##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
  þ
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the Quarterly Period Ended March 31, 2006
 OR
 o
    
    Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 Commission File Number: 000-50798
 Color Kinetics Incorporated
  Delaware
    
    04-3391805(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 
 
 
 þ o
  o þ o
 o þ




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##### 



COLOR KINETICS INCORPORATED
FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2006
INDEX
 Page No.PART I. FINANCIAL INFORMATIONItem 1.
    
    Unaudited Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2006 and 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    18Item 4.
    
    Controls and Procedures
    
    
    18PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    18Item 1A.
    
    Risk Factors
    
    
    19Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3.
    
    Defaults Upon Senior Securities
    
    
    21Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    21Item 5.
    
    Other Information
    
    
    21Item 6.
    
    Exhibits
    
    
    21Signatures
    
    
    
    
    22EX-31.1 SECTION 302 CERTIFICATION OF THE C.E.O.EX-31.2 SECTION 302 CERTIFICATION OF THE C.F.O.EX-32.1 SECTION 906 CERTIFICATIONS OF THE C.E.O. & C.F.O.
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PART I. FINANCIAL INFORMATION
 
 Item 1. Unaudited Condensed Consolidated Financial Statements
 Color Kinetics Incorporated
 
 Condensed Consolidated Balance Sheets
 (In thousands, except per share data)
 March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCURRENT ASSETS:Cash and equivalents
    
    $
    35,493
    
    
    $
    43,032Investments
    
    
    20,899
    
    
    
    14,137Restricted cash
    
    
    
    
    
    
    100Accounts receivable, net
    
    
    8,637
    
    
    
    7,813Accounts receivable from related party
    
    
    186
    
    
    
    249Inventory
    
    
    6,779
    
    
    
    7,159Prepaid expenses and other current assets
    
    
    2,670
    
    
    
    1,436Total current assets
    
    
    74,664
    
    
    
    73,926PROPERTY AND EQUIPMENTnet
    
    
    1,226
    
    
    
    1,026INTANGIBLE ASSETSnet
    
    
    297
    
    
    
    INVESTMENT IN JOINT VENTURE
    
    
    943
    
    
    
    887RESTRICTED CASHNon-current portion
    
    
    500
    
    
    
    900TOTAL ASSETS
    
    $
    77,630
    
    
    $
    76,739LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    1,770
    
    
    $
    1,019Accounts payable to related party
    
    
    
    
    
    
    63Accrued expenses
    
    
    1,894
    
    
    
    2,169Accrued compensation
    
    
    1,734
    
    
    
    2,251Accrued restructuring
    
    
    351
    
    
    
    385Accrued warranty
    
    
    881
    
    
    
    876Deferred revenue
    
    
    255
    
    
    
    231Total current liabilities
    
    
    6,885
    
    
    
    6,994ACCRUED RESTRUCTURINGNon-current portion
    
    
    182
    
    
    
    243COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Common stock, $0.001 par value
    
    
    18
    
    
    
    18Additional paid-in capital
    
    
    100,091
    
    
    
    99,210Accumulated other comprehensive loss
    
    
    (128
    )
    
    
    (120
    )Accumulated deficit
    
    
    (29,418
    )
    
    
    (29,606
    )Total stockholders equity
    
    
    70,563
    
    
    
    69,502TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    77,630
    
    
    $
    76,739
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Color Kinetics Incorporated
 
 Condensed Consolidated Statements of Income
 (In thousands, except per share data)
 Three Months Ended March 31,2006
    
    
    2005REVENUES (1):Lighting systems
    
    $
    13,098
    
    
    $
    9,639OEM and licensing
    
    
    1,560
    
    
    
    1,877Total revenues
    
    
    14,658
    
    
    
    11,516COST OF REVENUES:Lighting systems
    
    
    6,099
    
    
    
    4,643OEM and licensing
    
    
    540
    
    
    
    901Total cost of revenues
    
    
    6,639
    
    
    
    5,544GROSS PROFIT
    
    
    8,019
    
    
    
