Item 3—"Legal Proceedings."

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        We depend on sales from outside the United States that could be adversely affected by changes in international markets.

        We sell more than half of our products and services outside the United States. International sales accounted for approximately 62% of our revenue for fiscal year 2008 and we expect that they will continue to be significant. Accordingly, a major part of our revenues and operating results could be adversely affected by risks associated with international commerce. Significant fluctuations in the exchange rates between the United States dollar and foreign currencies could cause us to lower our prices and thus reduce our profitability, or could cause prospective customers to push out orders to later dates because of the increased relative cost of our products in the aftermath of a currency devaluation or currency fluctuation. Other risks associated with international business include:

•

longer payment cycles common in foreign markets;



•

changes in tax and other laws;



•

regulatory practices and tariffs; and



•

difficulties in staffing and managing our foreign operations.

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

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

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

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

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

Market supply and demand

•

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



•

potential decrease in demand for our products; and



•

possible delays in market acceptance of our new products.

Customer behavior

•

changes in or extensions of our customers' budgeting and purchasing cycles; and



•

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

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Company operations

•

absence of significant product backlogs;



•

our effectiveness in our manufacturing process;



•

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



•

timing of any acquisitions and related costs.

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

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

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

        The types of medical devices that we seek to market in the United States generally must receive either "510(k) clearance" or "PMA approval" in advance from the United States Food and Drug Administration ("FDA") pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA's 510(k) clearance process usually takes from three to twelve months, but it can last longer. The process of obtaining PMA approval is much more costly and uncertain and generally takes from one to three years or even longer. To date, the FDA has deemed our products eligible for the 510(k) clearance process. We believe that most of our products in development will receive similar treatment. However, we cannot be sure that the FDA will not impose the more burdensome PMA approval process upon one or more of our future products, nor can we be sure that 510(k) clearance or PMA approval will ever be obtained for any product we propose to market.

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

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

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

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for any modification, we also may be required to cease marketing and/or recall the modified device until we obtain a new 510(k) clearance.

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

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

•

fines, injunctions and civil penalties against us;



•

recall or seizure of our products;



•

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



•

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



•

withdrawing product approvals already granted; and



•

criminal prosecution.

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

        Our products may also be subject to state regulations. Federal regulation allows our products to be sold to and used by licensed practitioners as determined on a state-by-state basis, which complicates monitoring compliance. As a result, in some states non-physicians may purchase and operate our products. In most states, it is within a physician's discretion to determine whom they can supervise in the operation of our products and the level of supervision. However, some states have specific regulations as to appropriate supervision and who may be supervised. A state could disagree with our decision to sell to a particular type of end user or change regulations to prevent sales to particular types of end users or change regulations as to supervision requirements. In several states applicable regulations are in flux. Thus, state regulations and changes to state regulations may decrease revenues or prevent growth of revenues.

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

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

•

result in costly litigation;



•

divert our technical and management personnel;



•

cause product shipment delays;



•

require us to develop non-infringing technology; and

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•

require us to enter into royalty or licensing agreements.

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

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

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

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

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

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

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

•

identify appropriate acquisition or joint venture candidates;



•

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



•

successfully manage any joint ventures or collaborations.

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

        We face risks associated with product warranties.

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

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

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

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

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

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

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

Item 1B.    Unresolved Staff Comments.

        Not applicable.

Item 2.    Properties.

        We lease two facilities totaling approximately 38,000 square feet for our operations in Wayland, Massachusetts, which is located approximately 20 miles west of Boston. The leases on these facilities expire September 2009. We also lease a 12,000 square foot facility in South Plainfield, New Jersey for our diode operation. This lease ends on October 31, 2011. Our management believes that its current facilities are suitable and adequate for our near-term needs.

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        Our subsidiaries currently lease the following facilities:

•

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



•

Candela KK.—We lease 4 offices in Japan in Tokyo, Osaka, Nagoya, and Fukuoka. These leases expire between January 1, 2009 and May 23, 2011.



•

Candela Iberica, S.A.. We lease two locations in Lisbon, Portugal and Madrid, Spain. These leases expire on December 12, 2010 and December 31, 2008, respectively.



•

Candela Deutschland GmbH. The lease on this facility in Neu Isenberg, Germany expires on October 14, 2011.



•

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



•

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



•

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



•

Candela (U.K.) Limited. The lease on this facility in Cwmbran, U.K. expires on December 21, 2012.



