Candela (CLZR) 10-Q 2002 Q3 Quarterly report

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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 30, 2002.

Commission file number 0-14742

CANDELA CORPORATION
(Exact name of registrant as specified in its charter)

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

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

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

Class	Outstanding at May 7, 2002
Common Stock, $.01 par value	9,704,944

CANDELA CORPORATION
Index

			Page(s)
Part I.	Financial Information:
	Item 1.	Unaudited Condensed Consolidated Balance Sheets as of March 30, 2002 and June 30, 2001	3
		Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three-month and nine-month periods ended March 30, 2002 and March 31, 2001	4
		Unaudited Condensed Consolidated Statements of Cash Flows for the three-month and nine-month periods ended March 30, 2002 and March 31, 2001	5
		Notes to Unaudited Condensed Consolidated Financial Statements	6-9
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10-15
		Cautionary Statements	15-16
	Item 3.	Quantitative and Qualitative Disclosure about Market Risk	17
Part II.	Other Information:
	Item 1.	Legal proceedings	18
	Item 6.	Exhibits and Reports on Form 8-K	18

2

Part I. Financial Information

Item 1—Financial Statements

CANDELA CORPORATION
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)

			March 30, 2002			June 30, 2001
Assets
Current assets:
	Cash and cash equivalents		$	20,664		$	32,318
	Accounts receivable, net			20,577			19,648
	Notes receivable			663			1,205
	Inventories, net			11,467			10,071
	Other current assets			1,171			980
		Total current assets		54,542			64,222
Property and equipment, net				3,188			2,678
Deferred tax assets				5,306			5,327
Prepaid licenses				1,449			1,595
Other assets				201			196
		Total assets	$	64,686		$	74,018
Liabilities and Stockholders' Equity
Current liabilities:
	Accounts payable		$	5,019		$	5,781
	Accrued payroll and related expenses			2,090			1,832
	Accrued warranty costs			4,111			3,629
	Income taxes payable			905			2,549
	Restructuring reserve			653			1,689
	Other accrued liabilities			3,239			1,909
	Current portion of long-term debt			740			318
	Deferred revenue			4,358			4,205
		Total current liabilities		21,115			21,912
Long-term portion of deferred revenue				2,069			2,317
Long-term debt				2,274			2,815
		Total liabilities		25,458			27,044
Stockholders' equity:
	Common stock			119			118
	Additional paid-in capital			43,853			43,475
	Accumulated earnings			10,560			13,244
	Treasury stock, at cost			(12,997	)		(7,782	)
	Accumulated other comprehensive loss			(2,307	)		(2,081	)
		Total stockholders' equity		39,228			46,974
		Total liabilities and stockholders' equity	$	64,686		$	74,018

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

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CANDELA CORPORATION
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(in thousands, except per share data)
(unaudited)

		For the three months ended:						For the nine months ended:
		March 30, 2002			March 31, 2001			March 30, 2002			March 31, 2001
Revenue
	Lasers and other products	$	11,983		$	14,468		$	29,096		$	34,533
	Product-related service		3,490			3,337			9,385			9,189
	Skin care center		674			991			2,202			2,874
	Total revenue		16,147			18,796			40,683			46,596
Cost of sales
	Lasers and other products		5,284			6,903			13,335			15,479
	Product-related service		3,010			1,880			7,408			5,578
	Skin care center		504			581			1,731			1,721
	Total cost of sales		8,798			9,364			22,474			22,778
Gross profit			7,349			9,432			18,209			23,818
Operating expenses:
	Selling, general and administrative		7,006			5,917			19,524			16,634
	Research and development		1,260			1,392			3,508			4,329
	Restructuring reserve		(693	)		—			(693	)		—
	Total operating expenses		7,573			7,309			22,339			20,963
Income (loss) from operations			(224	)		2,123			(4,130	)		2,855
Other income (expense):
	Interest income		169			322			534			1,307
	Interest expense		(120	)		(101	)		(359	)		(349	)
	Other income (expense)		113			72			478			190
	Total other income (expense)		162			293			653			1,148
Income (loss) before income taxes			(62	)		2,416			(3,477	)		4,003
Provision for (benefit from) income taxes			229			861			(793	)		1,433
Net income (loss)		$	(291	)	$	1,555		$	(2,684	)	$	2,570
Basic earnings (loss) per share		$	(0.03	)	$	0.14		$	(0.26	)	$	0.23
Diluted earnings (loss) per share		$	(0.03	)	$	0.14		$	(0.26	)	$	0.22
Weighted average shares outstanding			9,641			10,732			10,194			10,987
Adjusted weighted average shares outstanding			9,641			11,211			10,194			11,621
Net Income (loss)		$	(291	)	$	1,555		$	(2,684	)	$	2,570
Other comprehensive income (net of tax):
	Foreign currency translation adjustment		305			(482	)		761			(198	)
Comprehensive income (loss)		$	14		$	1,073		$	(1,923	)	$	2,372

