, as follows:

(in thousands)	For the year ended June 30, 2007			For the year ended July 1, 2006
Selling, general and administrative		$	3,154		$	1,016
Research and development		640			258
Cost of sales		330			11
		$	4,124		$	1,285

The fair value of each option/SARs award is estimated on the date of grant using the Black-Scholes option-pricing model incorporating the assumptions noted in the following table. Expected volatility is determined using both current and historical implied volatilities of the underlying stock which is obtained from public data sources. The expected term of the options is based on historical observations adjusted for the estimated exercise dates of unexercised options/SARs. Additionally, separate groups of employees that have dissimilar historical exercise behavior are considered separately for valuation purposes. The average risk-free interest rate is based on the U.S. treasury security rate with a term-to-maturity that approximates the option’s expected life as of the grant date. The forfeiture rate is based on historical experience as well as future expectations. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

As of June 30, 2007, there was approximately $8.0 million of total unrecognized compensation cost related to non-vested stock options/SARs granted under the Company’s incentive plans. This cost is expected to be recognized over a weighted-average period of 1.81 years.

As of July 1, 2006, there was approximately $3.4 million of total unrecognized compensation cost related to non-vested stock options/SARs granted under the Company’s incentive plans. This cost is expected to be recognized over a weighted-average period of 1.5 years.

The amount of cash received from the exercise of stock options for the fiscal year ended June 30, 2007 and July 1, 2006 was approximately $0.8 million and $7.8 million for stock options/SARs, respectively, and approximately $0.4 million and $0.3 million for the employee stock purchase plan, respectively. The actual tax benefit realized from the tax deductions resulting from option exercises totaled approximately $0.3 million and $0.8 million for fiscal year 2007 and fiscal year 2006, respectively.

	For the year ended June 30, 2007			For the year ended July 1, 2006
Risk-free interest rate		4.59% to 5.125	%		5.125	%
Estimated volatility		63% to 73%			72	%
Expected life for SARs (years)		2.5 to 5.0			3.39
Expected dividend yield		—			—

The weighted average grant-date fair value per share of SARs granted, calculated using the Black-Scholes option-pricing model, and was $6.77 in fiscal year 2007. No options were granted in fiscal year 2007.

The weighted average grant-date fair value per share of SARs granted, calculated using the Black-Scholes option-pricing model, and was $7.97 in fiscal year 2006. No options were granted in fiscal year 2006.

Prior to July 3, 2005, the Company followed the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). The provisions of SFAS 123 allowed companies to either expense the estimated fair value of stock options or to continue to follow the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), but disclose the pro forma effects on net income (loss) had the fair value of the options been expensed. The Company elected to apply APB 25 in accounting for its stock option incentive plans.

In accordance with APB 25 and related interpretations, compensation expense for stock options was recognized in income based on the excess, if any, of the quoted market price of the stock at the grant date of the award or other measurement date over the amount an employee must pay to acquire the stock. Generally, the exercise price for stock options granted to employees equals or exceeds the fair market value of the Company’s common stock at the date of grant, thereby resulting in no recognition of compensation expense for fixed term grants. For awards that generate compensation expense as defined under APB 25, the Company calculated the amount of compensation expense and recognized the expense over the vesting period of the award.

On May 2, 2005, the Company’s Board of Directors approved accelerating the vesting of unvested, “out-of-the-money” options to purchase approximately 535 thousand shares of the Company’s common stock awarded to employees, officers and non-employee directors under its stock option plans. The accelerated options had exercise prices ranging from $9.50 to $12.33 and a weighted average exercise price of $11.52. The acceleration was unconditional to the employees, officers and non-employee directors and was applied to all outstanding, unvested options priced above the closing price of the Company’s common stock on Monday, May 2, 2005. Approximately $6.4 million of the FY 2005 pro forma expense listed below relates to options included in this acceleration pool.

The primary purpose of the accelerated vesting was to enable the Company to avoid recognizing future compensation expense associated with the accelerated stock options upon the adoption of SFAS 123R by the Company in fiscal 2006.

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

	July 2, 2005
	(in thousands, except per-share data)
Net income as reported		$	7,323
Less: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of tax effect		(6,609		)
Pro forma net income		$	714
Earnings per share
Basic—as reported		$	0.33
Basic—pro forma		$	0.03
Diluted—as reported		$	0.32
Diluted—pro forma		$	0.03

In computing this pro forma amount, the Company has used the Black-Scholes pricing model and the following assumptions for options granted in fiscal year 2005:

	2005
Risk-free interest rate	4.25	%
Estiamted volatility	76	%
Expected life for options/SARs (years)	2.87
Expected dividends	None

The weighted average grant-date fair value per share of options granted, calculated using the Black-Scholes option-pricing model, and was $7.77 in 2005. No SARs were issued in fiscal year 2005.

Income Taxes. The Company accounts for income taxes using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. In estimating future tax consequences, all expected future events are considered other than enactments of changes in tax laws or rates. Valuation allowances are established as necessary to reduce deferred tax assets in the event that realization of the assets is considered unlikely.

Foreign Currency Translation. The local currency is the functional currency of the Company’s subsidiaries. The activity of the Company’s foreign subsidiaries is translated into United States dollars in accordance with SFAS No. 52, “Foreign Currency Translation”. Assets and liabilities are translated into United States dollars at current exchange rates, while income and expense items are translated at average rates of exchange prevailing during the year. Exchange gains and losses arising from translation of the subsidiary balance sheets are accumulated as a separate component of stockholders’ equity. Net exchange-related gains and losses resulting from foreign currency transactions amounted to gains of approximately $0.1 million for the years ended June 30, 2007 and July 1, 2006, respectively, and loss of approximately $0.2 million for the year ended July 2, 2005. The aforementioned net gains and losses are included in other income (expense) in the respective fiscal years.

Earnings Per Share (“EPS”). Basic EPS is calculated by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding stock options, warrants, restricted shares, and SARs using the treasury stock method.