•

Candela Corporation Australia PTY, Ltd. The lease on the facility in Heidelberg West, Australia expires on March 4, 2010.

Item 3.    Legal Proceedings.

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

•

On August 9, 2006, Palomar filed suit against the Company in the United States District Court for the District of Massachusetts, asserting willful infringement by the Company of U.S. Patent No. 5,735,844. Palomar seeks compensatory and treble damages, as well as attorneys' fees and injunctive relief. In November 2006, the Company answered the complaint by denying Palomar's allegations and asserting a variety of affirmative defenses and counterclaims against Palomar. This response included a counterclaim by the Company against Palomar seeking a declaratory judgment that United States patent No. 5,595,568 ("the '568 Patent") is either invalid, or products manufactured by the Company do not infringe the '568 Patent, or both. In November 2006, Palomar filed an answer denying the Company's counterclaim. In February 2007, Palomar moved to amend its Complaint to add The General Hospital Corporation as a party, to add a claim for infringement by Candela of the '568 patent, and to allege that additional Candela products infringe the '568 Patent. Palomar's motion to amend its Complaint was granted in August 2007. In February 2007, Candela moved to amend its Answer and Counterclaims to add allegations of inequitable conduct, double-patenting and violation of Mass. Gen. Laws Ch. 93A by Palomar. The Company's motion to amend its complaint was granted in March 2007. Palomar filed a general denial response to Candela's Amended Answer and Counterclaim in March 2007. In August 2007, the parties had a Markman hearing before the U.S. District Court Judge presiding over the above-described legal proceeding. In a Markman hearing, the Court interprets the definition of the disputed claim term of a patent. Pre-trial fact discovery has ended and the parties are in the midst of exchanging expert reports. No trial date has been established.



•

On August 10, 2006, the Company filed suit against Palomar in the United States District Court for the District of Massachusetts, asserting willful infringement by Palomar of U.S. Patent Nos. 6,659,999, 5,312,395, and 6,743,222. The Company seeks compensatory and treble damages for the patent infringement, as well as attorneys' fees and an injunction against Palomar to prevent Palomar's continuing infringement. The Company served its complaint on Palomar in

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August 2006. In October 2006, the Company amended the Company's suit against Palomar by removing from the suit allegations that Palomar infringes Patent 6,659,999. In October 2006, Palomar answered the Company's amended complaint by denying the Company's allegations and asserting an affirmative defense of inequitable conduct with respect to the '395 patent. In addition, Palomar filed a demand for a declaratory judgment seeking a judicial determination that Palomar products either do not infringe the '395 and '222 patents or that such patents are invalid. In November 2006, the Company answered the counterclaim by denying Palomar's allegations. In February 2008, Palomar filed a request for re-examination of the Company's 6,743,222 patent with the United States Patent and Trademark Office ("PTO"). In March 2008, the PTO granted re-examination. In June 2008, the Court stayed the case until the PTO rules on the re-examination.



•

In December 2006, the Company filed suit against Palomar in the United States District Court for the Eastern District of Texas, Lufkin Division, asserting that Palomar infringes one or more claims of United States patents Nos: 5,810,801, 6,659,999 and 6,120,497. The Company seeks compensatory and treble damages for past infringement, as well as attorneys' fees and an injunction against Palomar from future infringement. In January 2007, Palomar answered the complaint by denying the Company's allegations and filing a declaratory judgment motion seeking a court ruling that it does not infringe such patents and/or that such patents are invalid. In addition, Palomar filed a motion to transfer the case to the United States District Court for the District of Massachusetts. In February 2007, the Company added Massachusetts General Hospital as a party to its action. The Court denied Palomar's motion to transfer the case to Massachusetts. The parties have completed pre-trial fact discovery, and are preparing for the September 29, 2008 trial.

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

        On February 19, 2008, Cardiofocus, Inc. ("Cardiofocus") filed suit against the Company and eight other companies in the United States District Court for the District of Massachusetts, asserting willful infringement by the Company of U.S. Patent 6,547,780, 6,159,203 and 5,843,073. Cardiofocus seeks compensatory and treble damages, as well as attorneys' fees and injunctive relief. On April 21, 2008, the Company answered Cardiofocus' complaint and asserted a variety of counterclaims against Cardiofocus.

