Cosine Communications (COSN) 10-K 2007 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                           to                           ..

Commission File Number 000-30715

CoSine Communications, Inc.

(Exact name of registrant as specified in its charter)

Delaware	94-3280301
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

61 East Main Street, Suite B Los Gatos, California	95030
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number including area code:

(408) 399-6494

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $.0001 Par Value

(Title of each class)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No x

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

Indicate by check mark whether the Company is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company. See definition of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Small reporting company x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes x  No o 

The aggregate market value of the voting and non voting common equity held by non-affiliates of the Registrant was $15,412,353 based on the number of shares held by non-affiliates as of March 1, 2008, and based on the reported last sale price of common stock on June 30, 2007, which is the last business day of the Registrant’s most recently completed second fiscal quarter. Shares of stock held by officers, directors and 5 percent or more stockholders have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 1, 2008, there were 10,090,635 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for our 2008 Annual Meeting of Shareholders are incorporated into Part III of this Form 10-K.

COSINE COMMUNICATIONS, INC.

FORM 10-K

Year Ended December 31, 2007

TABLE OF CONTENTS

		Page
	Part I
Item 1.	Business	3
Item 1A	Risk Factors	6
Item 1B	Unresolved Staff Comments	10
Item 2.	Properties	10
Item 3.	Legal Proceedings	10
Item 4.	Submission of Matters to a Vote of Security Holders	11
	Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	11
Item 6.	Selected Financial Data	13
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 8.	Financial Statements and Supplementary Data	23
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	43
Item 9A.	Controls and Procedures	44
Item 9B.	Other Information	44
	Part III
Item 10.	Directors, Executive Officers and Corporate Governance	44
Item 11.	Executive Compensation	45
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	45
Item 13.	Certain Relationships and Related Transactions and Director Independence	45
Item 14.	Principal Accountant Fees and Services	45
	Part IV
Item 15.	Exhibits	45
	Financial Statement Schedules	45
	Signatures	47
	Exhibit Index	48

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SAFE HARBOR STATEMENT UNDER

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Annual Report on Form 10-K contains forward-looking statements. We use words such as "anticipate," "believe," "plan," "expect," "future," "intend" and similar expressions to identify forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, failure to achieve revenue growth and profitability, our ability to identify and acquire new business operations, the time and costs required to identify and acquire new business operations, management and board interest in and distraction due to identifying and acquiring new business operations, and the reactions, either positive or negative, of investors and others to our strategic direction and to any specific business opportunity selected by us, all as are discussed in more detail in the section entitled "Risk Factors" on pages 7 to 11 of this report, as well as the other risk factors discussed in that section. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in other documents that we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q that we file in fiscal year 2008.

PART I

Item 1. Business

Overview

CoSine Communications, Inc. ("CoSine" or the "Company," which may be referred to as "we," "us" or "our") was incorporated in California on April 14, 1997 and in August 2000 was reincorporated in the State of Delaware. We were a provider of carrier network equipment products and services until the fourth quarter of fiscal year 2004 during which time we discontinued our product lines, took actions to lay off most of our employees, terminated contract manufacturing arrangements, contractor and consulting arrangements and various facility leases, and sold, scrapped or wrote-off our inventory, property, and equipment. From the fourth quarter of fiscal year 2004 through December 31, 2006, our business consisted primarily of a customer support capability for our discontinued products provided by a third party. In March 2006, we sold the rights to our patent portfolio, and in November 2006, we sold the remaining intellectual property rights to our carrier network equipment products and services. We terminated all customer service operations effective December 31, 2006 and do not intend to offer customer support services for our discontinued products in the future. We are currently attempting to redeploy our existing assets by identifying and acquiring one or more new business operations with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards (“NOLs”). No candidate for acquisition has yet been identified, and no assurance can be given that we will find suitable candidates, and if we do, that we will be able to utilize our existing NOLs.

Current Business

In July 2005 after discontinuing our product lines, we completed a comprehensive review of strategic alternatives, including a sale of the Company, a sale or licensing of intellectual property, a redeployment of our assets into new business ventures, or a winding-up and liquidation of the business and a return of capital. Our board of directors approved a plan to enhance stockholder value by redeploying our existing assets and resources to identify and acquire one or more new business operations, while continuing to support our existing customers. With the termination of our customer service operations effective December 31, 2006, our current business involves the redeployment of our existing assets to acquire one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our NOLs. No candidate for acquisition has yet been identified, and no assurance can be given that we will find suitable candidates, and if we do, that we will be able to utilize our existing NOLs.

To protect our NOLs, on September 1, 2005, we entered into a stockholders rights plan which provided for a dividend distribution of one preferred share purchase right for each outstanding share of our common stock which, when exercisable, would allow its holder to purchase from us one one-hundredth of a share of our Series A Junior Participating Preferred Stock, par value $0.0001, for a purchase price of $3.00. Each fractional share of this preferred stock would give the stockholder approximately the same dividend, voting and liquidation rights as does one share of our common stock. The purchase rights become exercisable after the acquisition or attempted acquisition of 5% or more of our outstanding common stock without the prior approval of our board of directors. The dividend was paid to our stockholders of record at the close of business on September 12, 2005. Our board of directors adopted the stockholders rights plan to protect stockholder value by protecting our stockholders from coercive takeover practices or takeover bids that are inconsistent with their best interests, and by protecting our ability to carry forward our NOLs.

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On August 31, 2007, we amended the stockholders rights plan. The amendment extends the expiration date of the purchase rights from September 1, 2007 until September 1, 2009, unless earlier redeemed, exchanged, or amended by the board of directors. The amendment was not made in response to any pending takeover bid for us. 

To further protect our NOLs, at our 2005 Annual Meeting of Stockholders, the stockholders approved an amendment to our Certificate of Incorporation. The amendment restricts certain acquisitions of our securities which could impair or limit our ability to utilize our NOLs. Although the transfer restrictions imposed on our securities are intended to reduce the likelihood of an impermissible ownership change, no assurance can be given that such restrictions would prevent all transfers that would result in an impermissible ownership change. This amendment generally restricts and requires prior approval of our board of directors of direct and indirect acquisitions of our equity securities if such an acquisition will affect the percentage of our capital stock that is treated as owned by a 5% stockholder. The restrictions will generally only affect persons trying to acquire a significant interest in our common stock in order to help assure the preservation of our NOLs.

In efforts to reduce our operating expenses while executing our redeployment strategy, on June 15, 2007, our board of directors approved an agreement (the “Services Agreement”) with SP Corporate Services, LLC (“SP”) pursuant to which SP provides us, on a non-exclusive basis, a full range of executive, financial and administrative support services and personnel, including the services of a Chief Executive Officer, Chief Financial Officer, Secretary, Principal Executive Officer, and Principal Accounting Officer, maintenance of our corporate office and records, periodic reviews of transactions in our stock to assist in preservation of our NOLs, and related executive, financial, accounting, and administrative support services. The Service Agreement became effective as of July 1, 2007. Under the Services Agreement, we pay SP a monthly fee of $17,000 in exchange for SP's services. SP is responsible for compensating and providing all applicable employment benefits to any SP personnel in connection with providing services under the Services Agreement. We reimburse SP for reasonable and necessary business expenses of ours incurred by SP, and we are responsible for payment of fees related to audit, tax, legal, stock transfer, insurance broker, investment advisor, and banking services provided to us by third party advisors. The Services Agreement has a term of one year and automatically renews for successive one year periods unless otherwise terminated by either party. The Services Agreement is also terminable by us upon the death of Terry R. Gibson or his resignation as our Chief Executive Officer, Chief Financial Officer or Secretary of the Company. Under the Services Agreement, SP and its personnel are entitled to the same limitations on liability and indemnity rights available under our charter documents to any other person performing such services for us. During fiscal year 2007, prior to the effectiveness of the Services Agreement, we incurred approximately $24,500 per month in performing the services which are to be performed by SP under the Services Agreement.

SP is affiliated with Steel Partners II, L.P., our largest stockholder, by virtue of SP’s President, Warren Lichtenstein, serving as the sole executive officer and managing member of Steel Partners, L.L.C., the general partner of Steel Partners II, L.P. SP is a wholly owned subsidiary of Steel Partners Ltd., also controlled by Mr. Lichtenstein.