The following table provides share information used in the calculation of the Company’s basic and diluted earnings per share:

	For the years ended:
	June 30,		July 1,	July 2,
	2007		2006	2005
	(in thousands, except per share data)
Shares used in the calculation of Basic earnings per share		23,086	23,017	22,388
Effect of dilutive securities:
Stock options/SAR’s		439	931	685
Diluted shares used in the calculation of earnings per share		23,525	23,948	23,073

During the years ended June 30, 2007, July 1, 2006, and July 2, 2005, options/SARs to purchase 1.1 million, 0.1 million, and 1.4 million shares of common stock, respectively, were not included in the computation of diluted earnings (loss) per share because they would have had an anti-dilutive effect.

Comprehensive Income (Loss). The Company computes comprehensive income in accordance with SFAS 130 “Reporting Comprehensive Income” (“SFAS 130”). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Other comprehensive income (loss), as defined, includes all changes in equity during a period from non-owner sources. For the periods presented, other comprehensive income (loss) includes the effect of foreign currency translation and the unrealized gain (loss), net of taxes, on its marketable securities.

The following table summarizes the components of accumulated other comprehensive income, net of income taxes:

(in thousands)	June 30, 2007				July 1, 2006
Foreign currency translation adjustment		$	482			$	236
Unrealized loss on available-for-sale securities		(777		)		—
Accumulated other comprehensive (loss) income		$	(295	)		$	236

Concentration of Risk. Financial instruments that are subject to credit risk primarily consist of cash and cash equivalents, marketable securities, commercial paper and accounts receivable. The Company places its cash and cash equivalents and held-to-maturity marketable securities in established financial institutions. Deposits in the financial institutions may exceed the amount of insurance provided on such deposits. The Company believes the financial institutions are financially sound and, accordingly, minimal credit risk exists. The Company invests in high quality debt securities to minimize any adverse changes in interest rates.

The Company’s sales are to end users, leasing companies, and distributors servicing the medical device market, and reflect a broad domestic and international customer base. The Company does not require collateral and has not historically experienced significant credit losses related to receivables from individual customers or groups of customers in any particular industry or geographic area. The Company maintains an allowance for potential losses. No single customer accounted for 10% of the Company’s total net sales or accounts and notes receivable.

The Company is subject to risks common to companies in the aesthetic laser industry, including (i) the Company’s ability to successfully complete preclinical and clinical development and obtain timely regulatory approval and adequate patent and other proprietary rights protection of its products and services, (ii) the content and timing of decisions made by the Food & Drug Administration and other agencies regarding the procedures for which the Company’s products may be approved, (iii) the ability of the Company to manufacture adequate supplies of its products for development and commercialization activities, (iv) the accuracy of the Company’s estimates of the size and characteristics of markets to be addressed by the Company’s products and services, (v) market acceptance of the Company’s products and services, (vi) the Company’s ability to obtain reimbursement for its products from third-party payers, where appropriate, and (vii) the accuracy of the Company’s information concerning the products and resources of competitors and potential competitors.

The Company depends on a single vendor for Alexandrite rods used to manufacture the GentleLASE® systems. This product accounts for a significant portion of total revenues.

Recent Accounting Pronouncements.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN No. 48). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure relative to uncertain tax positions. FIN No. 48 is effective for fiscal years beginning after December 15, 2006, with early adoption encouraged. We are currently assessing the potential impact that the adoption of FIN No. 48 will have on our consolidated financial statements.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. This standard permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; requires evaluation of interests in securitized financial assets; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and eliminates the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This standard is effective for all financial instruments acquired or issued for fiscal years beginning after September 15, 2006. We do not believe that adoption of SFAS No. 155 will have a material effect on our financial position or results of operations.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB No. 108 was effective for our fiscal year 2007 annual financial statements. The adoption of SAB No. 108 did not have a significant impact on our financial statements.

2. Marketable Securities

Marketable securities consist of the following:

	June 30, 2007										July 1, 2006
	Net Carrying						Unrealized				Net Carrying						Unrealized
	Amount			Fair Value			loss				Amount			Fair Value			loss
	(in thousands)
Short-term (Held-to-maturity):
Government-backed securities		$	6,999		$	6,988		$	(11	)		$	17,997		$	17,946		$	(51	)
Certificates of deposit		3,476			3,459			(17		)		2,368			2,356			(12		)
Corporate bonds		—			—			—				3,005			2,996			(9		)
Commercial paper		—			—			—				3,962			3,960			(2		)
		10,475			10,447			(28		)		27,332			27,258			(74		)
Short-term (Available-for-sale):
Equity investments with an original cost of $2,546 (Note 15)		1,298			1,298			—				—			—			—
Total marketable securities, short-term		$	11,773		$	11,745		$	(28	)		$	27,332		$	27,258		$	(74	)
Long-term (Held-to-maturity):
Government-backed securities		$	9,993		$	9,974		$	(19	)		$	8,998		$	8,917		$	(81	)
Certificates of deposit		2,267			2,247			(20		)		2,955			2,903			(52		)
Total marketable securities, long-term		$	12,260		$	12,221		$	(39	)		$	11,953		$	11,820		$	(133	)

Long-term held-to-maturity investments reach maturity as follows:

	Fiscal Year Ended
	2008		2009		2010		Total
	(in thousands)
Government-backed securities	$	1,999	$	5,995	$	1,999	$	9,936
Certificates of deposit	97		2,170		—		2,267
	$	2,096	$	8,165	$	1,999	$	12,260

3. Inventories

Inventories consist of the following:

	June 30,		July 1,
	2007		2006
	(in thousands)
Raw materials	$	8,377	$	5,936
Work in process	2,657		1,151
Finished goods	10,334		9,579
	$	21,368	$	16,666

4. Property and Equipment

Property and equipment consist of the following:

	June 30,			July 1,
	2007			2006
	(in thousands)
Leasehold improvements	$	1,014		$	920
Office furniture	662			603
Computers, software, and other equipment	10,044			9,236
	$	11,720		$	10,759
Less: accumulated depreciation and amortization	(8,241		)	(7,457		)
Property and equipment, net	$	3,479		$	3,302

Depreciation expense was approximately $1.0 million, $0.6 million, and $0.8 million for the fiscal years ended 2007, 2006 and 2005, respectively.

