UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

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

 

For the quarterly period ended March 27, 2004.

 

Commission file number 000-14742

 

CANDELA CORPORATION

(Exact name of registrant as specified in its charter)

 

 

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

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý   No  o

 

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

Yes  o   No  ý

 

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

 

 

 

CANDELA CORPORATION

Index

 

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

 

2

 

Part I.  Financial Information

Item 1 - Financial Statements

 

CANDELA CORPORATION

Condensed Consolidated Balance Sheets

(in thousands)

(unaudited)

 

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

 

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

 

3

 

CANDELA CORPORATION

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 

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

 

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

 

4

 

CANDELA CORPORATION

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

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

 

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

 

5

 

1.                                      Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements and notes do not include all of the disclosures made in the Annual Report on Form 10-K of Candela Corporation (the “Company”, or “Candela”) for fiscal year 2003, which should be read in conjunction with these financial statements.  The financial information included herein is unaudited, with the exception of the condensed consolidated balance sheet as of June 28, 2003, which was derived from the audited consolidated balance sheet dated June 28, 2003.  However, in the opinion of management, the financial statements include all necessary adjustments, consisting of normal recurring accruals, for a fair presentation of the quarterly results and are prepared and presented in a manner consistent with the Company’s Annual Report on Form 10-K. The results for the three and nine month periods ended March 27, 2004 are not necessarily indicative of the results to be expected for the full year.

 

2.                                      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 the fiscal quarter ended September 27, 2003, the Company recorded a $2,095 charge for the accrual of $3,000 of future occupancy costs, primarily relating to future lease payments for the Boston facility, and $348 of severance obligations and other related costs of closure, net of anticipated tax benefits of $1,253. Approximately 45 positions have been eliminated as a result of this restructuring plan, and 44 employees have been terminated as of March 27, 2004. In addition, all prior period financial statements have been restated to reflect skin care centers operations as discontinued.

 

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

 

The following table reflects the combined restructuring charges incurred in the nine month period ended March 27, 2004:

 

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

 

6

 

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

 

3.                                      Stock-based Compensation

 

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

 

The Company follows the provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”). The provisions of FAS 123 allow 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. Candela has elected to continue 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 Candela common stock at the date of grant, thereby resulting in no recognition of compensation expense by Candela. For awards that generate compensation expense as defined under APB 25, the Company calculates the amount of compensation expense and recognizes the expense over the vesting period of the award.

 

7

 

Had compensation cost for Candela’s stock option plans been determined based on the fair value method set forth in FAS 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:

 

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

 

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

 

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

 

4.                                      Earnings Per Share

 

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

 

8

 

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

 

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

 

During the three and nine month periods ended March 27, 2004, options to purchase 217,625 and 125,518 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because the exercise price of such options was greater than the average market price of the common stock for the period.  During the three and nine month periods ended March 29, 2003, options to purchase 87,280 and 228,095 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share because the exercise price of such options was greater than the average market price of the common stock for the period.

 

5.                                      Comprehensive Income

 

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

 

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

 

9

 

6.                                      Inventories

 

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

 

7.                                      Segment 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 Condensed Consolidated Statements of Operations for the appropriate periods.

 

8.                                      Guarantees

 

The Company’s products generally carry a standard one-year warranty, except for Vbeam products which typically carry a three-year warranty. The Company records a reserve based on anticipated warranty claims at the time product revenue is recognized. In anticipation of actual warranty claims, the Company amortizes the reserve ratably over the life of the warranty, thereby offsetting actual warranty claims incurred. Actual warranty claims incurred and charged to product costs of sales during an interim period may be more or less than the amount of amortized warranty reserve allocated against them. 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.

 

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

 

 

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

 

The Company also 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 service costs of sales during an interim period may be more or less than the amount of amortized service contract revenue recognized in that period.

 

10

 

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

 

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

 

The Company has an agreement (the “Agreement”) with an independent leasing company whereby the Company will purchase delinquent leases (the “UNL Provision”) relating to Company products purchased by customers and financed through the leasing company.  The Company is required to honor the UNL Provision when the leasing company’s aggregate losses reach levels specified in the Agreement.  The UNL Provision of the Agreement was recently eliminated for any lease initiated after December 31, 2002.  Since the inception of the Agreement, the cumulative amounts paid to the leasing company under the UNL Provision have not been significant.