Pursuant to the Services Agreement, Terry R. Gibson terminated his employment with us, effective as of June 30, 2007, but continues to serve as our Chief Executive Officer, Chief Financial Officer, Secretary, Principal Executive Officer, and Principal Accounting Officer as an employee of SP. SP is responsible for compensating Mr. Gibson, including providing him with all applicable employment benefits to which he may be entitled, for his serving as our Chief Executive Officer, Chief Financial Officer, Secretary, Principal Executive Officer, and Principal Accounting Officer and for any other services he may provide to us under the Services Agreement.

Prior Business

Until September 2004, we developed, marketed and sold a communications platform referred to as our IP Service Delivery Platform. Our product was designed to enable carrier network service providers to rapidly deliver a portfolio of communication services to business and consumer customers. We marketed our IP Service Delivery Platform through our direct sales force and through resellers to network service providers in Asia, Europe and North America.

We did not generate sufficient revenue to fund our communications platform product operations and were unable to increase our revenue in order to reduce our cash consumption and remain a viable and competitive supplier of communications platform products. We formally discontinued our communications platform products in fiscal year 2004 and ceased all our related customer support services as of December 31, 2006.

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Products, Services and Technology

Prior to discontinuing the sale of our products in September 2004, we were a supplier of carrier network equipment which we referred to as our IP Service Delivery Platform. Our IP Service Delivery Platform consisted of hardware elements: a chassis, including our IPSX 9500 and IPSX 3500 Service Processing Switches, and sub-systems known as our IPSGs; and software components consisting of our InVision and InGage software. We formally discontinued our IP Service Delivery Platform in fiscal year 2004, sold the rights to our patent portfolio in March 2006, sold the remaining rights to our carrier network intellectual property in November 2006 and ceased all our related customer support services as of December 31, 2006.

Customers

Effective December 31, 2006, we ceased all customer service operations. During the year ended December 31, 2006, we recognized revenue from seven customers. Sprint, AT&T and Rogers Telecom accounted for 58%, 19% and 11% of our revenue, respectively. Geographically, our revenue was distributed as follows: North America 89% and Europe 11% (See Note 1 of the Notes to Consolidated Financial Statements). A small number of customers accounted for a substantial portion of our revenues, and the loss of any one customer would have a material impact on our results of operations. At December 31, 2007, we had no customers.

Sales and Marketing

We ceased all sales and marketing activities in September 2004. We had no sales and marketing employees at December 31, 2007.

Customer Service and Support

Beginning in the fourth quarter of fiscal 2004, we provided transition support services to our existing customers through a third party contractor. We ceased providing customer support services effective December 31, 2006. We had no employees in customer service and support at December 31, 2007.

Research and Development

We ceased all research and development activities in September 2004, other than to offer our existing customers transition support services, as provided by a third party contractor through December 31, 2006. At December 31, 2007, we had no employees in research and development.

Our research and development expenses, including non-cash charges related to equity issuances, totaled nil, nil and $0.1 million for the years ended December 31, 2007, 2006 and 2005, respectively.

Manufacturing

We ceased all manufacturing activities in December 2004 and had no employees in manufacturing at December 31, 2007.

Backlog

Historically, our backlog included purchase orders from customers with approved credit status, representing products and services we planned to deliver within 12 months, plus our then current balance of deferred revenue. At December 31, 2007, 2006 and 2005, we had no backlog.

Competition

We provided transition support services for our discontinued products to our existing customers beginning in the fourth quarter of fiscal 2004 through December 31, 2006 at which time we terminated all such services. Due to the fact that our transition support services were limited to our own discontinued products and the limited period of availability for those transition support services, we did not foresee any material competition for our transition support services.

5

With the termination of our customer service operations effective December 31, 2006, our current business involves the redeployment of our existing assets to acquire one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our NOLs. No candidate for acquisition has yet been identified, and no assurance can be given that we will find suitable candidates, and if we do, that we will be able to utilize our existing NOLs. We are encountering competition from other entities seeking to acquire profitable businesses. Such entities include private equity companies, blank check companies, leveraged buyout funds, as well as operating businesses seeking acquisitions. Many of these entities are well established and have extensive experience identifying and effecting business combinations directly or through affiliates. Moreover, many of these entities possess greater financial, technical, human, and other resources than us.

Intellectual Property

We have relied on copyright, patent, trade secret, and trademark law to protect our intellectual property. In March 2006, we sold the rights to our patent portfolio for cash consideration of $180,000, retaining a royalty-free license allowing us to continue to use our former patent portfolio in support of our existing customers. In November 2006, we sold the remaining intellectual property rights related to our carrier networking products and services for consideration of $80,000, retaining rights to support our existing customers through December 31, 2006.

Employees

We have no employees at December 31, 2007.

Executive Officers of the Registrant

Terry R. Gibson, 54, has served as our Chief Executive Officer since January 16, 2005, as our Secretary since September 23,2004, and as our Executive Vice President and Chief Financial Officer since joining us in 2002. Mr. Gibson is a Managing Director of SP Corporate Services, LLC (“SP”) an affiliate of Steel Partners II, L.P., our largest shareholder. Pursuant to a service agreement between the Company and SP, effective July 1, 2007, Mr. Gibson terminated his employment with us and joined SP as a Managing Director, however, he continues to serve as our Chief Executive Officer, Chief Financial Officer, Secretary, Principal Executive Officer, and Principal Accounting Officer as an employee of SP. Prior to joining us, Mr. Gibson served as Chief Financial Officer of Calient Networks, Inc. from May 2000 to December 2001. He served as Chief Financial Officer of Ramp Networks, Inc. from March 1999 to May 2000 and as Chief Financial Officer of GaSonics, International, from June 1996 through March 1999. He has also served as Vice President and Corporate Controller of Lam Research Corporation from February 1991 through June 1996. Mr. Gibson holds a B.S. in Accounting from the University of Santa Clara.

Available Information

We file annual reports, quarterly reports, proxy statements and other documents with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934 (the "Exchange Act"). The public may read and copy any materials that we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street N.W., Washington, D.C. 20549. The public may obtain information on the operation of the public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at http://www.sec.gov.

Item 1A. Risk Factors

Our future results and the market price for our stock are subject to numerous risks, many of which are driven by factors that we cannot control or predict. The following discussion, as well as other sections of this Annual Report on Form 10-K including Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations, describes certain risk factors related to our business. You should carefully consider the risk factors described below in conjunction with the other information in this document.

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We have sold our operating assets, our patent portfolio, and our intellectual property and are executing a redeployment strategy. There can be no assurance that the redeployment strategy will increase shareholder value, and we may decide to liquidate.

Between September 2004 and December 2004, we announced the termination of most of our employees and that our products had been formally discontinued to facilitate the strategic alternatives then in consideration and ceased all operations other than a customer service and support capability. In July 2005, we completed a comprehensive review of strategic alternatives and approved a plan to redeploy our existing resources to identify and acquire one or more new business operations, while continuing to support our existing customers and continuing to offer our intellectual property for license or sale. In March 2006, we sold the rights to our patent portfolio, and in November 2006, we sold the remaining intellectual property rights related to our carrier network equipment products and services. In December 2006, we discontinued our customer service business. If we are not successful in executing our redeployment strategy we will continue to incur operating losses and negative cash flow and may at some point decide to liquidate and return the net proceeds to our stockholders. In the case of a liquidation or bankruptcy, we would need to hold back or distribute assets to cover liabilities before paying stockholders, which may therefore reduce or delay the proceeds that stockholders may receive for their ownership in us. However, we believe we have adequate cash resources to continue to realize our assets and discharge our liabilities as a company through 2008. 

Failure to execute our redeployment strategy could cause our stock price to decline.

Our stock price may decline due to any or all of the following potential occurrences:

· we may not be able to find suitable acquisition candidates or may not be able to acquire suitable candidates with our limited financial resources;

· we may not be able to utilize our existing NOLs to offset future earnings;

· we may have difficulty retaining our board of directors or attracting suitable qualified candidates should a director resign.

We will incur significant costs in connection with our evaluation of suitable acquisition candidates.

As part of our plan to redeploy our assets, our management is seeking, analyzing and evaluating potential acquisition and merger candidates. We will incur significant costs, such as due diligence and legal and other professional fees and expenses, as part of these redeployment efforts. Notwithstanding these efforts and expenditures, we cannot give any assurance that we will identify an appropriate acquisition opportunity in the near term, or at all.