5. Acquisitions

On March 6, 2007, we acquired Inolase (2002) Ltd. (“Inolase”) a non-public company engaged in the development and manufacture of proprietary devices for the aesthetic light-based treatment industry as well as the development of intellectual property related to medical devices and light sources. The aggregate purchase price was approximately $16.8 million in cash, including $0.3 million of acquisition-related transaction costs. No Candela common stock was issued in the acquisition. The acquisition-related transactions costs included legal, accounting, and other external costs directly related to the acquisition. Results of operations for Inolase have been included in the accompanying consolidated statement of operations since the date of acquisition.

This acquisition was accounted for as a business combination. Assets acquired and liabilities assumed were recorded as their fair values as of March 6, 2007. The fair value of intangible assets were based on valuations using an income approach, with estimates and assumption provided by management of Inolase and Candela. The excess of the purchase price over the fair value of tangible assets, identified intangible assets, and liabilities assumed were recorded as goodwill.

The agreement to purchase Inolase contains certain earn-out provisions and we are currently assessing the likelihood of their attainment. If we conclude that the outcome of these contingencies is determinable beyond a reasonable doubt, and that they are directly attributable to the purchase price itself, such a conclusion would result in an adjustment to goodwill and the establishment of an additional liability when the purchase-price allocation is finalized. Our final evaluation may also conclude that these provisions are directly attributable to the purchase price itself, but that we are unable to presently calculate the additional future amounts to be paid. If this is our conclusion, any future earn-out payments would represent increases to goodwill in the period(s) in which they are made. The purchase-price allocation is based upon the external valuation, but is preliminary pending our final determination in the above-mentioned area.

Based upon the valuations, the total purchase price was allocated as follows:

	(in thousands)
Goodwill		$	10,997
Identifiable intangible assets		7,433
Inventory		214
Accounts receivable & other assets		195
Accounts payable and accrued expenses		(248		)
Deferred tax liability		(1,581		)
Other liabilities		(201		)
Total preliminary purchase price allocation		$	16,809

Identifiable intangible assets acquired consisted of patents related to PSF and developed technology related to PSF. Core technology represents a combination of Inolase’s processes, inventions and trade secrets related to the design and development of its products. Developed and core technologies totaled $7.4 million and are being amortized over 6 years.

None of the goodwill or intangible assets acquired in the acquisition is deductible for income tax purposes. As a result, and in accordance with SFAS 109, Income Taxes, we recorded in the purchase accounting a deferred tax liability of $1.6 million, equal to the tax effect of the amount of the acquired intangible assets other than goodwill.

This transaction resulted in $11.0 million of purchase price that exceeded the estimated fair values of tangible and intangible assets and liabilities, all of which was allocated to goodwill. We believe that such excess in purchase price for accounting purposes was warranted by certain factors, including: 1) the potential to facilitate up-sell and cross-sell opportunities for our products with that of Inolase; 2) the potential to exploit reduced pain applications across our existing and future products; and 3) the potential to leverage Inolase intellectual property into home use applications.

6. Warranty Reserve

The following table reflects changes in the Company’s accrued warranty account during the fiscal years ended June 30, 2007, July 1, 2006, and July 2, 2005:

	2007			2006			2005
	(in thousands)
Beginning balance	$	9,629		$	8,645		$	8,257
Incremental accruals on current sales	5,722			8,323			8,864
Amortization of prior-period accruals	(7,738		)	(7,339		)	(8,476		)
Ending balance	$	7,613		$	9,629		$	8,645

7. Deferred Revenue

The Company offers extended service contracts that may be purchased after a standard warranty has expired. Service contracts may be purchased for periods from one to five years. The Company recognizes service contract revenue ratably over the life of the contract. Actual service contract expenses incurred and charged to costs of sales during an interim period may be more or less than the amount of amortized service contract revenue recognized in that period.

The following table reflects changes in the Company’s deferred revenue during the fiscal year ended June 30, 2007 and July 1, 2006:

	2007			2006
	(in thousands)
Beginning balance	$	10,329		$	8,350
Deferral of new sales	13,918			11,892
Recognition of previously deferred revenue	(10,496		)	(9,913		)
Ending balance	$	13,751		$	10,329

The following table reflects the Company’s current and long-term portions of deferred revenues for the fiscal year ended June 30, 2007 and July 1, 2006:

	2007			2006
	(in thousands)
Total service contract revenue	$	13,751		$	10,329
Less: current portion	(10,000		)	(8,342		)
Long-term pertion of deferred revenue	$	3,751		$	1,987

8. Debt, Lease and Other Obligations

Line of Credit. The Company has a renewable $10,000,000 revolving credit agreement with a major bank with interest at the bank’s base rate or LIBOR plus 2.25 percent. Any borrowings outstanding under the line of credit are due on demand or according to a payment schedule established at the time funds are borrowed. The line of credit is unsecured. The agreement contains restrictive covenants limiting the establishment of new liens, and the purchase of margin stock. No amounts were outstanding under the line of credit as of June 30, 2007 or July 1, 2006.

Restricted Cash. A financing company used by customers has limited recourse with the Company on a small number of product leases. As such, the Company has placed approximately $0.1 million and $0.2 million in restricted funds at this institution as collateral as of June 30, 2007 and July 1, 2006, respectively. This restricted cash represents the entire exposure under these agreements.

Operating Lease Commitments. The Company leases several facilities and automobiles under non-cancelable lease arrangements. The facility leases may be adjusted for increases in maintenance and insurance costs above specified levels. In addition, certain facility leases contain escalation provisions based on certain inflationary indices. These operating leases expire in various years through fiscal year 2012. These leases may be renewed for periods ranging from one to five years.