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

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CANDELA CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

				For the nine months ended:
				March 30, 2002			March 31, 2001
Cash flows from operating activities:
	Net income (loss)			$	(2,684	)	$	2,571
	Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities:
		Depreciation and amortization			393			572
		Provision for bad debts			163			18
		Effect of exchange rate changes on foreign currency denominated assets and liabilities			39			(16	)
		Reversal of restructuring reserve			(693	)		—
		Accretion of debt discount			76			73
		Increase (decrease) in cash from working capital:
			Accounts receivable		(724	)		(1,051	)
			Notes receivable		459			562
			Inventories		(1,493	)		(1,969	)
			Other current assets		(137	)		(819	)
			Other assets		128			(684	)
			Accounts payable		(804	)		(371	)
			Accrued payroll and related expenses		263			(445	)
			Deferred revenue		204			2,047
			Accrued warranty costs		490			(456	)
			Income taxes payable		(1,417	)		(577	)
			Restructuring reserve		(343	)		(345	)
			Long-term portion of deferred revenue		(251	)		—
			Other accrued liabilities		1,226			2,500
Net cash provided by (used for) operating activities					(5,105	)		1,610
Cash flows from investing activities:
		Purchases of property and equipment			(906	)		(130	)
Net cash used for investing activities					(906	)		(130	)
Cash flows from financing activities:
		Principal payments of long-term debt			(189	)		—
		Net borrowings (repayments) on line of credit			237			(11	)
		Proceeds from the issuance of common stock			378			1,368
		Repurchase of treasury stock			(5,215	)		(4,736	)
Net cash used for financing activities					(4,789	)		(3,379	)
Effect of exchange rates on cash and cash equivalents					(854	)		(134	)
Net increase (decrease) in cash and cash equivalents					(11,654	)		(2,033	)
Cash and cash equivalents at beginning of period					32,318			34,863
Cash and cash equivalents at end of period				$	20,664		$	32,830

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

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CANDELA CORPORATION
Notes to Unaudited Condensed Consolidated Financial Statements

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") for fiscal 2001, 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 30, 2001, which was derived from the audited consolidated balance sheet dated June 30, 2001. However, in the opinion of management, the statements include all necessary adjustments 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. In addition to normal recurring adjustments, the financial statements for the period ended March 30, 2002 include an adjustment to reverse a portion of the restructuring reserve (see note 5). The results for the three-month period or the nine-month period ended March 30, 2002 are not necessarily indicative of the results to be expected for the full year.

2.    New Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 141, "Business Combinations". SFAS No. 141 revises the standards of business combinations by eliminating the use of the pooling-of-interests method and requiring that all business combinations be accounted for using the purchase method of accounting. SFAS No. 141 also changes the criteria to recognize intangible assets apart from goodwill. The provisions of SFAS No. 141 are effective for all business combinations initiated after June 30, 2001. The adoption of this statement had no impact on the Company's financial position and results of operations.