We will likely have no operating history in our new line of business, which is yet to be determined, and therefore we will be subject to the risks inherent in establishing a new business.

We have not identified what our new line of business will be and, therefore, we cannot fully describe the specific risks presented by such a business. It is likely that we will have had no operating history in the new line of business and it is possible that the target company may have a limited operating history in its business. Accordingly, there can be no assurance that our future operations will generate operating or net income, and as such our success will be subject to the risks, expenses, problems, and delays inherent in establishing a new line of business for us. The ultimate success of such new business cannot be assured.

We may be unable to realize the benefits of our net operating loss carry-forwards ("NOLs").

NOLs may be carried forward to offset federal and state taxable income in future years and eliminate income taxes otherwise payable on such taxable income, subject to certain adjustments. Based on current federal corporate income tax rates, our NOLs and other carry-forwards could provide a benefit to us, if fully utilized, of significant future tax savings. However, our ability to use these tax benefits in future years will depend upon the amount of our otherwise taxable income. If we do not have sufficient taxable income in future years to use the tax benefits before they expire, we will lose the benefit of these NOLs permanently. Consequently, our ability to use the tax benefits associated with our substantial NOLs will depend significantly on our success in identifying suitable acquisition candidates, and once identified, successfully consummating an acquisition of these candidates.

Additionally, if we underwent an ownership change, the NOLs would be subject to an annual limit on the amount of the taxable income that may be offset by our NOLs generated prior to the ownership change. If an ownership change were to occur, we may be unable to use a significant portion of our NOLs to offset taxable income. In general, an ownership change occurs when, as of any testing date, the aggregate of the increase in percentage points is more than 50 percentage points of the total amount of a corporation's stock owned by "5-percent stockholders," within the meaning of the NOLs limitations, whose percentage ownership of the stock has increased as of such date over the lowest percentage of the stock owned by each such "5-percent stockholder" at any time during the three-year period preceding such date. In general, persons who own 5% or more of a corporation's stock are "5-percent stockholders," and all other persons who own less than 5% of a corporation's stock are treated, together, as a single, public group "5-percent stockholder," regardless of whether they own an aggregate of 5% of a corporation's stock.

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The amount of NOLs that we have claimed has not been audited or otherwise validated by the U.S. Internal Revenue Service (“IRS”). The IRS could challenge our calculation of the amount of our NOLs or our determinations as to when a prior change in ownership occurred and other provisions of the Internal Revenue Code may limit our ability to carry forward our NOLs to offset taxable income in future years. If the IRS was successful with respect to any such challenge, the potential tax benefit of the NOLs to us could be substantially reduced.

Certain transfer restrictions implemented by us to preserve our net operating loss carryforwards may not be effective or may have some unintended negative effects.

On November 15, 2005, at our 2005 Annual Meeting of Stockholders, our stockholders approved an amendment to our Amended and Restated Certificate of Incorporation to restrict certain acquisitions of our securities in order to help assure the preservation of our NOLs. The amendment generally restricts direct and indirect acquisitions of our equity securities if such acquisition will affect the percentage of our capital stock that is treated as owned by a "5-percent stockholder."

Although the transfer restrictions imposed on our capital stock are intended to reduce the likelihood of an impermissible ownership change, there is no guarantee that such restrictions would prevent all transfers that would result in an impermissible ownership change. The transfer restrictions also will require any person attempting to acquire a significant interest in us to seek the approval of our board of directors. This may have an "anti-takeover" effect because our board of directors may be able to prevent any future takeover. Similarly, any limits on the amount of capital stock that a stockholder may own could have the effect of making it more difficult for stockholders to replace current management. Additionally, because the transfer restrictions will have the effect of restricting a stockholder's ability to dispose of or acquire our common stock, the liquidity and market value of our common stock might suffer.

We could be required to register as an investment company under the Investment Company Act of 1940, which could significantly limit our ability to operate and acquire an established business.

The Investment Company Act of 1940 (the "Investment Company Act") requires registration, as an investment company, for companies that are engaged primarily in the business of investing, reinvesting, owning, holding, or trading securities. We have sought to qualify for an exclusion from registration including the exclusion available to a company that does not own "investment securities" with a value exceeding 40% of the value of its total assets on an unconsolidated basis, excluding government securities and cash items. This exclusion, however, could be disadvantageous to us and/or our stockholders. If we were unable to rely on an exclusion under the Investment Company Act and were deemed to be an investment company under the Investment Company Act, we would be forced to comply with substantive requirements of the Investment Company Act, including: (i) limitations on our ability to borrow; (ii) limitations on our capital structure; (iii) restrictions on acquisitions of interests in associated companies; (iv) prohibitions on transactions with affiliates; (v) restrictions on specific investments; (vi) limitations on our ability to issue stock options; and (vii) compliance with reporting, record keeping, voting, proxy disclosure, and other rules and regulations. Registration as an investment company would subject us to restrictions that would significantly impair our ability to pursue our fundamental business strategy of acquiring and operating an established business. In the event the SEC or a court took the position that we were an investment company, our failure to register as an investment company would not only raise the possibility of an enforcement action by the SEC or an adverse judgment by a court, but also could threaten the validity of corporate actions and contracts entered into by us during the period we were deemed to be an unregistered investment company. Moreover, the SEC could seek an enforcement action against us to the extent we were not in compliance with the Investment Company Act during any point in time.

We may issue a substantial amount of our common stock in the future which could cause dilution to new investors and otherwise adversely affect our stock price.

A key element of our growth strategy is to make acquisitions. As part of our acquisition strategy, we may issue additional shares of common stock as consideration for such acquisitions. These issuances could be significant. To the extent that we make acquisitions and issue our shares of common stock as consideration, your equity interest in us will be diluted. Any such issuance will also increase the number of outstanding shares of common stock that will be eligible for sale in the future. Persons receiving shares of our common stock in connection with these acquisitions may be more likely to sell off their common stock, which may influence the price of our common stock. In addition, the potential issuance of additional shares in connection with anticipated acquisitions could lessen demand for our common stock and result in a lower price than might otherwise be obtained. We may issue common stock in the future for other purposes as well, including in connection with financings, for compensation purposes, in connection with strategic transactions, or for other purposes.

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Our customers may sue us because we discontinued our products and may not meet all our contractual commitments.

Certain of our customer contracts contained provisions relating to the availability of products, spare parts, and services for periods up to ten years. We have worked with our customers to aid in a smooth transition, but our customers may choose to sue us for breach of contract.

If our products contain defects, we may be subject to significant liability claims from customers, distribution partners, and the end-users of our products and incur significant unexpected expenses and lost sales.

Our products are technically complex and can be adequately tested only when put to full use in large and diverse networks with high amounts of traffic. They have in the past contained, and may in the future contain, undetected or unresolved errors or defects. Despite extensive testing, errors, defects, or failures may be found in our products. If this happens, we may experience product returns, increased service and warranty costs, any of which could have a material adverse effect on our business, financial condition, and results of operations. Moreover, because our products are designed to provide critical communications services, we may receive significant liability claims. We attempted to include in our agreements with customers and distribution partners provisions intended to limit our exposure to liability claims. However, such provisions may not be effective in any or all cases or under any or all scenarios, and they may not preclude all potential claims resulting from a defect in one of our products or from a defect related to the installation or operation of one of its products. Although we maintain product liability and errors and omissions insurance covering certain damages arising from implementation and use of their products, our insurance may not cover all claims sought against us. Liability claims could require us to spend significant time and money in litigation or to pay significant damages. As a result, any such claims, whether or not successful, could seriously damage our business prospects.

If we became involved in an intellectual property dispute, we could be subject to significant liability and the time and attention of our management could be diverted from pursuing strategic alternatives.

We may become a party to litigation in the future because others may allege infringement of their intellectual property. These claims and any resulting lawsuits could subject us to significant liability for damages. These lawsuits, regardless of their merits, likely would be time-consuming and expensive to resolve and would divert management’s time and attention. Any potential intellectual property litigation alleging our infringement of a third-party’s intellectual property also could force us to:

· obtain from the owner of the infringed intellectual property right a license to sell the relevant technology, which license may not be available on reasonable terms, or at all; or

· redesign those products or services that use the infringed technology.

If we cannot obtain director and officer liability insurance in acceptable amounts for acceptable rates, we may have difficulty recruiting and retaining qualified directors and officers.