    5,972OPERATING EXPENSES:Selling and marketing
    
    
    3,755
    
    
    
    2,420Research and development
    
    
    1,604
    
    
    
    1,032General and administrative
    
    
    3,091
    
    
    
    2,227Total operating expenses
    
    
    8,450
    
    
    
    5,679INCOME (LOSS) FROM OPERATIONS
    
    
    (431
    )
    
    
    293INTEREST INCOME
    
    
    562
    
    
    
    339EQUITY IN EARNINGS OF JOINT VENTURE
    
    
    57
    
    
    
    40NET INCOME
    
    $
    188
    
    
    $
    672EARNINGS PER SHARE:Basic
    
    $
    0.01
    
    
    $
    0.04Diluted
    
    $
    0.01
    
    
    $
    0.03WEIGHTED AVERAGE SHARES OUTSTANDING:Basic
    
    
    18,410
    
    
    
    17,959Diluted
    
    
    19,946
    
    
    
    19,531
 
 Three Months Ended March 31,2006
    
    
    2005(1) Includes revenues from a related party as follows:Lighting systems
    
    $
    778
    
    
    $
    1,265OEM and licensing
    
    
    43
    
    
    
    Total related party revenues
    
    $
    821
    
    
    $
    1,265
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Color Kinetics Incorporated
 
 Condensed Consolidated Statements of Cash Flows
 (In thousands)
 Three Months Ended March 31,2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    188
    
    
    $
    672Adjustments to reconcile net income to cash from operating activities:Depreciation and amortization
    
    
    247
    
    
    
    228Stock-based compensation
    
    
    547
    
    
    
    8Loss on disposal of property and equipment
    
    
    
    
    
    
    3Equity in earnings of joint venture
    
    
    (57
    )
    
    
    (40
    )Common stock issued for services
    
    
    23
    
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    (761
    )
    
    
    (621
    )Inventory
    
    
    380
    
    
    
    (2,241
    )Prepaid expenses and other current assets
    
    
    (1,233
    )
    
    
    252Accounts payable
    
    
    688
    
    
    
    258Accrued expenses
    
    
    (787
    )
    
    
    (1,061
    )Deferred revenue
    
    
    24
    
    
    
    62Accrued restructuring
    
    
    (95
    )
    
    
    (101
    )Cash flows from operating activities
    
    
    (836
    )
    
    
    (2,581
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of investments
    
    
    (6,768
    )
    
    
    (3,810
    )Purchases of property and equipment
    
    
    (444
    )
    
    
    (273
    )Purchase of patent
    
    
    (300
    )
    
    
    Proceeds from restricted cash
    
    
    500
    
    
    
    Cash flows from investing activities
    
    
    (7,012
    )
    
    
    (4,083
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from the exercise of stock options
    
    
    179
    
    
    
    434Proceeds from issuance of common stock
    
    
    132
    
    
    
    153Cash flows from financing activities
    
    
    311
    
    
    
    587EFFECT OF EXCHANGE RATE CHANGES ON CASH
    
    
    (2
    )
    
    
    DECREASE IN CASH AND EQUIVALENTS
    
    
    (7,539
    )
    
    
    (6,077
    )CASH AND EQUIVALENTSBeginning of period
    
    
    43,032
    
    
    
    26,198CASH AND EQUIVALENTSEnd of period
    
    $
    35,493
    
    
    $
    20,121
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Color Kinetics Incorporated
 
 Notes to Unaudited Condensed Consolidated Financial Statements
 1. Nature of Business and Basis of Presentation
 Nature of Business 
 Basis of Presentation 
  2. Revenue Recognition
   3. Stock-Based Compensation
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in thousands, except
per share data
 Net income, as reported
    
    $
    672Add: stock-based compensation expense included in reported net income
    
    
    8Less: stock-based compensation expense determined under fair value method
    
    
    (375
    )Pro forma net income
    
    $
    305Basic earnings per shareAs reported
    
    $
    0.04Pro forma
    
    $
    0.02Diluted earnings per shareAs reported
    
    $
    0.03Pro forma
    
    $
    0.02
  Stock Options
 th
 (in thousands, except per
share data)
 WeightedAverageShares
    