        In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 revises the standards of accounting for goodwill and indefinite lived intangible assets by replacing the regular amortization of these assets with the requirement that they are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets that have finite lives will continue to be amortized over their useful lives. The accounting standards of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001. The Company does not believe the adoption of this statement will have any impact on the earnings or financial position of the Company.

        In August 2001, the FASB issued SFAS No. 143, "Accounting for Obligations Associated with the Retirement of Long-Lived Assets". SFAS No. 143 addresses financial accounting and reporting for the retirement obligation of an asset. SFAS No. 143 states that companies should recognize the asset retirement cost, at its fair value, as part of the cost of the asset and classify the accrued amount as a liability in the condensed consolidated balance sheet. The asset retirement liability is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be subsequently updated for revised estimates of the discounted cash outflows. SFAS No. 143 will be effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the effect SFAS No. 143 will have on its financial position, results of operations, or cash flows.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supercedes SFAS No. 121 by requiring one accounting model to be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 will be effective for fiscal years beginning after December 15, 2001. The Company has not yet determined the effect SFAS No. 144 will have on its financial position, results of operations, or cash flows.

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3.    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.

        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 30, 2002			March 31, 2001		March 30, 2002			March 31, 2001
Numerator
Net income (loss)	$	(291	)	$	1,555	$	(2,684	)	$	2,570
Denominator
Basic earnings (loss) per share
Weighted average shares outstanding		9,641			10,732		10,194			10,987
Earnings (loss) per share	$	(0.03	)	$	0.14	$	(0.26	)	$	0.23
Diluted earnings (loss) per share
Weighted average shares outstanding		9,641			10,732		10,194			10,987
Effect of dilutive securities:
Stock options		—			268		—			352
Stock warrants		—			211		—			282
Adjusted weighted average shares outstanding		9,641			11,211		10,194			11,621
Earnings (loss) per share	$	(0.03	)	$	0.14	$	(0.26	)	$	0.22

        During the three and nine month periods ended March 31, 2001, options to purchase 279,096 and 209,096 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share. During the three and nine month periods ended March 30, 2002, options to purchase 1,006,945 and 888,733 shares of common stock, respectively, were excluded from the calculation of diluted earnings per share.

4.    Inventories

        Inventories consist of the following:

(in thousands)	March 30, 2002		June 30, 2001
Raw materials	$	4,441	$	3,723
Work in process		548		951
Finished goods		6,478		5,397
Total Inventories, net	$	11,467	$	10,071

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5.    Restructuring Charges

        During the quarters ended December 27, 1997 and June 30, 2001, the Company recorded combined restructuring charges of $3,721,000 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. Per the sublease agreement, the sublessee will pay all costs associated with the facility through the end of the lease term ending June 2006. As an incentive to the sublessee, the Company agreed to pay eight months of rent during the life of the sublease. The sublessee commenced making payments to the landlord on April 1, 2002.

        For the quarter ended March 30, 2002, the Company has revised the estimate of future costs associated with the Scottsdale facility and has reversed $693,000 of the restructuring reserve which represents primarily the amount of future contractual sublease payments as well as revisions to the net realizable value of leasehold improvements. The adjusted restructuring reserve at March 30, 2002 includes provisions for one month of rent to be paid by the Company in each of fiscal years 2003, 2004 and 2005, the remaining book value of leasehold improvements to be depreciated through fiscal year 2007, and a revised estimate of severance costs to be paid through December 2003.