Outstanding lease commitments are reflected in the following table as of June 30, 2007:

	Amount
	(in thousands)
2008		$	1,690
2009		856
2010		326
2011		175
2012		18
Thereafter		—
Total minimum lease payments		$	3,065

Total rent expense was approximately $1.2 million, $0.9 million, and $1.4 million in fiscal years 2007, 2006, and 2005, respectively.

Royalty. In August 2000, the Company obtained through an amended license agreement the with Regents of the University of California (“Regents”), the exclusive license rights to the Dynamic Cooling Device (‘DCD”)(subject to certain limited license rights of Cool Touch, Inc. (“Cool Touch”)) in the following fields of use: procedures that involve skin resurfacing and rejuvenation, vascular skin lesions, and laser hair removal. Cool Touch, a subsidiary of New Star Technology, Inc. obtained a license to the DCD on a co-exclusive basis with the Company in certain narrower fields of use. Cool Touch is restricted in its ability to assign its license rights to certain existing competitors of the Company. The Company is entitled to one-half of all royalty income payable to the Regents from Cool Touch. Under the amended agreement, the Company no longer is required by the Regents to negotiate sublicenses to third parties. However, the Company is entitled to one-half of all royalties due from any other entity that licenses the DCD technology from the Regents in other fields of use.

Effective July 3, 2005, the Company amended certain portions of their agreement with the Regents whereby for the annual license fee of $0.3 million, the Company’s royalty obligation was reduced to 3% from its prior level of 6%. The annual fee of $0.3 million was paid by a lump sum of $3.0 million and is being amortized over the remaining life of the patent agreement, which as of June 30, 2007 was approximately eight years. This reduced royalty rate and the amortization of the annual license fee payment is reflected in the Company’s financial statements for fiscal years 2007 and 2006, respectively. The unamortized portion of the license fee payment is reflected in prepaid licenses in the June 30, 2007 and July 1, 2006 balance sheets, respectively. The Company recognized royalty expense of $3.4 million and $3.6 million for the fiscal years ended 2007 and 2006, respectively.

The Company recognized royalty expense of $9.2 million for fiscal 2005 based on the license agreement in effect with the Regents during the year then ended. Included in the fiscal 2005 expense of $9.2 million was $4.8 million of expense related to the Regents arbitration decision issued in 2005. Of that $4.8 million, $1.3 million related to fiscal 2005, $3.0 million related to fiscal 2004 and 0.5 million related to prior years.

The outstanding contractual obligations relating to future minimum royalties payable to the Regents are reflected in the following table as of June 30, 2007:

	(in thousands)
2008		$	1,000
2009		1,000
2010		1,000
2011		250
2012		250
Thereafter		750
Total minimum royalty payments		$	4,250

9. Stockholders’ Equity

Stock Plans

1990 Candela Corporation Employee Stock Purchase Plan

The 1990 Employee Stock Purchase Plan (the “Purchase Plan”) provides for the sale of up to 1.5 million shares of common stock to eligible employees. The shares are issued at 85% of the market price on the last day of semi-annual periods. Substantially all full-time employees are eligible to participate in the Purchase Plan. At June 30, 2007 there were approximately 661 thousand shares available for sale.

The following is a summary of shares issued under the Purchase Plan:

Fiscal Year	Number of Shares		Per-share Price Range
2005		35,059	$	8.50 to $9.00
2006		25,001	$	12.50 to $13.25
2007		33,978	$	10.00 to $10.75

1998 Candela Corporation Stock Option Plans

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

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

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

Options and rights granted under the 1998 Stock Plan become exercisable on the date of grant or in installments, as specified by a Committee established by the Board of Directors, and expire ten years from the date of the grant. The maximum number of shares for which options and rights may be granted under the 1998 Stock Plan was increased by 2.5 million shares to 7.8 million by affirmative vote at the Company’s Annual Meeting of Shareholders held December 12, 2006. Upon exercise of a SAR, only the net number of shares of common stock issued in connection with such exercise shall be deemed “issued” for this purpose. The Company may satisfy the awards upon exercise with either newly-issued or treasury shares.

1990 and 1993 Candela Corporation Non-Employee Director Stock Option Plans

The 1990 and 1993 Non-Employee Director Stock Option Plans (the “Non-Employee Director Plans,” collectively with the Stock Option Plans, the “Plans”) provide for the issuance of options for the purchase of up to 180,000 and 240,000 shares of common stock, respectively. Under the Non-Employee Director Plans, each new director who is neither an employee nor an officer upon becoming a director receives a one-time grant of an option to purchase 20,000 shares of common stock at an exercise price equal to the fair market value of the common stock on the date of grant. Under the 1990 and 1993 Non-Employee Director Plans, options become exercisable in equal amounts over a period of four and two years, respectively. Shares under the Non-Employee Director Plans expire four and ten years, respectively, after the date of grant and are nontransferable.

There were approximately 1.1 million stock based SARs granted during the fiscal year ended June 30, 2007. The SARs granted to employees become exercisable ratably over one to four years, while the SARs granted to directors become exercisable over two years.

There were approximately 2.9 million outstanding options/SARs at June 30, 2007 with a weighted-average exercise price of $11.45 per share, an aggregate intrinsic value of approximately $0.4 million, and a weighted-average remaining contractual term of 8.0 years. None of the options/SARs outstanding at June 30, 2007 had cash settlement features.

There were approximately 1.5 million of exercisable options/SARs at June 30, 2007 with a weighted-average exercise price of $10.00 per share, an aggregate intrinsic value of approximately $2.3 million, and a weighted-average remaining contractual term of 6.85 years.

The total intrinsic value of options exercised during the fiscal years ended June 30, 2007 and July 1, 2006 was approximately $0.6 million and $17.0 million, respectively.

There were approximately 1.9 million options/SARs available to grant at June 30, 2007.

