| COLOR KINETICS INC 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 |
| Prior to 2004 we had never achieved profitability on an annual basis, and our limited operating history makes an evaluation of our future prospects difficult |
| Since inception, we have incurred significant net losses |
| As of December 31, 2005, we had an accumulated deficit of dlra29dtta6 million |
| We expect our research and development, sales and marketing, litigation, and general and administrative expenses to increase |
| Unless our revenues increase commensurately, we will not be able to continue to operate profitably |
| If we do not achieve sufficient growth in our revenues or sustain profitability in the future, our stock price may be adversely affected and we may be unable to continue our operations |
| 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 |
| Our future success depends on increased market acceptance of LED lighting generally, and of our intelligent LED lighting systems in particular |
| Potential customers for LED lighting systems may be reluctant to adopt LED lighting as an alternative to traditional lighting technology because of its higher initial cost and relatively low light output in comparison with the most powerful traditional lighting devices, or because of perceived risks relating to its novelty, complexity, reliability and quality, usefulness and cost-effectiveness when compared to other lighting sources available in the market |
| These factors, along with others discussed below, could also adversely affect demand for the new intelligent and simplified white light products that we began to introduce in the second half of 2004 |
| If acceptance of LED lighting in general, and of our intelligent LED lighting systems in particular, do not continue to grow, then opportunities to increase our revenues and operate profitably 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 |
| We do not design or manufacture LEDs |
| Our ability to continue penetrating our existing markets and to expand into new markets depends on continued advancements in the design and manufacture by others of LEDs |
| In the high performance color lighting markets that we currently serve, we rely on continued improvements in the brightness, efficiency and initial cost of color LEDs, particularly high brightness red, green and blue LEDs |
| In the white light market that we have recently entered with the introduction of our first white light products in 2004, we depend on improvements in the above factors and also in the color characteristics and source life of high brightness white LEDs |
| The continued development of LED technologies depends on other companies’ research and is out of our control |
| If advancements in LED technologies occur at a slower pace than we anticipate, or fail to occur at all, 12 _________________________________________________________________ [66]Table of Contents we may be unable to penetrate additional markets, our revenues will be significantly reduced, and our future prospects for success may be harmed |
| 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 |
| We believe the emergence of LED lighting is transforming the lighting industry |
| To be successful, we will need to keep pace with rapid changes in lighting technology, changing customer requirements, new product introductions by competitors and evolving industry standards, any of which could render our existing products obsolete if we fail to respond in a timely manner |
| Development of new products incorporating advanced technology is a complex process subject to numerous uncertainties |
| We have in the past experienced, and could in the future experience, delays in introduction of new products |
| If new LED lighting devices are introduced that can be controlled by methods not covered by our proprietary technology, or if effective new sources of light other than LED devices are discovered, our current products and technology could become less competitive or obsolete |
| If others develop innovative proprietary lighting technology that is superior to ours, or if we fail to accurately anticipate technology and market trends and respond on a timely basis with our own innovations, our competitive position may be harmed and we may not achieve sufficient growth in our revenues to attain, or sustain, profitability |
| 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 long-term business strategy includes penetration of the general lighting market with our intelligent white light LED lighting products and our simplified white light LED lighting products, presently in the market and currently in development |
| Substantial demand may not develop for the use of LED lighting in the general lighting market |
| Obstacles to adoption of LED lighting in the general lighting market include the high initial cost of high brightness white LEDs and the need for further advances in brightness, color characteristics and the predicted life of the LEDs before they require replacement, which we refer to as source life |
| Failure of LED manufacturers to introduce on a timely basis high brightness white light LEDs having satisfactory performance, quality and cost characteristics could delay the further development and enhancement of our white light products, or reduce the attractiveness to potential customers of our white light products incorporating white light LEDs |
| In addition, the characteristics of our intelligent LED lighting systems that we believe are desired by customers in the high performance color lighting markets may not provide us with competitive advantages in the general lighting market |