        On April 2 and April 22, 2008, respectively, two substantially similar putative class action lawsuits, entitled Western Pa. Elec. Employees Pension Fund, et al., 1:08-cv-10551-DPW ("Western Pa.") and Caballero v. Candela Corp., et al., Civ. No. 1:08-cv-10673-DPW ("Caballero"), were filed against Candela and two of its officers in the United States District Court for the District of Massachusetts purporting to assert claims for violations of §§10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and seeking, among other things, compensatory damages and reasonable costs and expenses. On June 2, 2008, plaintiffs in the Western Pa. case formally moved for consolidation and the appointment of lead plaintiff and lead counsel. On July 10, 2008, that motion was granted, the cases were consolidated, and a lead plaintiff and lead counsel were appointed. On August 25, 2008, lead plaintiff filed a consolidated amended complaint. The consolidated and amended complaint purports to be brought on behalf of all open-market purchasers of Candela common stock from November 1, 2005 through August 21, 2006 and alleges that Candela made certain false and misleading statements to investors expressing optimism regarding its financial condition and failed to disclose (i) the possibility that Palomar, one of Candela's leading competitors, would initiate patent enforcement litigation against Candela and (ii) that Candela was purportedly losing market share to its

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competitors. The Company believes the case is without merit and intends to defend against it vigorously.

        On April 16, 2008, a shareholder derivative action entitled Forlenzo v. Puorro, et al., Civ. No. 08-1532, was filed in Middlesex County, Massachusetts Superior Court against the individual members of Candela's board of directors and certain of its current and former officers purporting to assert claims for breach of fiduciary duty and related claims arising out of allegations similar to those asserted in the class action litigation discussed above. The complaint seeks on behalf of Candela, among other things, damages, restitution, and injunctive relief. The Company is considering what action to take in response.

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

        Not applicable.

PART II

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

        Candela's common stock trades on The NASDAQ Global Select Market under the symbol "CLZR."

        At September 9, 2008, there were approximately 307 holders of record of our common stock and the closing sale price of our common stock was $3.04.

Market Price of Common Stock

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

Repurchase of our Equity Securities

        We did not repurchase any of our common stock during the three-month period ended June 28, 2008.

Dividend Policy

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

Securities Authorized for Issuance under Equity Compensation Plans

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

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Stock Performance Graphs

        The following performance graph shall not be deemed "filed" for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Candela under the Securities Act or the Exchange Act.

        The graph below compares Candela Corporation's cumulative 5-year total shareholder return on common stock with the cumulative total returns of the S&P 500 index and SIC Code 3845. The companies in SIC Code 3845 are listed respectively in footnote (a) below. The graph tracks the performance of a $100 investment in our common stock, in each of the peer groups, and the index (with the reinvestment of all dividends) from 6/28/2003 to 6/28/2008.

(a)

4-D Neuroimaging, Abiomed Inc, Applied Biosystems Inc, Arrhythmia Research Technology, Aspect Medical Systems Inc, Biofield Corp., BSD Medical Corp., Cambridge Heart Inc, Candela Corp., Cardiodynamics International, Cardiogenesis Corp., Celsion Corp., Clarient Inc, Covidien Limited, Curon Medical Inc, Cutera Inc, Cyberonics Inc, Cybex International Inc, Cynosure Inc, Datascope Corp., Dexcom Inc, Digirad Corp., Dobi Medical International Inc, Dynatronics Corp., Edwards Lifesciences Corp., Embryo Development, Encision Inc, EP Medsystems Inc, Fischer Imaging Corp., Fonar Corp., Healthtronics Inc, Hypertension Diagnostics Inc, Imaging Diagnostic Systems, Ingen Technologies Inc, International Isotopes Inc, Iris International Inc, Ivivi Technologies Inc, Lectec Corp., Longport Inc, Magna-LAB Inc, Medtronic Inc, Millipore Corp., Misonix Inc, Nano Global Inc, Natus Medical Inc, Non Invasive Monitoring Systems Inc, Nxstage Medical Inc, Ophthalmic Imaging Systems Inco, Orthometrix Inc, Palomar Medical Technologies Inc, Paradigm Medical Industries Inc, PLC Systems Inc, Positron Corp., Precision Optics Corp. Inc, Saint Jude Medical Inc, Signalife Inc, Sirona Dental Systems Inc, Somanetics Corp., Spectranetics Corp., Spectrasource Corp., Spire Corp., Stereotaxis Inc, Surgilight Inc, Thermage Inc, Tomotherapy Inc, Varian Medical Systems Inc, Vasamed Inc, Viking Systems Inc, Vision-Sciences Inc, Vnus Medical Technologies Inc and Zoll Medical Corp.

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Item 6.    Selected Financial Data.

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