        The following table reflects the restructuring charges incurred during the nine-month period ended March 30, 2002 and the restructuring reserve reversal:

	Payroll and Severance			Leasehold Improvements and Fixed Assets			Facility Costs			Total
Balance at June 30, 2001	$	178		$	841		$	670		$	1,689
Cash charges		(41	)					(185	)		(226	)
Non-cash charges					(117	)					(117	)
Restructure reserve		(6	)		(239	)		(448	)		(693	)
Balance at March 30, 2002	$	131		$	485		$	37		$	653

6.    Debt

        In 1998, the Company issued eight-year, 9.75% subordinated term notes ("Note Agreement") to three investors in the aggregate amount of $3.7 million, secured by the assets of the Company. The notes become due in October 2006, and require quarterly interest payments. The Company began making quarterly principal payments of $185,000, along with any unpaid interest, on January 31, 2002. The Note Agreement also contains restrictive covenants establishing maximum leverage, certain minimum ratios, and minimum levels of net income. As of the quarter ended March 30, 2002, the Company was in violation of minimum profitability levels and the minimum net worth requirement giving the note holders the right to require us to repay the entire value of the loan at any time. We have received waivers from the note holders for the quarter ended March 30, 2002. Because the note holders have the right to call the loan at any time, the loan could be classified as a current liability instead of a long-term liability. Since we believe we will be in compliance with the restrictions by the end of the next quarter we continue to classify the loan as long-term debt on the balance sheet. If we classified the loan as short-term debt, our liquidity ratio, long-term debt to equity ratio and credit rating could be adversely affected.

7.    Segment Information

        We operate principally in two industry segments: the design, manufacture, sale, and service of medical devices and related equipment; and the performance of services in the skin care/health spa industry.

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Line of Business Data:

		For the three months ended:						For the nine months ended:
(in thousands)		March 30, 2002			March 31, 2001			March 30, 2002			March 31, 2001
Revenue:
	Product sales and service	$	15,473		$	17,805		$	38,481		$	43,722
	Skin care/health spa services		674			991			2,202			2,874
Total revenue		$	16,147		$	18,796		$	40,683		$	46,596
Operating income (loss):
	Product sales and service	$	(574	)	$	2,229		$	(3,612	)	$	3,238
	Skin care/health spa services		350			(106	)		(518	)		(383	)
Total operating income (loss)		$	(224	)	$	2,123		$	(4,130	)	$	2,855

		As of March 30, 2002		As of June 30, 2001
Total assets:
(net intercompany accounts)
	Product sales and service	$	63,733	$	72,718
	Skin care/health spa services		953		1,300
Total assets		$	64,686	$	74,018

8.    Legal Proceedings

        Reference is made to the Physicians Sales and Service, Inc. ("PSS") arbitration proceeding previously reported on Form 10-Q for Candela's second fiscal quarter ended December 29, 2001. No material developments in the resolution of this matter have transpired since it was initially reported.

        From time to time, Candela is a party to various legal proceedings incidental to its business. Apart from any possible adverse outcome in the PSS arbitration, Candela believes that none of the legal proceedings which are presently pending will have a material adverse effect upon our financial position, results of operations or liquidity.

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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, the provision of product-related services, and the operations of our remaining skin care center. Over half of our revenue in recent periods has come from international sales.

Significant 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 assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, warranty obligations, and income taxes. 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.    Our policy is to recognize revenue upon shipment of our products to our customers and the fulfillment of all contractual terms and conditions, pursuant to the guidance provided by Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), issued by the Securities and Exchange Commission. Judgments are required in evaluating the credit worthiness of our customers. Credit is not extended to customers and revenue is not recognized until we have determined that the risk of uncollectibility is minimal.

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 the customer 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.

        As of March 30, 2002, our accounts receivable balance of $20,577,000 is reported net of allowances for doubtful accounts of $1,015,000. We believe our reported allowances at March 30, 2002, 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, which would result in

10

additional selling, general and administrative expenses being recorded for the period in which such determination was 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 March 30, 2002, our inventory of $11,467,000 is stated net of inventory reserves of $1,851,000. If actual demand for our products deteriorate, or market conditions are less favorable than those that we project, additional inventory reserves may be required.

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 March 30, 2002, 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.

Contingencies.    The Company is subject to proceedings, lawsuits and other claims. The Company assesses 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 are 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. The Company records charges for the costs it anticipates incurring in connection with litigation and claims against the Company when management can reasonably estimate these costs.