 

9.                                      Asset Acquisition

 

On January 8, 2003, the Company acquired substantially all of the assets of Applied Optronics, the diode division of Schwartz Electro-Optics, Inc., for approximately $1,200 in cash. Applied Optronics was a leading manufacturer of high-powered, pulsed 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 the Company’s Smoothbeam™ diode laser system. In accordance with SFAS No. 141 “Business Combinations,” the Company records acquisitions under the purchase method of accounting. Accordingly, the purchase price is allocated to the tangible assets and liabilities and intangible assets acquired, based on their estimated fair values.

 

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

 

10.                               Stock split

 

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

 

11.                               Commitments and Contingencies

 

The Company has an Amended and Restated License Agreement (the “License”) with The Regents of the University of California (“The Regents”) pursuant to which the Company licenses certain patent rights to its dynamic cooling device (“DCD”). The Company sells its DCD as a component part of its Smoothbeam (®) laser system and as an accessory to its other laser systems. In April of 2004, The Regents issued a notice of default under the License, asserting, among other things, that the Company is in breach of the License for the alleged failure to make required royalty payments and make required disclosures. The notice asserted that the total underpaid royalties, interest and other charges for the period from August of 2000 through September 2003 is $1,128,000, and that unless paid, The Regents may terminate the License. The Company believes it has made all payments that it was required to make and is in the process of reviewing the underlying information in support of the alleged deficiencies recently furnished by The Regents to the Company. No legal action has been commenced by either The Regents or the Company at this time, and Candela is hopeful that the parties can resolve the issues raised by The Regents without formal legal proceedings. However, should The Regents attempt to terminate the License, the matter would likely result in a formal legal proceeding to determine the respective rights of the parties.

 

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

 

 

11

 

CANDELA CORPORATION

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

We research, develop, manufacture, market and service lasers used to perform aesthetic and cosmetic procedures. We sell our lasers principally to medical practitioners.  We market our 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 sales of lasers and other products, and the provision of product-related services.

 

Critical Accounting Policies

 

This discussion and analysis of our financial condition and results of operations is 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 assets and liabilities. We evaluate our estimates and judgments on an on-going basis, including those related to revenue recognition, bad debts, inventories, warranty obligations, contingencies, restructurings and income taxes. We base our estimates and judgments on historical experience and on various other assumptions that we believe 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 and judgments under different assumptions or conditions. A discussion of our critical accounting policies and the related estimates and judgments affecting the preparation of our condensed consolidated financial statements is included in our Annual Report on Form 10-K for fiscal year 2003.

 

12

 

Results of Operations

 

Revenue.

 

Revenue source by geographic region is reflected in the following table:

 

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

 

Consolidated Overview

 

Consolidated revenue increased 29%, to $27.7 million for the three months ended March 27, 2004, from $21.4 million for the three months ended March 29, 2003.  This increase in revenue resulted primarily from an increase in worldwide demand for our products and related services. Specifically, revenues from the introduction of our new GentleYag™ product contributed approximately $5.9 million to this increase while the remainder was derived from an incremental increase in comparative revenue from our Gentlelase™ product line.

 

Consolidated revenue increased 33% to $70.2 million for the first nine months of fiscal 2004, compared to $52.7 million for the nine months ended March 29, 2003. This increase in revenue resulted primarily from an increase in worldwide demand for our products and related services.  Specifically, wider market penetration and acceptance of our GentleLase™ product line represented approximately $10.0 million of the increase and the introduction of our new GentleYag™ product contributed approximately $5.9 million to this increase.

 

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

 

13

 

Revenue source by type is reflected in the following table:

 

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

 

The increase in revenue from lasers and other products for the three months ended March 27, 2004, compared to the three month period ended March 29, 2003, resulted from an increase in the sales volume of our new GentleYag™ product. The new GentleYag™ contributed approximately $5.9 million in revenue. The increase in revenue from product-related service for the three months ended March 27, 2004 compared to the three months ended March 29, 2003 resulted from an increase in the number of service related contracts sold.