The following is a summary of stock option/SARs activity under the Plans:

	Number of Shares		Option Prices					Weighted Exercise Price per Share
Balance at July 3, 2004	2,109,342
Granted	572,898		$	8.00	to	$	12.33		$	10.04
Exercised	(156,527	)	$	1.08	to	$	9.90		$	4.01
Forfeited and expired	(41,153	)	$	2.57	to	$	10.93		$	9.15
Balance at July 2, 2005	2,484,560								$	7.48
Granted	550,000		$	15.33	to	$	22.00		$	15.69
Exercised	(1,061,557	)	$	1.95	to	$	11.98		$	6.97
Forfeited and expired	(8,015	)	$	5.59	to	$	10.93		$	10.33
Balance at July 1, 2006	1,964,988
Granted	1,115,000		$	11.53	to	$	15.95		$	12.15
Exercised	(133,238	)	$	1.56	to	$	10.93		$	3.68
Forfeited and expired	(71,467	)	$	9.90	to	$	15.95		$	15.18
Balance at June 30, 2007	2,875,283

10. Income Taxes

The components of income before income taxes and the related provision for (benefit from) income taxes consist of the following (in thousands):

	For the Year Ended
	June 30,			July 1,			July 2,
	2007			2006			2005
Income from continuing operations before income taxes:
Domestic	$	7,684		$	20,645		$	7,075
Foreign	2,115			1,757			1,583
	$ 9,799			$	22,402		$	8,658
Income (loss) from discontinued operations before income taxes:
Domestic	$	—		$	—		$	1,374
Provision for (benefit from) income taxes:
Current provision:
Federal	$	2,488		$	8,173		$	2,101
State	244			735			193
Foreign	766			952			375
Total current provision or (benefit from) income taxes	3,498			9,860			2,669
Deferred provision (benefit)
Federal	319			(1,409		)	40
State	28			(173		)	—
Foreign	(302		)	(810		)	—
Total deferred provision or (benefit from) income taxes	45			(2,392		)	40
Total provision for income taxes	$	3,543		$	7,468		$	2,709

The components of the Company’s deferred tax assets and liabilities consist of the following:

	June 30,				July 1,
	2007				2006
	(in thousands)
Deferred Tax Asset—Current
Bad debt reserve		$	489		$	485
Inventory valuation reserves		978			1,186
Deferred revenue		990			1,657
Total Deferred Tax Asset—Current		$	2,457		$	3,328
Deferred Tax Asset—Noncurrent
Accrued warranty reserve		$	2,381		$	3,569
Restructuring reserve		165			337
Share-based compensation		2,214			604
Depreciation & amortization		198
Federal and state tax credit carryforwards		524			615
Foreign net operating losses		708			220
Other		48			94
		638			5,430
Less: Valuation reserve		(92		)	(136		)
Total Deferred Tax Asset—Noncurrent		$	6,146		$	5,294
Deferred Tax Liability—Noncurrent
Depreciation & amortization		$	2,178		$	480
Deferred gain		481			—
Total Deferred Tax Liability—Noncurrent		$	2,659		$	480

As of June 30, 2007, the Company has no valuation allowance against the deferred tax asset in the United States. A valuation allowance of approximately $0.1 million has been established in Israel. In accounting for the deferred tax asset, the Company has relied on historical data to determine the necessity of providing a valuation allowance. Under the requirements of SFAS No. 109, “Accounting for Income Taxes”, the Company believes it is more likely than not that the deferred tax asset, unless otherwise noted, will be fully utilized against future income taxes.

At June 30, 2007, the Company had available research and development tax credits of approximately $0.5 million for state income tax purposes:

(in thousands)	Available			Expires
Fiscal 2000		$	286	June 2015
Fiscal 2002		167		June 2017
Fiscal 2003		26		June 2018
Fiscal 2005		39		June 2020
Total		$	518

At June 30, 2007, the Company had the following foreign net operating losses available to it:

	Available			Expires
	(in thousands)
Germany		$	987	No Expiration
Italy		10		Fiscal 2011
Israel		1,227		No Expiration
Australia		19		No Expiration
Total		$	2,243

No amount for U.S. income tax has been provided on undistributed earnings of the Company’s foreign subsidiaries because the company considers the approximately $5.1 million of accumulated foreign earnings to be indefinitely reinvested. In the event of distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes, subject to an adjustment, if any, for foreign tax credits and foreign withholding taxes payable to certain foreign tax authorities. Determination of the amount of U.S income tax liability that would be incurred is not practicable because of the complexities associated with this hypothetical calculation; however, unrecognized foreign tax credits carry forwards may be available to reduce some portion of the U.S. tax liability, if any.

11. Segment, Geographic and Major Customer Information

The Company operates principally in one industry segment: the design, manufacture, sale, and service of medical devices and related equipment. The results in this segment have been presented in the Consolidated Statements of Operations for the appropriate periods. The Company has no single customer that represents a significant portion of revenue and accounts receivable during the periods presented.

Geographic data

Geographic information for fiscal 2007, 2006 and 2005 is as follows (in thousands):

	2007			2006			2005
Revenue:
United States	$	96,214		$	105,273		$	85,243
Intercompany	27,039			21,612			20,460
	123,253			126,885			105,703
Japan	20,333			20,586			19,550
Spain	21,322			15,913			12,242
Germany	3,162			3,088			3,540
France	4,502			3,404			3,326
Italy	2,033			1,202			—
Israel	858			—			—
Australia	133			—			—
	175,596			171,078			144,361
Elimination	(27,039		)	(21,612		)	(20,460		)
Consolidated total	$	148,557		$	149,466		$	123,901
Income (loss) from operations:
United States	$	3,321		$	20,057		$	7,390
Europe	996			861			763
Japan	1,260			906			626
All others	(354		)
Elimination	(1,868		)	(1,151		)	(688		)
Consolidated total	$	3,355		$	20,673		$	8,091
Geographic identification of long-lived assets:
United States	$	3,002		$	2,979		$	3,028
All others	477			323			212
Consolidated total	$	3,479		$	3,302		$	3,240

United States revenue includes export sales to unaffiliated companies located principally in Europe, the Asia-Pacific region and Latin America, which approximated $31.9 million, $35.9 million, and $27.7 million in fiscal years 2007, 2006, and 2005, respectively.

