Legal costs of patent lawsuits take their toll on Napster.

Napster Inc. may be on the straight and narrow now, but legal costs are taking a bite out of the online music service's bottom line.

Since its debut last year as a legal source of downloadable music, the Los Angeles-based company has been the target of several patent infringement suits, including one from Pittsburgh-based SightSound Technologies Inc.

"Napster is trying to build a business under really trying circumstances," said Ted Schadler, an analyst at Forrester Research. "Certainly, the world of litigation and technology rights is a pretty hot world right now."

SightSound claims that it holds general patents covering companies that sell downloadable music and videos online. The founder invented a business method of electronically selling digital audio and video recordings that he patented in 1993, and since then the company has been able to enforce its patents in various lawsuits.

In February, SightSound won a patent suit, similar to the Napster litigation, against CDnow, owned by Bertelsmann AG, after the defending firm agreed to pay $3.3 million to settle the case.

SightSound Chief Executive Scott Sander declined to comment about the Napster case. But in previous interviews, Sander said the suit against Napster was filed after talks broke down over licensing fees related to downloadable videos.

Several analysts generally disregard the suit's premise.

"It doesn't make sense that these patents hold up or that they have a claim," said Joe Sullivan, an analyst at Craig-Hallum Capital Group LLC in Minneapolis. He said SightSound's claims are similar to saying they have "a patent on the highway system. They're just claiming they've got a patent on how you deliver things over the Internet."

Earlier this year, a federal judge declined SightSound's request for a preliminary injunction that would have halted Napster's sales of online music. The judge also issued a stay on the litigation until the U.S. Patent and Trademark Office re-examines the patents at issue.

Meanwhile, Napster faces rising expenses, which include legal costs associated with the SightSound case. In a May 11 conference call, Chief Financial Officer Nand Gangwani said fourth-quarter general and administrative expenses increased $2 million over a guidance estimate of $5.7 million. For the full year, general and administrative costs totaled $23.3 million, an increase of 10 percent from the previous year.

Napster has assembled a formidable legal team to handle the SightSound case, including four litigation lawyers at Quinn Emanuel Urquhart Oliver & Hedges LLP, two lawyers at Pepper Hamilton LLP in Pittsburgh, a patent lawyer in Sunnyvale and two patent lawyers at New York-based Darby & Darhy PC.

In an e-mail statement to the Business Journal, Bill Growney, general counsel of Napster, said the "patent litigation, both offensive and defensive, is generally an expensive undertaking, but Napster's costs have been consistent with what would be expected in this type of case."

The legal costs also come at a time when Napster, which reported a fourth-quarter net loss of $24.3 million, is struggling to establish itself as a viable alternative to Apple Computer Inc.'s successful iTunes service.

Other competitors have ramped up their offerings, with Yahoo Inc. recently launching its Yahoo Music Limited, a subscription-based music offering, at nearly half the price of Napster's $14.95 per month.

"It will be a brutal market to compete in, from here on out," Schadler said. "Yahoo looks to be in good shape, MSN is in good shape, AOL is in pretty good shape. Napster will struggle."

Besides legal costs, Napster has expended considerable resources on marketing its "Napster to Go" subscriptions, which allow users to download music to their compatible MP3 players. That service helped Napster end its fiscal year with 412,000 subscribers while boosting fourth-quarter revenue to $17.4 million, up 44 percent from the previous quarter.

Sales and marketing costs totaled $16.3 million, up from $9.2 million in the previous quarter, because of expected increases associated with the "Napster to Go" offering.

Napster also has been signing deals to increase subscribers, such the University of Washington's agreement this month to offer Napster's legal online music service to its students, and a separate deal with Ericsson Inc. to offer online music service on its cell phones.

But those moves haven't improved its stock price, which dropped from December's high of $10 per share to a July 5 closing price of $4.23.

The original version of Napster, which was based on illegal file-trading of music, was eventually shut down after intense pressure from the entertainment industry. After several changes and owners, the company re-emerged as a subscription-based service.