 

The increase in revenue from lasers and other products for the nine months ended March 27, 2004, compared to the nine month period ended March 29, 2003, resulted from the introduction of our new GentleYag™ product and an increase in the sales volume of our GentleLase™ product line. Wider market acceptance of the GentleLase™ product line helped to contribute approximately $10.0 million to this increase, while the introduction of our new GentleYag™ product contributed approximately $5.9 million to this increase in revenue. The increase in revenue from product-related service for the nine months ended March 27, 2004 compared to the nine months ended March 29, 2003 resulted from an increase in the number of service related contracts sold.

 

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

 

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

 

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Selling, General and Administrative Expense.  Selling, general and administrative expenses increased 53%, to approximately $9.6 million for the three-month period ended March 27, 2004 from approximately $6.3 million for the three-month period ended March 29, 2003. As a percentage of revenue, selling, general and administrative expenses increased to 34.6% from 29.2% of revenues for the same respective period. This increase was primarily due to commissions and employee related expenses of approximately $1.5 million, and legal and professional fees expense of approximately $0.6 million. Selling, general and administrative expenses increased to approximately $22.8 million for the nine-month period ended March 27, 2004 from approximately $16.9 million for the nine-month period ended March 29, 2003. As a percentage of revenue, for the nine-month period ended March 27, 2004, selling, general and administrative expenses increased to 32.5% from 32.0% as compared to the same period one year earlier. The increase in selling, general and administrative expenses as a percentage of revenues is due primarily to the aforementioned increase in commission and employee related expenses.

 

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

 

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

 

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

 

Discontinued Operations

 

On September 27, 2003, we permanently closed our only remaining skin care center, which was located in Boston. The closure of the Boston skin care center, together with the earlier closing of our Scottsdale, Arizona spa, and the associated cessation of this line of business, is accounted for as discontinued operations. As a result of the closure of the Boston skin care center, in the fiscal quarter ended September 27, 2003, we recorded a $2.1 million charge for the accrual of $3.0 million of future occupancy costs and $0.3 million of severance obligations and other related costs of closure, net of anticipated tax benefits of $1.3 million. In addition, both the financial statements for the nine months ended March 27, 2004 and all prior financial statements have been restated to reflect skin care center operations as discontinued. While the building landlord has given the Company written notice that it believes the Company is in default under the lease, the Company has indicated that it plans to honor all of its obligations under the lease. The Company believes that the size of the accrual that it has established is sufficient to cover all future leasehold expenses for the remainder of the lease term. Leasehold expenses could potentially be mitigated if the landlord elects to relet or sublease the property.

 

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Liquidity and Capital Resources

 

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

 

Our outstanding contractual obligations as of March 27, 2004, are reflected in the following table:

 

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

 

We also maintain 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%.  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 March 27, 2004.

 

We believe that our current cash balances will be sufficient to meet anticipated cash requirements for the next twelve months.  However, we cannot be sure that we will not require additional capital beyond the amounts currently forecasted by us, or that any such required additional capital will be available on reasonable terms, if at all, when such capital becomes required.

 

Cautionary Statements

 

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

 

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•                  Our principle source of liquidity is our current cash and equivalents. Our ability to generate cash from operations is dependant upon our ability to generate revenue from selling our lasers and other products and providing product-related services. A decrease in demand for our products and related services or increases in operating costs would likely have an adverse effect on our liquidity.

 

•                  Because we typically derive more than half of our revenue from international sales, we are susceptible to currency fluctuations, negative economic changes taking place in foreign marketplaces, and other risks associated with conducting business overseas.

 

•                  The failure to obtain alexandrite rods for certain laser systems from our sole supplier would impair our ability to manufacture and sell these laser systems, which has accounted for a substantial portion of our revenue in certain recent periods.

 

•                  The cost of closing our remaining skin care center may be higher than management has estimated to date, and higher actual costs would negatively impact our operating results.

 

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

 

•                  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.

 

•                  We have modified some of our products without clearance from the Food and Drug Administration (the “FDA”). The FDA could retroactively decide the modifications were improper and require us to cease marketing and/or recall the modified products.

 

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

 

•                  Claims by others that our products infringe their patents or other intellectual property rights, or that the patents which we own or have licensed rights to are invalid, 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.