| For example, end-users in the general lighting market may not require the complex, dynamic lighting effects or sophisticated digital control that our systems provide |
| Similarly, if LED manufacturers are able to develop single LEDs that produce white light of acceptable consistency and color, our digital color control technologies may be of less importance in the general lighting market than in the high performance color lighting market |
| We have devoted, and intend to continue to devote, substantial resources to the development of white light products and technologies suitable for use in the general lighting market |
| If demand for these products and technologies in the general lighting market does not develop and we do not receive revenue to offset these expenditures, our profitability would be harmed and our ability to carry out our long-term business strategy would be adversely affected |
| We do not expect revenues from our white light products to contribute significantly to our total 2006 revenues |
| Our products could contain defects, which could reduce sales of those products or result in claims against us |
| Despite testing by our customers, and us, errors have been found and may be found in the future in our existing or future products |
| This could result in, among other things, a delay in the recognition or loss of revenues, loss of market share or failure to achieve market acceptance |
| These defects may cause us to incur significant warranty, support and repair costs, divert the attention of our engineering personnel from our product development efforts and harm our relationship with our customers |
| The occurrence of these problems could result in the delay or loss of market acceptance of our LED lighting products and would likely harm our business |
| Some of our products use line 13 _________________________________________________________________ [67]Table of Contents voltages of 100 or 240 volts, or are designed for installation in environments such as swimming pools and spas, which involve enhanced risk of electrical shock, injury or death in the event of a short circuit or other malfunction |
| Defects, integration issues or other performance problems in our LED lighting products could result in personal injury or financial or other damages to our customers or could damage market acceptance of our products |
| Our customers could also seek damages from us for their losses |
| A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend |
| 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 outsource the manufacture of our LED lighting systems, and do not own or operate a manufacturing facility |
| We currently depend on a small number of contract manufacturers to manufacture our products at plants in various locations in China |
| These manufacturers supply all necessary raw materials (other than certain critical components such as LEDs and ASICs, which we procure directly), and provide all necessary facilities and labor to manufacture our products |
| If these companies were to terminate their arrangements with us without adequate notice, or fail to provide the required capacity and quality on a timely basis, we would be unable to manufacture and ship our LED lighting products until replacement manufacturing services could be obtained |
| To mitigate these risks, we are currently seeking to qualify multiple contract manufacturers for most of our products |
| However, to qualify a new contract manufacturer, familiarize it with our products, quality standards and other requirements, and commence volume production is a costly and time-consuming process, which can take as long as six to nine months |
| We cannot assure you that, if it became necessary to do so, we would be able to establish alternative manufacturing relationships on acceptable terms |
| Our reliance on contract manufacturers involves certain additional risks, including the following: • lack of direct control over production capacity and delivery schedules; • lack of direct control over quality assurance, manufacturing yields and production costs; • risk of loss of inventory while in transit by ship from China; and • risks associated with international commerce with China, including unexpected changes in legal and regulatory requirements, changes in tariffs and trade policies, risks associated with outbreaks of disease, such as SARS and Avian Flu, risks associated with the protection of intellectual property and political and economic instability |
| Any interruption in our ability to manufacture and distribute products could result in delays in shipment, lost sales, limited revenue growth and damage to our reputation in the market, all of which would adversely affect our business |
| We face substantial competition, jeopardizing our prospects for future success |
| In the high performance lighting markets in which we have primarily sold our intelligent LED lighting systems, and in the OEM and licensing markets in which we participate, our systems compete with lighting products utilizing traditional lighting technology provided by many vendors |
| In addition, we face competition from a smaller number of manufacturers, including manufacturers of traditional lighting equipment, that have developed one or more LED lighting products |
| Some of our competitors, particularly those that offer traditional lighting products, are larger companies with greater resources to devote to research and development, manufacturing and marketing than we have |
| In the white light market, which we entered in the second half of 2004, we expect to encounter competition from some of the competitors described above |