    
    Exercise PriceOutstanding at December 31, 2005
    
    
    2,576
    
    
    $
    9.39Granted
    
    
    105
    
    
    
    18.49Exercised
    
    
    (29
    )
    
    
    6.10Forfeited
    
    
    (37
    )
    
    
    9.54Outstanding at March 31, 2006
    
    
    2,615
    
    
    $
    9.78Exercisable at March 31, 2006
    
    
    1,250
    
    
    $
    6.10
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2006
    
    2005Risk-free interest rate
    
    
    4.4
    %
    
    
    3.7
    %Expected volatility
    
    
    60.6
    %
    
    
    64.4
    %Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected life in years
    
    
    4.3
    
    
    
    4.0
    Employee Stock Purchase Plan
   2006
    
    2005Risk-free interest rate
    
    
    4.3
    %
    
    
    2.0
    %Expected volatility
    
    
    61.0
    %
    
    
    69.0
    %Expected dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected life in years
    
    
    0.5
    
    
    
    0.6
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4. Inventory
 in thousands
 March 31,
    
    
    December 31,2006
    
    
    2005Finished goods
    
    $
    6,377
    
    
    $
    6,589Raw material components
    
    
    402
    
    
    
    570Total
    
    $
    6,779
    
    
    $
    7,159
 5. Intangible Assets
  6. Warranty Reserve
 in thousands
 Three Months Ended March 31,2006
    
    
    2005Balance, beginning of period
    
    $
    876
    
    
    $
    860Provisions in cost of revenues
    
    
    169
    
    
    
    54Expenditures
    
    
    (164
    )
    
    
    (183
    )Balance, end of period
    
    $
    881
    
    
    $
    731
 7. Earnings per Share
  in thousands
 Three Months Ended March 31,2006
    
    
    2005Weighted average shares for basic computation
    
    
    18,410
    
    
    
    17,959Potential common shares from:Options
    
    
    1,061
    
    
    
    1,132Warrants
    
    
    475
    
    
    
    440Weighted average shares for diluted computation
    
    
    19,946
    
    
    
    19,531
 8. Segment Information
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in thousands
 2006
    
    
    2005Lighting
    
    
    OEM and
    
    
    
    
    
    
    Lighting
    
    
    OEM andThree Months Ended March 31,
    
    Systems
    
    
    Licensing
    
    
    Total
    
    
    Systems
    
    
    Licensing
    
    
    TotalRevenues
    
    $
    13,098
    
    
    $
    1,560
    
    
    $
    14,658
    
    
    $
    9,639
    
    
    $
    1,877
    
    
    $
    11,516Cost of revenues
    
    
    6,099
    
    
    
    540
    
    
    
    6,639
    
    
    
    4,643
    
    
    
    901
    
    
    
    5,544Gross profit
    
    
    6,999
    
    
    
    1,020
    
    
    
    8,019
    
    
    
    4,996
    
    
    
    976
    
    
    
    5,972Other direct costs
    
    
    4,029
    
    
    
    388
    
    
    
    4,417
    
    
    
    2,423
    
    
    
    246
    
    
    
    2,669Direct contribution margin
    
    $
    2,970
    
    
    $
    632
    
    
    
    3,602
    
    
    $
    2,573
    
    
    $
    730
    
    
    
    3,303Reconciling items to income (loss) from
operations:Unallocated selling and marketing
    
    
    
    
    
    
    
    
    
    
    648
    
    
    
    
    
    
    
    
    
    
    
    369Unallocated research and development
    
    
    
    
    
    
    
    
    
    
    294
    
    
    
    
    
    
    
    
    
    
    
    414Unallocated general and administrative
    
    
    
    
    
    
    
    
    
    
    3,091
    
    
    
    
    
    
    
    
    