 

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

 

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

 

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

 

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

 

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Item 3 - Quantitative and Qualitative Disclosures About Market Risk

 

We have foreign subsidiaries in Japan, Spain, France and Germany.  Approximately 54% of our revenues for the nine months ended March 27, 2004 were from our operations outside the United States.  These subsidiaries transact business in both local and foreign currency.  Therefore, we are exposed to foreign currency exchange risks and fluctuations in foreign currencies, which could adversely impact our results and financial condition.  However, sales from the United States made directly to customers or distributors in foreign countries are invoiced in U.S. dollars and are not exposed to foreign currency risk.

 

From time to time, we may enter into foreign currency exchange and option contracts to reduce our exposure to foreign currency 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. We do not engage in foreign currency speculation.

 

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

 

Item 4 - Controls and Procedures

 

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

 

(b) Changes to internal controls.  As previously disclosed, during fiscal 2003 we began the implementation of a new accounting software system.  In response to complications associated with the implementation of this system and the transition from our prior system, we made certain changes in our internal control over financial reporting.  These changes were primarily made during the fiscal quarter ended September 27, 2003.  We continued to monitor these changes during the fiscal quarter ended March 27, 2004, and also continued our ongoing process of routinely reviewing and evaluating our internal controls over financial reporting.  Based on that review and evaluation, management believes that it has implemented additional controls sufficient to prevent the problems we encountered during the implementation of our new accounting software system from occurring in the future, and that it has taken the necessary steps so that adequate control procedures are in place and will be followed.  There were no other changes in our internal controls over financial reporting during the fiscal quarter ended March 27, 2004 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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CANDELA CORPORATION

 

Part II.  Other Information

 

Item 1 - Legal Proceedings

 

The Company has an Amended and Restated License Agreement (the “License”) with The Regents of the University of California (“The Regents”) pursuant to which the Company licenses certain patent rights to its dynamic cooling device (“DCD”).  The Company sells its DCD as a component part of its Smoothbeam (®) laser system and as an accessory to its other laser systems.  In April of 2004, The Regents issued a notice of default under the License, asserting, among other things, that the Company is in breach of the License for the alleged failure to make required royalty payments and make required disclosures.  The notice asserted that the total underpaid royalties, interest and other charges for the period from August of 2000 through September 2003 is $1,128,000, and that unless paid, The Regents may terminate the License.  The Company believes it has made all payments that it was required to make and is in the process of reviewing the underlying information in support of the alleged deficiencies recently furnished by The Regents to the Company.  No legal action has been commenced by either The Regents or the Company at this time, and Candela is hopeful that the parties can resolve the issues raised by The Regents without formal legal proceedings.  However, should The Regents attempt to terminate the License, the matter would likely result in a formal legal proceeding to determine the respective rights of the parties.

 

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

 

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

 

Election of Directors

 

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

 

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

 

Ratification of Independent Public Accountants

 

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

 

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

 

Shareholders  voted  to increase the number of shares of Common Stock  that may be issued pursuant to the Amended and Restated 1998 Stock Plan by 1,000,000 shares to 2,650,000 shares of Common Stock in the aggregate: for 5,241,725;  against 1,629,940;  abstain 33,531; no-vote 2,639,013.

 

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Item 5.  Other Information

 

On January 26, 2004, the Company’s Board of Directors resolved to have its Nominating Committee review all stockholder proposals submitted to the Company relating to the nomination of a member of the Board of Directors.  The Nominating Committee will also recommend to the Board of Directors appropriate action with respect to each such proposal.

 

ITEM 6 - Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits

 

Exhibit 31.1                                    Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer

 

Exhibit 31.2                                    Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer

 

Exhibit 32.1                                    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Exhibit 32.2                                    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)                                 Reports on Form 8-K

 

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

 

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SIGNATURES

 

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

 

 

			CANDELA CORPORATION
Date:	May 7, 2004		/s/ F. Paul Broyer
			F. Paul Broyer
			(Senior Vice President, Finance and Administration and Chief Financial Officer)

 

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Candela Corporation

 

INDEX TO EXHIBITS

 

Exhibit No.		Description
Exhibit 31.1		Rule 13a-14(a)/15d-14(a) Certification of the Chief Executive Officer
Exhibit 31.2		Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer
Exhibit 32.1		Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2		Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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