| Additionally, to the extent that we seek to introduce additional white light products for use in general lighting applications, such as retrofit bulbs and lamps for standard fixtures, we expect to encounter competition from large, established companies in the general lighting industry such as General Electric, Matsushita, Osram Sylvania and Philips Lighting, each of which has, we believe, undertaken initiatives to develop white light LED technology |
| These companies have global marketing capabilities and substantially greater resources to devote to research and development and other aspects of the development, manufacture and marketing 14 _________________________________________________________________ [68]Table of Contents of LED lighting systems than we have |
| In addition, we have observed several newly emerging LED lighting startups focusing on the general illumination market, some of which draw on considerable industry experience |
| In each of our markets, we anticipate the possibility that LED manufacturers, including those that currently supply us with LEDs, may seek to compete with us by introducing more complete systems that do not infringe our patents |
| Our competitors’ lighting technologies and products may be more readily accepted by customers than our products |
| Additionally, to the extent that competition in our markets intensifies, we may be required to reduce our prices in order to remain competitive |
| If we do not compete effectively, or if we reduce our prices without making commensurate reductions in our costs, our revenues and profitability, and our future prospects for success, may be harmed |
| We rely on Color Kinetics Japan, a joint venture in which we hold a 50prca 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 |
| Our future performance depends in part on our ability to compete successfully in Japan |
| Most of our sales to date in Japan have been made through CK Japan, a joint venture in which we hold a 50prca equity interest, which is our exclusive distributor in Japan |
| An unrelated third party holds the other 50prca interest in the joint venture |
| In 2005 and 2004, respectively, we derived approximately 9prca and 11prca of our revenues from sales of our lighting systems and OEM products to CK Japan |
| We expect that sales to CK Japan will continue to represent a significant portion of our revenues in 2006 |
| Because we do not control the joint venture, its success depends on cooperation with our joint venture partner and its own business success, and so we cannot ensure that CK Japan will commit the resources or take other actions necessary to execute our sales and marketing strategy in Japan |
| If CK Japan fails to provide a high quality of service or suffers serious financial difficulty, then our reputation, and that of our products, in Japan and elsewhere in Asia may be harmed |
| Our contractual commitments to CK Japan may prevent us from quickly establishing new distributors for the Japanese market or from winding up CK Japan in the event that we do decide to discontinue our relationship |
| If CK Japan is unsuccessful in selling our products in Japan, we may fail to generate sufficient revenue in the Japanese market and our results of operations and financial condition could be adversely affected |
| CK Japan faces substantial competition in Japan, in particular from Matsushita, a large established company in the general lighting industry with substantially greater resources to devote to research and development and other aspects of the development, manufacture and marketing of LED lighting systems than we do |
| We believe Matsushita in particular has undertaken initiatives to develop white light LED technology |
| In addition, CK Japan’s competitors may not face the same margin pressure as does CK Japan, which must buy its products from us before reselling |
| Moreover, although we have filed a number of patent applications in Japan, to date we have not been successful in obtaining an issued patent in Japan; thus CK Japan’s competitors are not currently subject to infringement risk |
| 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 |
| In recent years, there has been significant litigation involving patents and other intellectual property rights in many technology-related industries, including our own |
| Since many patent applications are retained in secrecy by the US Patent Office until and unless a patent issues or the application is published, it is not possible for us to know whether US patent applications are pending that would be infringed by the use of our technology or a part thereof, thus substantially interfering with the future conduct of our business |
| In addition, there may be issued patents in the US or other countries that are pertinent to our business of which we are not aware |
| We have from time to time been notified of claims that we may be infringing patents or intellectual property rights owned by third parties |
| We could be sued by such parties, or others, for patent infringement in the future |
| Such lawsuits could subject us to liability for 15 _________________________________________________________________ [69]Table of Contents damages and invalidate our proprietary rights |
| In addition, intellectual property lawsuits may be brought by third parties against OEM customers that incorporate our LED lighting technology in their products |
| In addition to being subject to claims by third parties that we infringe their proprietary rights, we have in the past asserted, and may in the future assert, our intellectual property rights by instituting legal proceedings against others |