Like most other public companies, we carry insurance protecting our officers and directors against claims relating to the conduct of our business. This insurance covers, among other things, the costs incurred by companies and their management to defend against and resolve claims relating to management conduct and results of operations, such as securities class action claims. These claims typically are expensive to defend against and resolve. We pay significant premiums to acquire and maintain this insurance, which is provided by third-party insurers, and we agree to underwrite a portion of such exposures under the terms of the insurance coverage. One consequence of the current economic downturn and decline in stock prices has been a substantial increase in the number of securities class actions and similar claims brought against public corporations and their management, including the company and certain of its current and former officers and directors. Consequently, insurers providing director and officer liability insurance have in recent periods sharply increased the premiums they charge for this insurance, raised retentions (that is, the amount of liability that a company is required to pay to defend and resolve a claim before any applicable insurance is provided), and limited the amount of insurance they will provide. Moreover, insurers typically provide only one-year policies. The insurance policies that may cover any current securities claims against us have a $500,000 retention. As a result, the costs we incur in defending such claims will not be reimbursed until they exceed $500,000. The policies that would cover any future claims may not provide any coverage to us and may cover the directors and officers only in the event we are unwilling or unable to cover their costs in defending against and resolving any future claims. As a result, our costs in defending any future claims could increase significantly. Particularly in the current economic environment, we cannot assure you that in the future we will be able to obtain sufficient director and officer liability insurance coverage at acceptable rates and with acceptable deductibles and other limitations. Failure to obtain such insurance could materially harm our financial condition in the event that we are required to defend against and resolve any future or existing securities class actions or other claims made against us or our management arising from the conduct of our operations. Further, the inability to obtain such insurance in adequate amounts may impair our future ability to retain and recruit qualified officers and directors.

9

Our earnings are sensitive to fluctuations in interest rates.

Our business no longer generates any revenues as we ceased all customer operations as of December 31, 2006. Our net income depends on the amount of interest paid on the investment of our cash in cash equivalents and other short term investments. Accordingly, our earnings are subject to risks and uncertainties surrounding changes in the interest rate environment

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

We lease approximately 1,000 square feet of office space in Los Gatos, California under an operating lease.

Item 3. Legal Proceedings

On November 15, 2001, we, along with certain of our officers and directors, were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re CoSine Communications, Inc. Initial Public Offering Securities Litigation, Case No. 01 CV 10105. The complaint generally alleges that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in our initial public offering. The complaint brings claims for the violation of several provisions of the federal securities laws against those underwriters, and also against us and each of the directors and officers who signed the registration statement relating to the initial public offering. The plaintiffs seek unspecified monetary damages and other relief. Similar lawsuits concerning more than 300 other companies' initial public offerings were filed during 2001, and this lawsuit is being coordinated with those actions in the Southern District of New York before Judge Shira A. Scheindlin.

On or about July 1, 2002 an omnibus motion to dismiss was filed in the coordinated litigation on behalf of the issuer defendants, of which we and our named officer and directors are a part, on common pleading issues. In October 2002, pursuant to stipulation by the parties, the Court entered an order dismissing our named officers and directors from the action without prejudice. On February 19, 2003, the Court dismissed the Section 10(b) and Rule 10b-5 claims against us but did not dismiss the Section 11 claims against us.

In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including us, was submitted to the court for approval. The terms of the settlement, if approved, would dismiss and release all claims against the participating defendants (including us). In exchange for this dismissal, D&O insurance carriers would agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1 billion, and the issuer defendants would agree to an assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. On August 31, 2005, the Court issued an order granting preliminary approval of the settlement. On April 24, 2006, the court held a fairness hearing in connection with the motion for final approval of the settlement but has yet to rule on this motion.

On December 5, 2006, the Court of Appeals for the Second Circuit reversed the Court's October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints in the six focus cases, which the defendants in those cases have moved to dismiss.  Plaintiffs have also moved for class certification in the six focus cases, which the defendants in those cases have opposed. It is uncertain whether there will be any revised or future settlement. If a settlement is not consummated, we intend to defend the lawsuit vigorously. However, we cannot predict its outcome with certainty. If we are not successful in our defense of this lawsuit, we could be forced to make significant payments to the plaintiffs and their lawyers, and such payments could have a material adverse effect on our business, financial condition, and results of operations if not covered by our insurance carrier. Even if these claims are not successful, the litigation could result in substantial costs and divert management's attention and resources, which could adversely affect our business, results of operations, and financial position.

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On October 9, 2007, a purported CoSine shareholder filed a complaint for violation of Section 16(b) of the Securities Exchange Act of 1934, which prohibits short-swing trading, against our IPO underwriters. The complaint, Vanessa Simmonds v. The Goldman Sachs Group, et al., Case No. C07-1629, filed in District Court for the Western District of Washington, seeks the recovery of short-swing profits. We are named as a nominal defendant. No monetary recovery is sought from us.

In the ordinary course of business, we are involved in legal proceedings involving contractual obligations, employment relationships, and other matters. Except as described above, we do not believe there are any pending or threatened legal proceedings that will have a material impact on our financial position or results of operations.

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

None.

PART II

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

Market Information

Our common stock currently trades in the over the counter market and is quoted on the Pink Sheets Electronic Quotation Service under the symbol “COSN.PK.” Our common stock had been traded on the NASDAQ National Market under the symbol COSN from our initial public offering in September 2000 through June 15, 2005, when we were de-listed from the NASDAQ National Market System. There was no public market for our common stock prior to our September 2000 initial public offering.

The following table sets forth the high and low sales price of our common stock in the years ended December 2006 and 2007. Our common stock was de-listed from NASDAQ National Market System on June 15, 2005. Our common stock is traded in the over-the-counter market. The following table sets forth the range of high and low bid information of our common stock. The high and low bid quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission, and may not represent actual transactions.

	High		Low
2007
First quarter	$	3.75	$	2.94
Second quarter	$	3.70	$	3.32
Third quarter	$	3.57	$	2.86
Fourth quarter	$	2.96	$	2.46
2006
First quarter	$	2.55	$	2.31
Second quarter	$	2.70	$	2.35
Third quarter	$	2.85	$	2.42
Fourth quarter	$	3.40	$	2.58

Stockholders

According to the records of our transfer agent, at March 1, 2008 we had approximately 282 shareholders of record. The majority of our shares are held in approximately 4,100 customer accounts held by brokers and other institutions on behalf of stockholders.

Dividends

To date, we have not declared or paid any cash dividends on our common stock. Our current policy is to retain future earnings, if any, for use in the operations, and we do not anticipate paying any cash dividends in the foreseeable future.

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Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes equity compensation plans that were approved and not approved by the stockholders as of December 31, 2007:

EQUITY COMPENSATION PLAN INFORMATION

	Number of Securities						Number of Securities
	to be Issued Upon			Weighted-Average			Remaining Available for
	Exercise of Outstanding			Exercise Price of			Future Issuance Under
	Options, Warrants and			Outstanding Options,			Equity Compensation
Plan category	Rights			Warrants and Rights			Plans (1)
Equity compensation plans approved by stockholders		153,000	(2)	$	7.52	(2)		1,934,455	(3)
Equity compensation plans not approved by stockholders (4)		—			—			1,000,000
Total		153,000		$	7.52			2,934,455

(1)  These numbers exclude shares listed under the column heading "Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights."

(2) Includes 5,000 shares subject to outstanding options under the 1997 Stock Plan, 112,000 shares subject to outstanding options under the 2000 Stock Plan, and 36,000 shares subject to outstanding options under the Director Plan.

(3) Includes 1,924,455 shares available for future issuance under the 2000 Stock Plan, and 10,000 shares available for future issuance under the Director Plan. 