Restructuring.    The Company records restructuring charges incurred in connection with consolidation or relocation of operations, exited business lines, or shutdowns of specific sites. These restructuring charges, which reflect management's 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.

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Results of Operations

        Revenue.    Revenue source by geography is reflected in the following table:

	For the three months ended:
(in thousands)	March 30, 2002				March 31, 2001				Change
US revenue	$	8,183	51	%	$	8,695	35	%	$	(512	)	-6	%
Foreign revenue		7,964	49	%		10,101	65	%		(2,137	)	-21	%
Total revenue	$	16,147	100	%	$	18,796	100	%	$	(2,649	)	-14	%

	For the nine months ended:
	March 30, 2002				March 31, 2001				Change
US revenue	$	17,709	44	%	$	20,205	41	%	$	(2,496	)	-12	%
Foreign revenue		22,974	56	%		26,391	59	%		(3,417	)	-13	%
Total revenue	$	40,683	100	%	$	46,596	100	%	$	(5,913	)	-13	%

        The US revenue reported for the nine months ended March 30, 2002 was lower than the same period one year earlier due primarily to a decrease in sales from a major US distributor. Our own direct sales force is now servicing the sales channels previously serviced by this distributor contributing to the lesser decrease in US revenue for the three months ended March 30, 2002 as compared to the same period one year earlier. Lower sales volume of GentleLase™ products contributed approximately $3,000,000 to the decrease for the nine months ended March 30, 2002, and was offset by a $1,000,000 increase in sales volume of Vbeam products, as compared to the same period one year earlier. Lower sales volume of GentleLase™ and Smoothbeam products contributed approximately $1,800,000 to the decrease for the quarter ended March 30, 2002 as compared to the same period the prior year, but was offset by an approximate $1,500,000 increase in sales of Vbeam products.

        Foreign revenue decreased in the nine-month period ended March 30, 2002 due primarily to a $1,500,000 decrease in revenue of AlexLazr™ products and a $1,700,000 decrease in GentleLase™ systems as compared to the same periods one year earlier. Both decreases are the result of lower average selling prices and lower sales volume. The decrease in foreign revenue for the quarter ended March 30, 2002, as compared to the same period one year earlier, is the result of lower sales volume of GentleLase™ ($400,000), Vbeam ($500,000), Smoothbeam ($500,000) and AlexLazr™ ($300,000) products. A lower average selling price of GentleLase™ products also contributed approximately $400,000 to the decrease.

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        Revenue source by type is reflected in the following table:

	For the three months ended:
(in thousands)	March 30, 2002				March 31, 2001				Change
Lasers and other products	$	11,983	74	%	$	14,468	77	%	$	(2,485	)	-17	%
Product related service		3,490	22	%		3,337	18	%		153		5	%
Skin care centers		674	4	%		991	5	%		(317	)	-32	%
Total revenue	$	16,147	100	%	$	18,796	100	%	$	(2,649	)	-14	%

	For the nine months ended:
	March 30, 2002				March 31, 2001				Change
Lasers and other products	$	29,096	72	%	$	34,533	74	%	$	(5,437	)	-16	%
Product related service		9,385	23	%		9,189	20	%		196		2	%
Skin care centers		2,202	5	%		2,874	6	%		(672	)	-23	%
Total revenue	$	40,683	100	%	$	46,596	100	%	$	(5,913	)	-13	%

        The decrease in laser product revenue for the three-month and nine-month periods ended March 30, 2002, resulted primarily from decreases in the sales volumes of systems as described above. Product related service revenue increased inconsequentially during the three-month and nine-month periods ended March 30, 2002 as compared to the same periods one year earlier. Skin care centers revenue decreased during the three-month period ended March 30, 2002 primarily due to decreases in revenue from spa services of $130,000 and from salon services of $150,000 as compared to the same period one year earlier. Decreases in revenue from spa services of $278,000 and from salon services of $280,000 contributed to the decrease in revenue from the nine-month period ended March 30, 2002 as compared to the same period in the previous fiscal year.