12. Employee Benefit Plans

The Company offers a 401(k) Plan which allows eligible United States employees to make tax-deferred contributions, a portion of which are matched by the Company. The Company may make discretionary matching contributions to the Plan in an amount determined by its Board of Directors. Company contributions vest ratably with three years of employment and amounted to $0.5 million, $0.4 million, and $0.3 million for the fiscal years ended 2007, 2006, and 2005, respectively.

13. Discontinued Operations

During fiscal year 2005, the landlord for the Boston facility secured a sublease for that property. The sub-lessee commenced making payments to the landlord in December of 2004. As a result of these and future payments scheduled under the sublease, we revised the estimated future costs associated with the Boston facility and, in the fiscal year 2005, reversed approximately $0.9 million of the restructuring reserve. This reversal represents the aforementioned anticipated economic benefit due to sub-lessee payments of $1.7 million, net of legal and other fees of approximately $0.3 million and income taxes of approximately $0.5 million.

At June 30, 2007, the discontinued segment had a net liability of approximately $1.3 million consisting primarily of the aforementioned reserve of approximately $0.4 million and deferred gift certificate revenue of approximately $0.9 million. There were no revenues from discontinued operations in fiscal 2007, fiscal 2006, or fiscal 2005.

14. Legal Proceedings

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

a patent. The parties are presently in the midst of pre-trial fact discovery which shall end on December 31, 2007.

15. Other Income

During the fiscal year ended June 30, 2007, the Company recognized a $3.5 million gain on the exchange of common stock of Solx Inc. for cash and common stock of OccuLogix, Inc. (NasdaqGM: OCCX). The gain was a result of the acquisition of Solx Inc., a privately-held company, by OccuLogix, Inc., a publicly traded company. The Company held 19.99% of the outstanding common stock of Solx Inc. on an as-converted basis, prior to the merger with an associated book value of $0.

As a result of the acquisition of Solx, Inc., Candela received approximately $1.0 million in cash at the time of closing, future cash consideration of approximately $2.5 million, and approximately 1.3 million shares of common stock in OccuLogix, Inc.

The future cash consideration of approximately $2.5 million is to be paid in the following installments: $0.6 million in August 2007, $0.9 million in August 2008, and $1.0 million upon the achievement of a contingent event as specified in the transaction agreement. Due to the inherent uncertainty associated with the collection of the future cash consideration, Candela did not record the gain related to the $2.5 million. The Company will record such future receipts as gains in the periods in which the remaining cash payments are actually received.

The value of the shares of OccuLogix, Inc. is included in Candela’s marketable securities at June 30, 2007 as they are considered available-for-sale securities in accordance with SFAS 115. In accordance with the guidance provided by SFAS 115, Candela adjusted the value of this investment to its market value of approximately $1.3 million at June 30, 2007 and recorded the associated unrealized loss, net of related tax effects, as a separate component of accumulated other comprehensive income.

16. Quarterly Results of Operations (unaudited)

	Quarter Ended
2007	First			Second		Third		Fourth
	(in thousands, except per-share data)
Revenue	$	33,474	*	$	37,406	$	38,690	$	38,987
Gross profit	17,425			17,778		19,740		20,120
Net income	4,419			1,024		1,540		(727		)
Earnings per common share:
Basic	$	0.19		$	0.04	$	0.07	$	(0.03	)
Diluted	$	0.18		$	0.04	$	0.07	$	(0.03	)

* Includes $3.5 million gain on exchange of Solx, Inc. common stock. See Note 15.

	Quarter Ended
2006	First		Second		Third		Fourth
	(in thousands, except per-share data)
Revenue	$	28,087	$	37,720	$	42,314	$	41,345
Gross profit	14,552		18,975		21,398		18,923
Net income	3,017		4,510		5,003		2,404
Earnings per common share:
Basic	$	0.13	$	0.20	$	0.22	$	0.10
Diluted	$	0.13	$	0.19	$	0.21	$	0.10

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Not Applicable

Item 9A. Controls and Procedures.

(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

We have established disclosure controls and procedures (“Disclosure Controls”) to ensure that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to ensure that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls were designed to provide reasonable assurance that the controls and procedures would meet their objectives. Our management, including the Chief Executive Officer and Principal Financial Officer, realizes that no control system can prevent all possibilities of error or fraud. A control system, no matter how well designed and operated, can provide only reasonable assurance of achieving the designed control objectives and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusions of two or more people,

or by management override of the control. Because of the inherent limitations in a cost-effective, maturing control system, misstatements due to error or fraud may occur and not be detected.

As of the end of the period covered by this Form 10-K, management, with the participation of the Chief Executive Officer and Principal Financial Officer, has performed an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). This evaluation included consideration of the controls, processes and procedures that comprise our internal control over financial reporting. Based on such evaluation, our Chief Executive Officer and Principal Financial Officer concluded that, as of June 30, 2007, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.

(b) MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2007, based on the framework in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). We have excluded from our evaluation, the internal control over financial reporting of Inolase (2002) Ltd, which was acquired on March 6, 2007 and is included in the fiscal year 2007 consolidated financial statements of Candela Corporation since the date of acquisition, and constituted 11% of the consolidated assets as of June 30, 2007, and less than 1% of consolidated revenue for the year then ended.

Based on our assessment, management determined that no material weakness existed in the Company’s internal controls over financial reporting as of June 30, 2007. In addition, based on such assessment, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2007, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.

The Company’s external auditors, BDO Seidman, LLP, an independent registered public accounting firm, have issued an audit report on their assessment of the Company’s internal control over financial reporting.

There was no change in our internal control over financial reporting (as defined under Rule 13a-15(f) under the Exchange Act) during our fourth quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

/s/ GERARD PUORRO		/s/ ROBERT E. QUINN
Gerard Puorro		Robert E. Quinn
President and Chief Executive		Treasurer, Corporate Controller
		and Principal Financial Officer

September 12, 2007

Item 9B. Other Information

None.