(4) The only equity compensation plan not approved by stockholders is the 2002 Stock Plan (the "2002 Plan"). The board of directors adopted the 2002 Plan in January 2002 to make available for issuance certain shares of our common stock that have been (i) previously issued pursuant to the exercise of stock options granted under the 1997 Plan and (ii) subsequently reacquired by us pursuant to repurchase rights contained in restricted stock purchase agreements or pursuant to optionee defaults on promissory notes issued in connection with the exercise of such options ("Reacquired Shares"). Under the terms of the 1997 Plan and the 2000 Plan, these Reacquired Shares would not otherwise have been available for reissuance. No shares that were not previously issued under the 1997 Plan and subsequently reacquired by us have been or will be reserved for issuance under the 2002 Plan. A maximum of 1,000,000 shares may be reserved for issuance under the 2002 Plan. An aggregate of 335,791 shares were initially reserved for issuance under the 2002 Plan upon its adoption. These shares consisted of Reacquired Shares as of the date of adoption. Additional shares that become Reacquired Shares after the date of adoption of the 2002 Plan, up to a maximum of 664,209 additional shares, will also become available for issuance under the 2002 Plan. The provisions of the 2002 Plan are substantially similar to those of the 2000 Plan, except that the 2002 Plan does not permit the grant of awards to officers or directors and does not permit the grant of Incentive Stock Options. The 2002 Plan provides for the grant of nonstatutory stock options to employees (excluding officers) and consultants. Stock options granted under the 2002 Plan will be at prices not less than the fair value of the common stock at the date of grant. The term of each option, generally 10 years or less, will be determined by CoSine.

Use of Proceeds of Registered Securities

On September 25, 2000, in connection with our initial public offering, a Registration Statement on Form S-1 (File No. 333-35938) was declared effective by the Securities and Exchange Commission, pursuant to which 1,150,000 shares of our common stock were offered and sold for our account at a price of $230 per share, generating gross offering proceeds of $264.5 million. The managing underwriters were Goldman, Sachs & Co., Chase Securities Inc., Robertson Stephens, Inc. and JP Morgan Securities Inc. Our initial public offering closed on September 29, 2000. The net proceeds of the initial public offering were approximately $242.5 million after deducting approximately $18.5 million in underwriting discounts and approximately $3.5 million in other offering expenses.

We did not pay directly or indirectly any of the underwriting discounts or other related expenses of the initial public offering to any of our directors or officers, any person owning 10% or more of any class of our equity securities, or any of our affiliates. We have used approximately $220 million of the funds from the initial public offering to fund our operations. We expect to use the remaining net proceeds for general corporate purposes, including funding our operations, our working capital needs, and potential acquisitions pursuant to our redeployment strategy. Pending further use of the net proceeds, we have invested them in short-term, interest-bearing, investment-grade securities.

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Item 6. Selected Financial Data

The selected consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes. The selected consolidated statements of operations data for the years ended December 31, 2007, 2006 and 2005 and the selected consolidated balance sheet data as of December 31, 2007 and 2006, are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected consolidated statements of operations data for the fiscal years ended prior to December 31, 2005, and the selected consolidated balance sheet data prior to December 31, 2006, are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. The historical results presented below are not necessarily indicative of future results.

	Year Ended December 31,
	2007			2006			2005			2004			2003
	(In thousands, except per share data)
Consolidated Statements of Operations Data:
Revenue	$	—		$	1,361		$	3,315		$	9,675		$	14,621
Cost of revenue		—			1,663			2,049			7,086			6,765
Gross profit (loss)		—			(302	)		1,266			2,589			7,856
Operating expenses:
Research and development		—			—			103			15,078			21,756
Sales and marketing		—			—			105			10,052			13,808
General and administrative		781			1,316			3,227			6,064			7,226
Restructuring and impairment charges		—			—			(91	)		8,909			336
Total operating expenses		781			1,316			3,344			40,103			43,126
Loss from operations		(781	)		(1,618	)		(2,078	)		(37,514	)		(35,270	)
Other income (expense):
Interest income		1,180			1,101			678			489			1,296
Interest expense		—			(4	)		—			(3	)		(224	)
Other		—			918			(46	)		(276	)		(447	)
Total other income		1,180			2,015			632			210			625
Income (loss) before income tax provision (credit)		399			397			(1,446	)		(37,304	)		(34,645	)
Income tax provision (credit)		(17	)		(52	)		(228	)		33			287
Net income (loss)	$	416		$	449		$	(1,218	)	$	(37,337	)	$	(34,932	)
Basic net income (loss) per common share	$	0.04		$	0.04		$	(0.12	)	$	(3.70	)	$	(3.57	)
Diluted net income (loss) per common share	$	0.04		$	0.04		$	(0.12	)	$	(3.70	)	$	(3.57	)
Shares used in computing basic net income (loss) per common share		10,091			10,091			10,094			10,082			9,791
Shares used in computing diluted net income (loss) per common share		10,115			10,096			10,094			10,082			9,791
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	23,119		$	22,857		$	23,166		$	24,913		$	57,752
Working capital		22,927			22,477			22,353			23,214			59,705
Total assets		23,231			23,036			23,840			27,823			73,426
Accrued rent		—			—			—			—			2,078
Total stockholders’ equity		22,930			22,477			22,603			23,364			61,174

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Quarterly financial information (unaudited):

	2007								2006
	1st Quarter		2nd Quarter		3rd Quarter		4th Quarter		1st Quarter			2nd Quarter			3rd Quarter			4th Quarter
	(In thousands, except per share data)
Revenue	$	—	$	—	$	—	$	—	$	579		$	520		$	134		$	128
Gross profit (loss)		—		—		—		—		9			(13	)		(232	)		(66	)
Net income (loss)	$	94	$	122	$	127	$	73	$	(126	)	$	205		$	(225	)	$	595
Basic and diluted net income (loss) per share	$	0.01	$	0.01	$	0.01	$	0.01	$	(0.01	)	$	0.02		$	(0.02	)	$	0.05

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Our strategy is to enhance stockholder value by pursuing opportunities to redeploy our assets through an acquisition of one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards (“NOLs”). In 2006, we completed the wrap-up of our carrier services business, providing customer support services for our discontinued products through December 31, 2006, at which time we terminated all customer support offerings. We also sold the remaining assets of our carrier network products business with the sale of our patent portfolio in March 2006 and the sale of the rights to the related intellectual property in November 2006.

We were a provider of carrier network equipment products and services until the fourth quarter of fiscal year 2004 during which time we discontinued our product lines, took actions to lay off most of our employees, terminated contract manufacturing arrangements, contractor and consulting arrangements and various facility leases, and sold, scrapped or wrote-off our inventory, property and equipment. In July 2005, we completed a comprehensive review of strategic alternatives, including a sale of the Company, a sale or licensing of intellectual property, a redeployment of our assets into new business ventures, or a winding-up and liquidation of the business and a return of capital. At that time, the board of directors approved the strategy of redeploying our existing resources to identify and acquire one or more new business operations, while continuing to support our existing customers and continuing to offer our intellectual property for license or sale.

Due to the adoption of our redeployment strategy, the information appearing below, which relates to prior periods, may not be indicative of the results that may be expected for any subsequent periods. The year ended December 31, 2007 primarily reflects, and future periods prior to a redeployment of our assets are expected to primarily reflect, general and administrative expenses and transaction expenses associated with the continuing administration of the Company and its efforts to redeploy its assets.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

General

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation, long-lived assets, warranties and equity issuances. Additionally, the audit committee of our board of directors reviews these critical accounting estimates at least annually. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates form the basis for certain judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The following accounting policies are significantly affected by the judgments and estimates we use in the preparation of our consolidated financial statements.

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Revenue Recognition

Historically, prior to discontinuing our products, most of our sales were generated from complex arrangements. Recognizing revenue in these arrangements required our making significant judgments, particularly in the areas of customer acceptance and collectibility.

Certain of our historic product sales arrangements required formal acceptance by our customers. In such cases, we did not recognize revenue until we received formal notification of acceptance. Although we worked closely with our customers to help them achieve satisfaction with our products prior to and after acceptance, the timing of customer acceptance could greatly affect the timing of the recognition of our revenue.

While the end user of our product was normally a large network service provider, we also sold products and services through small resellers and to small network service providers in Asia, Europe, and North America. To recognize revenue before we received payment, we were required to assess that collection from the customer was probable. If we could not satisfy ourselves that collection was probable, we deferred revenue recognition until we collected payment.

Through December 31, 2006, our business consisted primarily of customer service revenue. We record revenue as earned for customer service revenue once we satisfy ourselves that collection from the customer is probable. If we cannot satisfy ourselves that collection is probable, we defer revenue recognition until we collect payment.

Impact of Equity Issuances on Operating Results

Equity issuances have a material impact on our operating results. The equity issuances that have affected operating results to date include warrants granted to customers and suppliers, stock options granted to employees and consultants, and stock issued in lieu of cash compensation to suppliers.