        Gross Profit.    Gross profit decreased to $7,349,000 (46% of revenue) from $9,432,000 (50% of revenue) for the quarters ended March 30, 2002 and March 31, 2001 respectively. Gross profit decreased to $18,209,000 (45% of revenue) for the nine-month period ended March 30, 2002 from $23,818,000 (51% of revenue) for the same period one year earlier. This decrease in gross profit results principally from a decrease in the sales volume and average selling price of various systems as described above. Gross profit on product related service fell $1,000,000 in the quarter ended March 30, 2002 as compared to the same period one year earlier, due primarily to increases in field service personnel, unexpected warranty costs and lower service contract revenue. Skin care center direct labor costs remained stable while revenue fell, resulting in gross profit levels that were $240,000 and $700,000 lower in the three-month and nine-month periods ended March 30, 2002, respectively, as compared to the same periods one year earlier.

        Selling, General and Administrative Expense.    Selling, general and administrative expenses increased from $5,917,000 (31% of revenue) to $7,006,000 (43% of revenue) for the three-month periods ended March 31, 2001 and March 30, 2002. Selling, general and administrative costs increased from $16,634,000 (36% of revenue) to $19,524,000 (48% of revenue) for the nine-month periods ending March 31, 2001 and March 30, 2002. Higher marketing expenses for the trade shows and the Cbeam release contributed approximately $500,000 and $900,000 to the overall increase for the three-month and nine-month periods respectively ending March 30, 2002 as compared to the same periods one year earlier. Costs to increase our domestic sales force to replace sales channels formerly serviced by a major U.S. distributor also contributed approximately $400,000 and $1,000,000 respectively to the increase in selling, general and administrative expenses for the three-month and nine-month periods respectively ending March 30, 2002 as compared to the same periods one year earlier. Our selling expenses are expected to continue to increase as the domestic sales force is strengthened, but the added costs should be offset by a corresponding increase in domestic revenue. A $300,000 increase in

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the provision for bad debts and a one-time $90,000 settlement in the Skin Care Center during the quarter ended December 29, 2001 also contributed to the overall increase in selling, general and administrative expenses for the nine-month period ended March 30, 2002.

        Research and Development Expense.    Research and development spending decreased to $1,260,000 (8% of revenue) and $3,508,000 (9% or revenue) respectively for the three and nine-month periods ended March 30, 2002, compared to $1,392,000 (7% of revenue) and $4,329,000 (9% of revenue) for the same periods one year earlier. The decrease in research and development expenses is primarily due to the spending cycle associated with product development. Expenditures for this department will likely remain at less than 10% of sales for the remainder of the year.

        Restructuring Charge.    For the three months ended March 30, 2002, the Company revised the estimate of future costs associated with closing the skin care center in Scottsdale, Arizona and reversed $693,000 of the restructuring reserve.

        Other Income/Expense.    Other income/expense was $162,000 and $653,000 for the three month and nine-month periods ended March 30, 2002, compared to income of $293,000 and $1,148,000 for the three and nine-month periods ended March 31, 2001. This decrease resulted primarily from lower interest income due to lower rates and lower cash balances invested as compared to the same periods one year earlier.

        Income Taxes.    The provision for income taxes results from a combination of activities of both the domestic and foreign subsidiaries of the Company. The provision for income taxes for the nine-month period ended March 30, 2002, includes a tax provision calculated for income generated in Japan and Spain using rates in excess of the U.S. statutory rate. The Company has recorded a 23% tax benefit for the nine-month period ended March 30, 2002, in comparison to the nine-month period ended March 31, 2001, in which the Company recorded a 36% tax rate. The Company expects a tax benefit for U.S. tax purposes based on its ability to file a net operating loss carry back claim for current year losses.

