Patents Flatter Color Kinetics

I've said patents aren't all they're cracked up to be, because today's patented innovation is tomorrow's technological obsolescence. Until new technology is in place, however, the protection a patent offers can be daunting for competitors -- and Color Kinetics (NASDAQ:CLRK), which provides solid-state lighting, has quite a bit of protection.

It has been involved in a legal grudge match with archrival Super Vision (NASDAQ:SUPVA), and so far, it's been winning decisively. Back in August, the courts not only ruled that Color Kinetics did not infringe on patents held by Super Vision, but also held that Super Vision infringed on its patents. That was followed in September with courts' dismissal of another of Super Vision's lawsuits against Color Kinetics, ruling that Super Vision was only a non-exclusive licensee of the so-called "high end" patent, rather than its owner, and had no standing to bring a patent infringement case.

When it reported its third-quarter results the other day, Color Kinetics said these legal victories played a negligible role in the record numbers. Revenues grew 27% to $14.1 million and were up 9% from the second quarter, while earnings jumped 47% to $1.3 million, or $0.06 per share. Yet going forward, the rulings have strengthened the company's position, are driving new licensees to it, and should be a source for future growth.

This actually happens to be a sore point in the lighting community. Many competitors are convinced that Color Kinetics' patents are based on prior art (systems that were already in the public domain before the company filed for the patents). They contend that Color Kinetics was granted the patents only because of a lack of technological knowledge in the U.S. Patent Office. They fear that the company will have a stranglehold on an industry marred by slowing growth and innovation. But then again, they are competitors, and so far the courts have upheld Color Kinetics' position.

Super Vision has not given up. It has said it will go back to court on the high-end patent ruling because the decision hinged upon a technicality, rather than the substantive issues surrounding the patent claim itself. Color Kinetics also says it will continue to strenuously enforce its patents; it's proceeding against Canadian lighting firm TIR Systems. Yet these legal wranglings are becoming expensive for Color Kinetics: Legal expenses were up 73% over last year, to $697,000, and are expected to increase another $500,000 next quarter. At some point they may become a burdensome drain on performance.

Still, Color Kinetics sees fourth-quarter revenues growing 30% to 40% and earnings doubling to around $0.05 to $0.07 per share. Gross margins are also expected to continue their steady march upward to 53% to 54% as other costs are contained.

In spite of competitor complaints, solid-state lighting appears to be a growth industry with lots of potential, and Color Kinetics appears to be leading the way on many fronts.

For a related Foolish article:

• Color Kinetics Lights Up Victory

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Fool contributor Rich Duprey owns shares of Color Kinetics but does not own any of the other stocks mentioned in this article. The Motley Fool has a disclosure policy.