Our cost of revenue, operating expenses and interest expense were affected significantly by charges related to warrants and options issued for services.

In the second quarter of 2004, we issued to a reseller a warrant to acquire 254,489 shares of our common stock at an exercise price of $4.65 per share. The warrant had a two-year term beginning May 28, 2004 and vested ratably over the term. If during the two-year term (1) any person or entity had acquired a greater than 50% interest in us or the ownership or control of more than 50% of our voting stock or (2) we had sold substantially all of our intellectual property assets, the warrant would have become exercisable. Even if the reseller did not immediately exercise the warrant upon the occurrence of such an event that made the warrant exercisable (a “trigger event”), the reseller would have been entitled to securities, cash and property to which it would have been entitled upon the consummation of the trigger event, less the aggregate price applicable to the warrant. We calculated the fair value of the warrant to be approximately $487,000 using the Black-Scholes option pricing model, using a volatility factor of .97, a risk-free interest rate of 2.5%, and an expected life of two years. The fair value of the warrant was being amortized over the two-year expected life of the warrant. During the years ended December 31, 2006 and 2005, we amortized $100,000 and $339,000, respectively, to cost of revenue. The warrant was fully amortized in the year ended December 31, 2006 and the warrant expired unexercised in May 2006.

Income Taxes

We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. We adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB statement 109, on January 1, 2007.  This Interpretation clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in our consolidated financial statements.  The Interpretation also provides guidance for the measurement and classification of tax positions, interest and penalties, and requires additional disclosure on an annual basis.  The cumulative effect of the change had no impact on the consolidated balance sheet or statement of operations. Following implementation, the ongoing recognition of changes in measurement of uncertain tax positions will be reflected as a component of income tax expense. Interest and penalties incurred associated with unresolved income tax positions will continue to be included in other income (expense).

15

RESULTS OF OPERATIONS

Revenue

We ceased all customer operations on December 31, 2006. In 2005 and 2006, our revenues were earned primarily from our customer service contracts. We recognize product revenue at the time of shipment or delivery (depending on shipping terms), assuming that persuasive evidence of an arrangement exists, the sales price is fixed or determinable and collection is probable, unless we have future obligations for installation or require customer acceptance, in which case revenue is deferred until these obligations are met. Our product incorporates software that is not incidental to the related hardware and, accordingly, we recognize revenue in accordance with the American Institute of Certified Public Accountants issued Statement of Position 97-2 “Software Revenue Recognition.” For arrangements that include the delivery of multiple elements, the revenue is allocated to the various products based on “vendor-specific objective evidence” (VSOE) of fair value. We establish VSOE based on either the price charged for the product when the same product is sold separately or for products not yet sold separately, based on the list prices of such products individually established by management with the relevant authority to do so.

Revenue from perpetual software licenses is recognized upon shipment or acceptance, if required. Revenue from one-year term licenses is recognized on a straight-line basis over the one-year license term. Post-delivery technical support, such as on-site service, phone support, parts and access to software upgrades, when and if available, is provided under separate support services agreements. In cases where the support services are sold as part of an arrangement including multiple elements, we allocate revenue to the support service based on the VSOE of the service and recognize it on a straight-line basis over the service period. Revenue from consulting and training services is recognized as the services are provided.

Amounts billed in excess of revenue recognized are included as deferred revenue in the accompanying consolidated balance sheets.

Revenue from customers by geographic region for the years ended December 31, 2007, 2006, and 2005 was as follows, in thousands:

	2007		%		2006		%			2005		%
North America	$	—		—	$	1,211		89	%	$	1,901		57	%
Asia/Pacific		—		—		—		—			617		19	%
Europe		—		—		150		11	%		797		24	%
Total revenue	$	—		—	$	1,361		100	%	$	3,315		100	%

Hardware, software and service revenue for the years ended December 31, 2007, 2006, and 2005 was as follows, in thousands:

	2007		%		2006		%			2005		%
Hardware	$	—		—	$	—		—		$	26		1	%
Software		—		—		—		—			190		6	%
Services		—		—		1,361		100	%		3,099		93	%
Total revenue	$	—		—	$	1,361		100	%	$	3,315		100	%

We had no revenues in 2007, as we discontinued all service offerings at December 31, 2006.

In 2006, all of our revenue was earned from our customer service contracts. The decline in revenue as compared to the prior year is due to the fact that our customers continued their transition from the discontinued CoSine products to other suppliers and, as a result, the demand for our services decreased during the year. See "Outlook" section on pages 21 to 23 and "Risk Factors" section on pages 7 to 11.

In 2005, our revenues were earned primarily from our customer service contracts. Hardware revenue consisted of a $26,000 sale of previously written-down equipment and software revenue consisted of $190,000 for sales of nonexclusive software licenses. Our customers purchased service contracts for their installed systems while they planned and executed their transition from our networking systems to other suppliers.

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As of December 31, 2007, 2006, and 2005, we deferred nil, nil and $0.1 million, respectively, of revenue from contracts that we immediately invoiced but which provide for subsequent customer acceptance, consulting services, and post-contract support services.

Non-Cash Charges and Credits Related to Equity Issuances

We amortized $39,000, $140,000 and $339,000 of non-cash charges related to equity issuances to cost of revenue, operating expenses and interest expense, for the years ended December 31, 2007, 2006 and 2005, respectively.

Below is a reconciliation of non-cash charges related to equity issuances for the years ended December 31, 2007, 2006, and 2005, affecting our cost of revenue, operating expenses and interest expense, in thousands:

	Year ended December 31,
	2007		2006		2005
Amortization of charges related to warrants or stock options issued to non-employees in conjunction with lease, debt, and reseller agreements	$	—	$	100	$	339
Employee stock-based compensation		39		40		—
Net non-cash charges related to equity issuances	$	39	$	140	$	339

Equity-related charges, which are largely dependent on our quarterly stock price, may cause our expenses to materially fluctuate from quarter-to-quarter and year-to-year.

Cost of Revenue

Cost of revenue includes all costs of producing our sold products, including the costs of outsourced manufacturing, software royalties, shipping, warranties, related manufacturing overhead costs and the costs of providing our service offerings, including personnel engaged in providing maintenance and consulting services to our customers. To the extent that the value of inventory is written down, this is reflected in cost of revenue. We have also incurred non-cash charges and credits related to equity issuances including amortization of a warrant issued to a reseller in 2004. We outsourced the majority of our manufacturing and repair operations and customer support capabilities. A significant portion of our cost of revenue consists of payments to our contract manufacturers and third party customer support service provider. Historically, we conducted manufacturing engineering, final assembly, configuration testing, and documentation control at our facilities in Redwood City, California.

There were no customer operations effective December 31, 2006 and no charges to cost of revenue after that date.

Cost of revenue for the year ended December 31, 2006 was $1.7 million. Cost of revenue included $1.6 million for the cost of our third party customer support service provider, and $0.1 million for amortization of a warrant issued to a reseller in 2004.

Cost of revenue for the year ended December 31, 2005 was $2.0 million, or 61.8% of revenue. Cost of revenue included $1.7 million or 83% for the cost of our third party customer support service provider, and $0.3 million or 17% for amortization of a warrant issued to a reseller in 2004.

Gross Profit

For the years ended December 31, 2007, 2006, and 2005, gross profit (loss) was nil, ($0.3) million and $1.3 million, respectively.

The decrease in gross profit for the year ended December 31, 2006 compared to December 31, 2005 is due to the decline in revenue and to the fact that the resources needed to provide the support services could not be reduced to fully offset the revenue decline.

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Research and Development Expenses

Research and development expenses consist primarily of salaries and related personnel costs, fees paid to contractors and outside service providers, and the costs of laboratory equipment and prototypes related to the design, development and testing of our products. We discontinued all research and development in 2005.

Research and development expenses were nil, nil and $0.1 million for the years ended December 31, 2007, 2006, and 2005, respectively.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of salaries and related expenses for personnel engaged in sales, marketing and customer evaluations, as well as the costs associated with customer evaluations and trials and other promotional and marketing expenses. We discontinued all sales and marketing in 2005. Sales and marketing expenses were nil, nil and $0.1 million for the years ended December 31, 2007, 2006, and 2005, respectively.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related expenses for executive, finance, legal, accounting, and human resources personnel as well as other corporate expenses, including non-cash charges related to equity issuances.