    
    
    2,227Income (loss) from operations
    
    
    
    
    
    
    
    
    
    $
    (431
    )
    
    
    
    
    
    
    
    
    
    $
    293
 9. Comprehensive Income
 in thousands
 Three Months Ended March 31,2006
    
    
    2005Net income
    
    $
    188
    
    
    $
    672Foreign currency translation adjustments
    
    
    (2
    )
    
    
    23Unrealized holding losses on investments
    
    
    (6
    )
    
    
    (62
    )Total comprehensive income
    
    $
    180
    
    
    $
    633
 10. Contingencies
 Super Vision International, Inc.
  10




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Super Vision International, Inc. (High End)
     TIR Systems, Ltd.
   
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Cautionary Statements
  11




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Overview
  
    
    Lighting systems:we offer intelligent LED lighting systems sold under the Color
Kinetics brand for installation in lighting projects where their use has been specified,
typically by a designer or architect. We also similarly sell, under the Color Kinetics
brand, simplified LED lighting systems for broader categories of the lighting market.
    
    OEM and licensing:we offer a standard line of LED lighting modules, custom and basic
components and other products that can be incorporated by manufacturers in products sold
under their own brands. We also license access to our intellectual property portfolio.
     Description of Our Revenues, Costs and Expenses
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Adoption of SFAS No. 123R
    13




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Critical Accounting Estimates
   Revenue Recognition.
 
    
    evidence exists of an arrangement with the customer, typically consisting of a purchase
order;
    
    our products have been delivered and risk of loss has passed to the customer, which
typically occurs when a product is shipped under our customary terms, generally FOB
shipping point;
    
    the amount of revenue to which we are entitled is fixed or determinable; and
    
    we believe it is probable that we will be able to collect the amount due us from our customer.
   Allowance for Doubtful Accounts.
 Product Warranty.
 Inventory Reserves.
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Accounting for Income Taxes.
 Stock-Based Compensation
 Results of Operations
  Percentage of Total RevenuesThree Months Ended March 31,2006
    
    
    2005Revenues:Lighting systems
    
    
    89
    %
    
    
    84
    %OEM and licensing
    
    
    11
    
    
    
    16Total revenues
    
    
    100
    
    
    
    100Cost of revenues:Cost of lighting systems, as a percentage of lighting systems revenues
    
    
    46
    
    
    
    48Cost of OEM and licensing, as a percentage of OEM and licensing revenues
    
    
    37
    
    
    
    48Total cost of revenues
    
    
    45
    
    
    
    48Gross profit
    
    
    55
    
    
    
    52Operating expenses:Selling and marketing
    
    
    26
    
    
    
    21Research and development
    
    
    11
    
    
    
    9General and administrative
    
    
    21
    
    
    
    19Total operating expenses
    
    
    58
    
    
    
    49Income (loss) from operations
    
    
    (3
    )
    
    
    3Interest income
    
    
    4
    
    
    
    3Equity in earnings of joint venture
    
    
    
    
    
    
    Net income
    
    
    1
    %
    
    
    6
    %
 Revenues.
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Gross Profit.
   Selling and Marketing Expenses.
 Research and Development Expenses.
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General and Administrative Expenses.
 Interest Income.
 Equity in Earnings of Joint Venture.
 Provision for Income Taxes.
 Liquidity and Capital Resources
      17




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
     
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 Super Vision International, Inc.
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Super Vision International, Inc. (High End)
     TIR Systems, Ltd.
   
 Item 1A. Risk Factors
  
    
    Because we have a limited history of profitable operations, it is difficult to evaluate
the likelihood that we will maintain profitability in the future.
    
    If LED lighting in general, and our intelligent LED lighting systems in particular, do
not achieve greater market acceptance, prospects for our growth and profitability may be
limited.
    
    If advances in LED technology do not continue, we may be unable to increase our
penetration of our existing markets or expand into new markets.
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
    
    If we are unable to respond effectively as new lighting technologies and market trends
emerge, our competitive position and our ability to generate revenues and profits may be
harmed.
    