Liquidity and Capital Resources

        Cash used by operating activities amounted to $5,105,000 for the nine-month period ended March 30, 2002 as compared to cash generated by operating activities of $1,610,000 for the same period in the prior year. This decrease in cash primarily reflects the effects of a net loss for the nine-month period ended March 30, 2002 versus a net income for the nine-month period ended March 31, 2001. Cash used for investing activities totaled $906,000 for the nine-month period ended March 30, 2002 compared to cash used for investing activities of $130,000 for the same period one year earlier and primarily reflects payments to support the Company's Oracle software implementation initiatives. Cash used for financing activities in the nine-month period ended March 30, 2002 amounted to $4,789,000 and primarily reflects stock purchases pursuant to our stock repurchase program.

        In connection with our eight-year, 9.75% subordinated notes, a total of $335,000 has been accreted to the notes through March 30, 2002, resulting in a long-term liability balance of $2.3 million and a short-term liability balance of $740,000 at quarter end. A total of $25,510 was accreted to interest expense in the three-month period ended March 30, 2002.

        Outstanding contractual obligations of the Company are reflected in the following table:

(in thousands)	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Long-term debt	$	3,700	$	740	$	2,405	$	555
Operating leases		2,039		522		740		473		304
Total contractual cash obligations	$	5,739	$	1,262	$	3,145	$	1,028	$	304

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        Additionally, the Company has a $5,000,000 line of credit available to meet liquidity needs.

        We believe that 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.

Accounting Pronouncements

        In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations". SFAS No. 141 revises the standards of business combinations by eliminating the use of the pooling-of-interests ("pooling") method and requiring that all business combinations be accounted for using the purchase method of accounting. SFAS No. 141 also changes the criteria to recognize intangible assets apart from goodwill. The provisions of SFAS No. 141 are effective for all business combinations initiated after June 30, 2001. The adoption of this statement had no impact on the Company's financial position or results of operations.

        In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 revises the standards of accounting for goodwill and indefinite lived intangible assets by replacing the regular amortization of these assets with the requirement that they are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets that have finite lives will continue to be amortized over their useful lives. The accounting standards of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001. The Company does not believe the adoption of this statement will have any impact on the earnings and financial position of the Company.

        In August 2001, the FASB issued SFAS No. 143, "Accounting for Obligations Associated with the Retirement of Long-Lived Assets." SFAS No. 143 addresses financial accounting and reporting for the retirement obligation of an asset. SFAS No. 143 states that companies should recognize the asset retirement cost, at its fair value, as part of the cost of the asset and classify the accrued amount as a liability in the condensed consolidated balance sheet. The asset retirement liability is then accreted to the ultimate payout as interest expense. The initial measurement of the liability would be subsequently updated for revised estimates of the discounted cash outflows. SFAS No. 143 will be effective for fiscal years beginning after June 15, 2002. The Company has not yet determined the effect SFAS No. 143 will have on its financial position, results of operations, or cash flows.

        In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 supercedes SFAS No. 121 by requiring one accounting model to be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and by broadening the presentation of discontinued operations to include more disposal transactions. SFAS 144 will be effective for fiscal years beginning after December 15, 2001. The Company has not yet determined the effect SFAS No. 144 will have on its financial position, results of operations, or cash flows.

Cautionary Statements

        This Quarterly Report on Form 10-Q contains forward-looking statements including, without limitation, statements concerning 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. This Quarterly Report on Form 10-Q contains forward-looking statements that we have made based on our current expectations, estimates and projections about our industry, operations, and prospects, not historical facts. We have made these forward-looking statements pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These statements can be identified

15

by the use of forward-looking terminology such as "may," "will," "believe," "expect," "anticipate," "estimate," "intend," "continue" or other similar expressions. These statements discuss future expectations, and may contain projections of results of operations or of financial condition or state other forward-looking information. 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 "Cautionary Statements" in our annual report filed on Form 10-K for the fiscal year ended June 30, 2001, as well as other risks and uncertainties referenced in this Quarterly Report. These risks include, but are not limited to, the following:

•

Because we have historically derived 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 the GentleLASE™ and ALEXlazr™ from our sole supplier would impair our ability to manufacture and sell these laser systems, which accounted for a substantial portion of our revenue in certain recent periods.