General and administrative expenses were $0.8 million, $1.3 million and $3.2 million for the years ended December 31, 2007, 2006, and 2005, respectively.

General and administrative expense decreased by $0.5 million, $1.9 million and $2.8 million for the years ended December 31, 2007, 2006, and 2005, respectively. The decreases are due primarily to our decision in September 2004 to discontinue our products and lay off all of our employees to conserve cash. The majority of our general and administrative employees were laid off in October and November of 2004, and substantially all employees were laid-off by December 31, 2004. Between December 31, 2004 and July 1, 2007, our administrative functions were performed by our chief executive officer and a consultant.

As of July 1, 2007, our administrative functions are performed under an agreement (the “Services Agreement”) with SP Corporate Services, LLC (“SP”) pursuant to which SP provides us, on a non-exclusive basis, a full range of executive, financial, and administrative support services and personnel, including the services of our executive officers. The Service Agreement became effective as of July 1, 2007. Pursuant to the Services Agreement, Terry R. Gibson terminated his employment with us, effective as of June 30, 2007, but continues to serve as our Chief Executive Officer, Chief Financial Officer, Secretary, Principal Executive Officer, and Principal Accounting Officer as an employee of SP. Under the Services Agreement, we pay SP a monthly fee of $17,000 in exchange for SP's services. SP is responsible for compensating and providing all applicable employment benefits to any SP personnel, including Mr. Gibson, in connection with providing services under the Services Agreement. We reimburse SP for reasonable and necessary business expenses of ours incurred by SP, and we are responsible for payment of fees related to audit, tax, legal, stock transfer, insurance broker, investment advisor, and banking services provided to us by third party advisors. The Services Agreement has a term of one year and automatically renews for successive one year periods unless otherwise terminated by either party. The Services Agreement is also terminable by us upon the death of Terry R. Gibson or his resignation as our Chief Executive Officer, Chief Financial Officer, or Secretary of the Company. Under the Services Agreement, SP and its personnel are entitled to the same limitations on liability and indemnity rights available under our charter documents to any other person performing such services for us.

General and administrative non-cash charges (credits) related to equity issuances were $39,000, $40,000 and nil for the years ended December 31, 2007, 2006 and 2005, respectively.

Interest Income and Other Expense

For the year ended December 31, 2007, interest income was $1.2 million as compared to $1.1 million at December 31, 2006 and $0.7 million at December 31, 2005. The increase is due to higher interest rates in 2007 and 2006 as compared to 2005.

18

Other Income

For the year ended December 31, 2006, other income includes $640,000 gain on liquidation of foreign subsidiaries. The gain is due to the cumulative effect of gains and losses on translation of foreign subsidiaries’ financial statements into United States dollars. The gain, which had been deferred prior to the year ended December 31, 2006, was recognized in 2006 with the liquidation of the subsidiaries. The liquidations were completed in connection with the cessation of our service operations. Other income in 2006 also included $180,000 and $80,000 in connection with the sale of our patent portfolio and intellectual property, respectively.

Interest Expense

For the years ended December 31, 2007, 2006, and 2005, respectively, interest expense was nil, $4,000 and nil.

Income Tax Provision

Credits for income taxes of ($17,000), ($52,000), and ($228,000) for the years ended December 31, 2007, 2006, and 2005, respectively, were comprised entirely of foreign corporate income taxes, which are a function of our operations in subsidiaries in various countries. The credits in 2007, 2006, and 2005 relate to the liquidation of foreign subsidiaries, and completion of the related tax settlements.

We have not recognized any benefit from the future use of net operating loss carry-forwards for these periods, or for any other periods, since our incorporation. We are not recognizing the potential tax benefits of our net operating loss carry-forwards because we do not have sufficient evidence that we will generate adequate profits to use them.

Use of the net operating loss and tax credit carry-forwards may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, and similar state provisions. The annual limitation may result in the expiration of net operating loss and tax credit carry-forwards before utilization.

LIQUIDITY AND CAPITAL RESOURCES

Through December 31, 2006, our business consisted primarily of a customer support capability for our discontinued products provided by a third party. We terminated our customer service offerings at December 31, 2006. In March 2006, we signed an agreement to sell the rights to our patent portfolio for cash consideration of $180,000 and in November 2006 we sold the rights to our intellectual property for $80,000 (see Note 7 of the Notes to Consolidated Financial Statements). We have adopted a strategy of seeking to enhance stockholder value by pursuing opportunities to redeploy our assets through an acquisition of one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards. Based on our $23.1 million in cash and short term investments at December 31, 2007 and on our cost reduction activities over the past two years, we believe that we possess sufficient liquidity and capital resources to fund our operations and working capital requirements for at least the next 12 months. However, our restructuring activities and our new redeployment of assets strategy raise substantial doubt as to our ability to continue as a going concern. See “Liquidity and Redeployment Strategy” in Note 1 of the Notes to Consolidated Financial Statements. See “Outlook” on pages 21 to 23 and “Risk Factors” on pages 7 to 11, which describes our redeployment of assets strategy.

We will continue to prepare our financial statements on the assumption that we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As such, the financial statements do not include any adjustments to reflect possible future effects of the recoverability and classification of assets or the amounts and classification of liabilities that may result from any decisions made with respect to an assessment of our strategic alternatives. If at some point we were to decide to pursue alternative plans, we may be required to present the financial statements on a different basis. As an example, if we were to decide to pursue a liquidation and return of capital, it would be appropriate to prepare and present financial statements on the liquidation basis of accounting, whereby assets are valued at their estimated net realizable values and liabilities are stated at their estimated settlement amounts.

Cash, Cash Equivalents and Short-Term Investments

At December 31, 2007, cash, cash equivalents and short-term investments were $23.1 million, as compared to $22.9 million at December 31, 2006.

19

Operating Activities

We generated $264,000 cash from operations in the year ended December 31, 2007, used $334,000 in cash for operations for the year ended December 31, 2006, and used $1.8 million from the cash used for operations in 2005. The improvement is due primarily to the $416,000 net income in 2007 and the $449,000 in net income in 2006 as compared to a $1.2 million net loss in 2005, partially offset by decreases in accrued liabilities as we completed our restructuring activities.

Investing Activities

For the year ended December 31, 2007, we generated $7.2 million in cash from investing activities. For the year ended December 31, 2006, we used $6.9 million in cash to fund an increase in our short term investments. For the year ended December 31, 2005, we generated $5.0 million in cash from investing activities.

Financing Activities

We had no financing activities during the years ended December 31, 2007, 2006, or 2005.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material affect.

Contractual Obligations

We have future financial obligations related to (1) an operating lease and (2) purchase obligations. These obligations as of December 31, 2007 are summarized as follows, (in thousands of dollars):

Contractual Obligations	Total		2008		2009-2010		2011-2012		After 2012
Unconditional purchase obligations	$	102.0	$	102.0			$	$—	$	—
Operating leases		53.0		40.0		13.0		—		—
Total contractual cash obligations	$	155.0	$	142.0	$	13.0	$	0.0	$	0.0

Our operating lease obligations as of December 31, 2007 consist of an office lease expiring at the end of April in 2009.

Our unconditional purchase obligations relate to executive, financial and administrative support services, and personnel provided by SP Corporate Services LLC under an agreement which became effective as of July 1, 2007 (the "Services Agreement"). Under the Services Agreement, we pay SP Corporate Services LLP a monthly fee of $17,000 in exchange for SP Corporate Services LLP’s services. The Services Agreement has a term of one year and automatically renews for successive one year periods unless otherwise terminated by either party.

OUTLOOK

Our board of directors, on completion of a comprehensive review of strategic alternatives, has approved a plan to redeploy our existing resources to identify and acquire one or more new business operations. Our redeployment strategy will involve the acquisition of one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards (“NOLs”). As of this date, no candidate has been identified, and no assurance can be given that we will find suitable candidates, and if we do, that we will be able to utilize our existing NOLs.

20

At December 31, 2007, we had $23.1 million in cash and short-term investments. Cash generated by operations during the year ended December 31, 2007 was $264,000. We believe we possess sufficient liquidity and capital resources to fund our operations and working capital requirements for at least the next 12 months.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 157, Fair Value Measurements, or SFAS 157. The standard provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS 157 must be adopted prospectively as of the beginning of the year it is initially applied. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are still evaluating the impact this standard will have on our financial position or results of operations.