Part IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) The following Consolidated Financial Statements, Notes thereto and Report of Independent Registered Public Accounting Firm are set forth under Item 8:

(1) Consolidated Financial Statements:
Report of Registered Independent Public Accounting Firm		43
Consolidated Balance Sheets—July 1, 2006 and July 2, 2005		46
Consolidated Statements of Income and Comprehensive Income Years ended July 1, 2006, July 2, 2005, and July 3, 2004		47
Consolidated Statements of Stockholders’ Equity—Years ended July 1, 2006, July 2, 2005, and July 3, 2004		48
Consolidated Statements of Cash Flows—Years ended July 1, 2006, July 2, 2005, and July 3, 2004		49
Notes to Consolidated Financial Statements		50
(2) Consolidated Financial Statement Schedules:
Schedule II—Valuation and Qualifying Accounts		74

All other financial statements and schedules not listed have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable, material, or required.

(3) Exhibits: Except as otherwise noted, the following documents are incorporated by reference from the Company’s Registration Statement on Form S-1 (File Number 333-78339) or filed herewith:

3.1		Certificate of Incorporation, as amended
3.2(9)		By-laws of the Company, as amended and restated
10.1(1)		1985 Incentive Stock Option Plan
10.2(2)		1987 Stock Option Plan
10.2.1(2)		1989 Stock Plan
10.2.2(3)		1990 Employee Stock Purchase Plan
10.2.3(3)		1990 Non-Employee Director Stock Option Plan
10.2.4(7)		1993 Non-Employee Director Stock Option Plan
10.2.5(13)		1998 Amended and Restated Stock Plan
10.2.6(18)		1998 Second Amended and Restated Stock Plan
10.3(7)		Lease for premises at 526 Boston Post Road, Wayland, Massachusetts.
10.4(7)		Lease for premises at 530 Boston Post Road, Wayland, Massachusetts.
10.5(7)		Patent License Agreement between the Company and Patlex Corporation effective as of July 1, 1988.
10.6(4)		License Agreement among the Company, Technomed International, Inc. and Technomed International S.A. dated as of December 20, 1990.
10.7(5)		License Agreement between the Company and Pillco Limited Partnership effective as of October 1, 1991.
10.8(8)		Distribution Agreement between the Company and Cryogenic Technology Limited, dated October 15, 1993.
10.9(10)		Asset Purchase Agreement between the Company and Derma-Laser, Limited and Derma-Lase, Inc. dated June 23, 1994.

10.10(11)		Letter Agreement between the Company and Fleet Bank dated February 13, 1997.
10.10.1(11)		Amendment to Letter Agreement between the Company and Fleet Bank dated December 15, 1998.
10.12*(14)		Amended and Restated License Agreement between the Company and The Regents of the University of California for Dynamic Skin Cooling Method and Apparatus effective as of August 11, 2000.
10.12.1*(15)		Settlement Agreement dated August 11, 2000 by and among the Company, the Regents of the University of California, and Cool Touch, Inc.
10.13(12)		Note and Warrant Purchase Agreement, dated as of October 15, 1998 by and among the Company, Massachusetts Capital Resource Company, William D. Witter and Michael D. Witter.
10.13.1(12)		Form of Note delivered to the Company in the aggregate principal amount of $3,700,000 to Massachusetts Capital Resource Company, William D. Witter and Michael D. Witter.
10.13.2(12)		Form of Common Stock Purchase Warrant to purchase an aggregate of 370,000 shares of the Company’s Common Stock delivered to Massachusetts Capital Resource Company, William D. Witter and Michael D. Witter.
10.14		Amended and Restated Employment Agreement dated as of April 5, 2007, between Candela Corporation and Gerard E. Puorro
21.1**		Subsidiaries of the Company
23.1**		Consent of BDO Seidman, LLP (Independent Registered Public Accounting Firm)
31.1**		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2**		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1**		Section 1350 Certification of Chief Executive Officer
32.2**		Section 1350 Certification of Chief Financial Officer
99.1(16)		McKesson Medical-Surgical Inc. Distribution Agreement
99.2(17)		First Amendment to the Amended and Restated License Agreement by and between The Regents of the University of California and Candela Corporation

* Portions of the exhibit have been omitted and filed separately with the SEC in reliance upon the Company’s request for confidential treatment pursuant to Rule 24b-2.

** Filed herewith

(1) Previously filed as an exhibit to Registration Statement No. 33-54448B and incorporated herein by reference.

(2) Previously filed as an exhibit to the Company’s Amended and Restated Annual Report on Form 10-K for the fiscal year ended June 30, 1988 (Commission file number 000-14742), and incorporated herein by reference.

(3) Previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 1990 (Commission file number 000-14742), and incorporated herein by reference.

(4) Previously filed as an exhibit to Form 10-Q for the quarter ended December 29, 1990 (Commission file number 000-14742), and incorporated herein by reference.

(5) Previously filed as an exhibit to Form 10-Q for the quarter ended September 28, 1991 (Commission file number 000-14742), and incorporated herein by reference.

(6) Previously filed as an exhibit to Form 8-K, dated September 8, 1992 (Commission file number 000-14742), and incorporated herein by reference.

(7) Previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 1993 (Commission file number 000-14742), and incorporated herein by reference.

(8) Previously filed as an exhibit to Form 10-Q for the quarter ended January 1, 1994 (Commission file number 000-14742), and incorporated herein by reference.

(9) Previously filed as an exhibit to Form 10-Q for the quarter ended April 2, 1994 (Commission file number 000-14742), and incorporated herein by reference.

(10) Previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 1994 (Commission file number 000-14742), and incorporated herein by reference.

(11) Previously filed as an S1 filed on May 12, 1999 (Commission file number 333-78339), and incorporated herein for reference.

(12) Previously filed as an exhibit to the Company’s Amended and Restated Annual Report on Form 10-K for the fiscal year ended June 27, 1998 (Commission file number 000-14742), and incorporated herein by reference.

(13) Previously filed as Appendix A to the Company’s Schedule 14A, filed December 28, 2002, and incorporated herein by reference.