    If demand for our white light products in the general lighting market fails to emerge,
we may not be able to carry out long-term business strategies.
    
    Our products could contain defects, which could reduce sales of those products or result
in claims against us.
    
    If the companies to which we outsource the manufacture of our products fail to meet our
requirements for quality, quantity and timeliness, our revenues and reputation in the
marketplace could be harmed.
    
    We face substantial competition, jeopardizing our prospects for future success.
    
    We rely on Color Kinetics Japan, a joint venture in which we hold a 50% equity interest,
to distribute our products in Japan, and inadequate performance of this distributor could
substantially reduce our revenues and adversely affect our results of operations.
    
    We may incur substantial costs or lose important rights as a result of litigation or
other proceedings relating to patent and other intellectual property rights.
    
    If we are unable to obtain and maintain patent protection for our technology and
otherwise protect our intellectual property, the value of our technology and products will
be adversely affected.
    
    If critical components that we currently purchase from a small number of suppliers
become unavailable, we may incur delays in shipment, which could damage our business.
    
    If we are unable to increase production capacity for our products in a timely manner, we
may incur delays in shipment and our revenues and reputation in the marketplace could be
harmed.
    
    Our gross margins are subject to variability.
    
    Our OEM business consumes significant time and resources with no guarantee of revenues;
OEM and licensing revenues are generally not subject to our control.
    
    The loss of the services of any members of our key management team could adversely
affect our ability to execute our business strategy and, as a result, adversely affect our
sales and profitability.
    
    If we are unable to manage our growth effectively, our future growth, profitability and
liquidity could be adversely affected.
    
    If we are unable to obtain additional capital as needed in the future, our growth could
be limited and we may be unable to pursue our current business strategy.
    
    We have limited experience conducting operations internationally, which may make
overseas expansion more difficult and costly than we expect and adversely affect our
revenue growth and profitability.
    
    We must comply with new regulatory requirements regarding internal control over
financial reporting and corporate governance, which will cause us to incur significant
costs, and our failure to comply with these requirements could cause our stock price to
decline.
    
    Our operations are concentrated in a small number of facilities, and unavailability of
one or more of these facilities could interrupt our business.
    
    The market price of our common stock may be volatile, which could result in substantial
losses for investors holding our shares.
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
    
    Because our sales cycles are long and we lack long-term purchase commitments by our
customers, forecasting our sales accurately is difficult and our failure to meet
expectations for our quarterly revenue could cause our stock price to fall.
    
    We could be the subject of securities class action litigation due to future stock price
volatility.
    
    Anti-takeover provisions in our charter documents and Delaware law could prevent or
delay a change in control of our company.
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Items 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 Exhibit No.
    
    Description3.2
    
    Seventh Amended and Restated Certificate of Incorporation of Color Kinetics
Incorporated (1)3.4
    
    Second Amended and Restated By-Laws of Color Kinetics Incorporated (1)*10.26
    
    Senior Management Bonus Plan (2)*10.27
    
    Letter agreement by and between Color Kinetics Incorporated and George Mueller, dated
April 11, 2006 (3)31.1
    
    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002  William J. Sims.31.2
    
    Certification Pursuant to Section 302 of Sarbanes-Oxley Act of 2002  David K. Johnson31.3
    
    Certification Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
 
 *
    
    Management contract or compensatory plan or arrangement(1)
    
    Incorporated by reference to the similarly numbered exhibit to our Registration Statement on
Form S-1, File No. 333-114386.(2)
    
    Incorporated by reference to Exhibit 10.26 to our Annual Report on Form 10-K filed March 15,
2006(3)
    
    Incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K filed April 14,
2006 21




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SIGNATURES
  Date: May 10, 2006
    COLOR KINETICS INCORPORATED(Registrant)By:
    /s/    William J. SimsWilliam J. SimsChief Executive OfficerBy:
    /s/    David K. JohnsonDavid K. JohnsonChief Financial Officer 22