•

We have terminated our distributor agreement with Physician Sales & Service, Inc. that previously accounted for in excess of 10% of our net revenue in fiscal years 2001 and 2000. The termination of this relationship may result in reduced product sales in current and future periods. We also will incur expenses to add direct sales personnel to substitute for the sales channels provided by such distributor. An adverse determination in the presently pending arbitration proceeding between Candela and PSS also would have a material adverse impact on Candela.



•

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 FDA clearance. 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.

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Item 3—Quantitative and Qualitative Disclosures About Market Risk

        At March 30, 2002, the Company's cash and debt are exposed to interest rate risk. We are exposed to foreign currency risk due to accounts receivable from our foreign subsidiaries.

        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.

        We currently have long-term debt with a face value of $2.6 million with the interest rate fixed at the time of issuance. The long-term debt will be fully repaid by October 2006. The Note Agreement also contains restrictive covenants establishing maximum leverage, certain minimum ratios, and minimum levels of net income. As of the quarter ended March 30, 2002, the Company was in violation of minimum profitability levels and the minimum net worth requirement giving the note holder the right to require us to repay the entire value of the loan at any time. We have received waivers from the note holder for the quarter ended March 30, 2002. Because the note holder has the right to call the loan at any time, the loan could be classified as a current liability instead of a long-term liability. Since we believe we will be in compliance with the restrictions by the end of next quarter we continue to classify the loan as long-term debt on the balance sheet. If we classified the loan as short-term debt, our liquidity ratio, long-term debt to equity ratio and credit rating could be adversely affected.

        At March 30, 2002, the Company held foreign currency contracts with notional values totaling $1,086,606 for the delivery of 30,467,498 Japanese Yen and 992,781 Euros. These contracts have maturities prior to June 27, 2002. The carrying and net fair value of these contracts was $(16,107) at March 30, 2002. We believe that any near term changes in currency rates will be immaterial to any potential losses in future earnings, cash flow and fair value because any adjustments to fair value offset the change in the fair value of the foreign currency intercompany receivables.

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CANDELA CORPORATION

Part II. Other Information

Item 1—Legal Proceedings

        Reference is made to the Physicians Sales and Service, Inc. ("PSS") arbitration proceeding previously reported on Form 10-Q for Candela's second fiscal quarter ended December 29, 2001. No material developments in the resolution of this matter have transpired since it was initially reported.

        From time to time, Candela is a party to various legal proceedings incidental to its business. Apart from any possible adverse outcome in the PSS arbitration, Candela believes that none of the legal proceedings which are presently pending will have a material adverse effect upon our financial position, results of operations or liquidity.

Item 6—Exhibits and Reports on Form 8-K

(a)

Exhibits

        None.

(b)

Reports on Form 8-K

        None

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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 Registrant
Date: May 14, 2002	/s/ GERARD E. PUORROGerard E. Puorro (President and Chief Executive Officer)
Date: May 14, 2002	/s/ F. PAUL BROYERF. Paul Broyer (Senior Vice President of Finance and Administration and Chief Financial Officer)

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QuickLinks

CANDELA CORPORATION Index
Part I. Financial Information

Item 1—Financial Statements

CANDELA CORPORATION Condensed Consolidated Balance Sheets (in thousands) (unaudited)
CANDELA CORPORATION Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (in thousands, except per share data) (unaudited)
CANDELA CORPORATION Condensed Consolidated Statements of Cash Flows (in thousands) (unaudited)
CANDELA CORPORATION Notes to Unaudited Condensed Consolidated Financial Statements
CANDELA CORPORATION

Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3—Quantitative and Qualitative Disclosures About Market Risk

Part II. Other Information

Item 1—Legal Proceedings
Item 6—Exhibits and Reports on Form 8-K

SIGNATURES