(14) Previously filed as an exhibit to Form 10-Q for the quarter ended March 31, 2001 (Commission file number 000-14742), and incorporated herein by reference.

(15) Previously filed as an exhibit to Form 10-K for the fiscal year ended July 1, 2000 (Commission file number 000-14742), and incorporated by reference.

(16) Previously filed as an exhibit to Form 10-K for the fiscal year ended July 2, 2005 and incorporated by reference.

(17) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended December 31, 2005 and incorporated by reference.

(18) Previously filed as an exhibit to Form 10-Q for the quarter ended March 31, 2007 (Commission File number ), and incorporated herein by reference.

(c) The Company hereby files, as part of this Form 10-K, the exhibits listed in Item 15(a)(3) above, other than exhibits 32.1 and 32.2, which the Company hereby furnishes.

(d) The Company hereby files, as part of this Form 10-K, the consolidated financial Statement schedules listed in Item 15(a)(2) above.

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

	6/29/02		6/28/03		7/3/04		7/2/05		7/1/06		6/30/07
Candela Corporation		100.00		203.27		367.64		397.45		576.73		421.09
S&P 500		100.00		100.25		119.41		126.96		137.92		166.32
SIC Code 3845		100.00		101.91		117.15		126.42		120.80		145.54

	Balance at			Additions			Deductions			Balance at
	Beginning			Charged to			from			End of
	of Period			Income			Reserves			Period
	(In thousands)
Reserves deducted from assets to which they apply:
Allowance for doubtful accounts:
Year ended June 30, 2007		$	1,830		$	989		$	1,407	$	1,412
Year ended July 1, 2006		2,065			1,241			1,475		1,831
Year ended July 2, 2005		1,492			2,806			2,233		2,065
Reserve for inventory
Year ended June 30, 2007		$	624		$	408		$	62	$	970
Year ended July 1, 2006		520			536			432		624
Year ended July 2, 2005		490			525			495		520
Reserve for discontinued operations
Year ended June 30, 2007		$	447		$	—		$	—	$	447
Year ended July 1, 2006		995			—			548		447
Year ended July 2, 2005		3,006			—			2,011		995

		Begins on Page
	PART I
Item 1.	BUSINESS		3
Item 1A.	Risk Factors		21
Item 1B.	Unresolved Staff Comments		26
Item 2.	Properties		26
Item 3.	Legal Proceedings		26
Item 4.	Submission of Matters to a Vote of Security Holders		27
	PART II
Item 5.	Market for the Registrant’s Common Equity and Related Shareholders’ Matters and Issuer Purchases of Equity Services		27
Item 6.	Selected Consolidated Financial Data		31
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		32
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		41
Item 8.	Financial Statements and Supplementary Data		42
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		71
Item 9A.	Controls and Procedures		71
Item 9B.	Other Information		72
	PART III
Item 10.	Directors and Executive Officers of the Registrant		73
Item 11.	Executive Compensation		73
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters		73
Item 13.	Certain Relationships and Related Transactions		73
Item 14.	Principal Accountant Fees and Services		73
	PART IV
Item 15.	Exhibits, Financial Statement Schedules, AND REPORTS ON FORM 8-K		75

		Page
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting		43
Report on Independent Registered Public Accounting Firm on Financial Statements		45
Financial Statements:
Consolidated Balance Sheets—June 30, 2007 and July 1, 2006		46
Consolidated Statements of Income and Comprehensive Income—Years ended June 30, 2007, July 1, 2006, and July 2, 2005		47
Consolidated Statements of Stockholders’ Equity—Years ended June 30, 2007, July 1, 2006, and July 2, 2005		48
Consolidated Statements of Cash Flows—Years ended June 30, 2007, July 1, 2006, and July 2, 2005		49
Notes to Consolidated Financial Statements		50
Supporting Financial Statement Schedule:
Schedule II—Valuation and Qualifying Accounts		74

/s/ BDO SEIDMAN, LLP
BDO Seidman, LLP
Boston, Massachusetts
September 12, 2007

	CANDELA CORPORATION
	By:	/s/ GERARD E. PUORRO
		Gerard E. Puorro,
		President, Chief Executive Officer and Director

	Signature		Title		Date

/s/ GERARD E. PUORRO		President, Chief Executive		September 12, 2007
Gerard E. Puorro		Officer, and Director
		(Principal Executive Officer)
/s/ ROBERT E. QUINN		Treasurer, Corporate Controller		September 12, 2007
ROBERT E. QUINN		Principal Financial Officer
/s/ KENNETH D. ROBERTS		Chairman of the Board of		September 12, 2007
Kenneth D. Roberts		Directors
/s/ NANCY NAGER		Director		September 12, 2007
Nancy Nager
/s/ DOUGLAS W. SCOTT		Director		September 12, 2007
Douglas W. Scott
/s/ BEN BAILEY, III		Director		September 12, 2007
Ben Bailey, III
/s/ GEORGE ABE		Director		September 12, 2007
George Abe

21.1		Subsidiaries of the Company
23.1		Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm
31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification pursuant to 18 U.S.C. Section 1350
32.2		Certification pursuant to 18 U.S.C. Section 1350

		Place of
	Subsidiary	Incorporation
1)	Candela Iberica, S.A.	Spain
2)	Candela France SARL	France
3)	Candela KK	Japan
4)	Candela Deutschland GmbH	Germany
5)	Candela Italia	Italy
6)	Candela Holdings, B.V.	Netherlands
7)	Inolase (2002), Ltd.	Israel
8)	Candela Corporation Australia PTY, Ltd.	Australia
9)	Candela Skin Care Centers of Boston, Inc.	Massachusetts
10)	Candela Skin Care Centers of Scottsdale, Inc.	Massachusetts

Date: September 12, 2007	/s/ GERARD E. PUORRO
	Gerard E. Puorro
	President and Chief Executive Officer

/s/ GERARD E. PUORRO
Gerard E. Puorro
Chief Executive Officer
September 12, 2007

/s/ ROBERT E. QUINN
Robert E. Quinn
Principal Financial Officer
September 12, 2007