In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 creates a “fair value option” under which an entity may elect to record certain financial assets or liabilities at fair value upon their initial recognition. Subsequent changes in fair value would be recognized in earnings as those changes occur. The election of the fair value option would be made on a contract-by contract basis and would need to be supported by concurrent documentation or a preexisting documented policy. SFAS 159 requires an entity to separately disclose the fair value of these items on the balance sheet or in the footnotes to the financial statements and to provide information that would allow the financial statement user to understand the impact on earnings from changes in the fair value. SFAS 159 is effective for us beginning with fiscal year 2008. We are currently evaluating the impact that the adoption of SFAS 159 will have on our consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations(“SFAS 141(R)”). SFAS 141(R) changes accounting for acquisitions that close beginning in 2009. More transactions and events will qualify as business combinations and will be accounted for at fair value under the new standard. SFAS 141(R) promotes greater use of fair values in financial reporting. Some of the changes will introduce more volatility into earnings. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. We are currently assessing the impact that SFAS 141(R) may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements(“SFAS 160”), an amendment of ARB No. 51. SFAS 160 will change the accounting and reporting for minority interests which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. We are currently assessing the impact that SFAS 160 may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued EITF Issue 07-1 Accounting for Collaborative Arrangements (EITF 07-1). Collaborative arrangements are agreements between parties to participate in some type of joint operating activity. The task force provided indicators to help identify collaborative arrangements and provides for reporting of such arrangements on a gross or net basis pursuant to guidance in existing authoritative literature. The task force also expanded disclosure requirements about collaborative arrangements. Conclusions within EITF 07-1 are to be applied retroactively. We are currently assessing the impact that EITF 07-1 may have on our financial position, results of operations, and cash flows.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Sensitivity

We do not currently use derivative financial instruments for speculative trading or hedging purposes. In addition, we maintain our cash equivalents in government and agency securities, debt instruments of financial institutions and corporations, and money market funds. Our exposure to market risks from changes in interest rates relates primarily to corporate debt securities. We place our investments with high quality credit issuers and, by policy, limit the amount of the credit exposure to any one issuer.

21

Our general policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market and credit risk. All highly-liquid investments with a maturity of less than three months at the date of purchase are considered to be cash equivalents, and all investments with maturities of three months or greater are classified as available-for-sale and considered to be short-term investments.

A sensitivity analysis was performed on our December 31, 2007 investment portfolio based on a modeling technique that measures hypothetical fair market value changes that would result from a parallel shift in the yield curve of plus 100 basis points. Based on this analysis, a hypothetical 100 basis point increase in interest rates would result in a $21,000 decrease in the fair value of our investments in debt securities as of December 31, 2007.

Exchange Rate Sensitivity

Currently, all of our revenue and all of our expenses are denominated in U.S. dollars.

22

Item 8. Financial Statements and Supplementary Data

REPORT OF BURR, PILGER & MAYER LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

CoSine Communications, Inc.

We have audited the accompanying consolidated balance sheets of CoSine Communications, Inc. and its subsidiary (the “Company”) as of December 31, 2007, and 2006 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in Item 15(a)(2) as of and for the years ended December 31, 2007, 2006, and 2005. The consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CoSine Communications, Inc. and its subsidiary as of December 31, 2007 and 2006 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule as of and for the years ended December 31, 2007, 2006, and 2005, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note 1 and Note 7 to the consolidated financial statements, on January 1, 2007 the Company changed its method of accounting for uncertain tax positions as a result of adopting Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”.

As discussed in Note 1 to the consolidated financial statements, the Company’s actions in September 2004 in connection with its ongoing evaluation of strategic alternatives, to terminate most of its employees and discontinue production activities in an effort to conserve cash raise substantial doubt about its ability to continue as a going concern. Management’s plans as to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty.

/s/ Burr, Pilger & Mayer LLP

Palo Alto, California

March 12, 2008

23

COSINE COMMUNICATIONS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except for share and per share data)

	December 31, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	12,709		$	5,207
Short-term investments		10,410			17,650
Accounts receivable:
Trade (net of allowance for doubtful accounts of nil at December 31, 2007 and 2006, respectively)		—			55
Other		73			68
Prepaid expenses and other current assets		36			56
Total current assets		23,228			23,036
Long term deposit and other		3			—
	$	23,231		$	23,036
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	204		$	320
Other accrued liabilities		97			239
Total current liabilities		301			559
Commitments and contingencies (Notes 2 and 3)
Stockholders' equity:
Preferred stock, no par value, 3,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.0001 par value, 22,000,000 shares authorized; 10,090,635 shares issued and outstanding at December 31, 2007 and 2006		1			1
Additional paid-in capital		539,026			538,987
Accumulated other comprehensive income		15			17
Accumulated deficit		(516,112	)		(516,528	)
Total stockholders' equity		22,930			22,477
	$	23,231		$	23,036

See accompanying notes to consolidated financial statements.

24

COSINE COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except for per share data)

	Year Ended December 31,
	2007			2006			2005
Revenue:
Product	$	—		$	—		$	216
Service		—			1,361			3,099
Total revenue		—			1,361			3,315
Cost of revenue (1)		—			1,663			2,049
Gross profit (loss)		—			(302	)		1,266
Operating expenses:
Research and development		—			—			103
Sales and marketing		—			—			105
General and administrative (2)		781			1,316			3,227
Restructuring and impairment charges		—			—			(91	)
Total operating expenses		781			1,316			3,344
Loss from operations		(781	)		(1,618	)		(2,078	)
Other income (expense):
Interest income		1,180			1,101			678
Interest expense		—			(4	)		—
Other (3)		—			918			(46	)
Total other income		1,180			2,015			632
Income (loss) before income tax benefit		399			397			(1,446	)
Income tax (benefit)		( 17	)		( 52	)		(228	)
Net income (loss)	$	416		$	449		$	(1,218	)
Basic net income (loss) per share	$	0.04		$	0.04		$	( 0.12	)
Diluted net income (loss) per share	$	0.04		$	0.04		$	( 0.12	)
Shares used to calculate net income (loss) per share:
Basic		10,091			10,091			10,094
Diluted		10,115			10,096			10,094

__________

(1) Cost of revenue includes nil, $100 and $339 of non-cash charges related to equity issuances in 2007, 2006, and 2005, respectively.

(2) General and administrative expenses include $39 and $40 in non-cash charges related to equity issuances in 2007 and 2006, respectively and nil in 2005.

(3) Other includes gain on disposal of subsidiaries of nil, $640 and nil in 2007, 2006 and 2005, respectively.

See accompanying notes to consolidated financial statements.

25

 

COSINE COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

	Common Stock					Additional Paid-in			Notes Receivable From			Accumulated Other Comprehensive			Accumulated			Total Stockholders’
	Shares			Amount		Capital			Stockholders			Income			Deficit			Equity
Balance at January 1, 2005		10,159,790		$	1	$	540,028		$	(1,520	)	$	614		$	(515,759	)	$	23,364
Repurchase of unvested shares		(69,155	)		—		(1,520	)		1,520			—			—			—
Valuation of warrant		—			—		439			—			—			—			439
Components of comprehensive loss:
Net loss		—			—		—			—			—			(1,218	)		(1,218	)
Unrealized gain on investments, net of tax		—			—		—			—			20			—			20
Translation adjustment, net of tax		—			—		—			—			(2	)		—			( 2	)
Total comprehensive income ( loss)		—			—		—			—			18			(1,218	)		(1,200	)
Balance at December 31, 2005		10,090,635			1		538,947			—			632			(516,977	)		22,603
Stock based compensation		—			—		40			—			—			—			40
Components of comprehensive income (loss):
Net income		—			—		—			—			—			449			449
Unrealized gain on investments, net of tax		—			—		—			—			25			—			25
Translation adjustment, net of tax		—			—		—			—			(640	)		—			(640	)
Total comprehensive income ( loss)		—			—		—			—			(615	)		449			(166	)
Balance at December 31, 2006		10,090,635			1		538,987			—			17			(516,528	)		22,477
Stock based compensation		—			—		39			—			—			—			39
Components of comprehensive income (loss):
Net income		—			—		—			—			—			416			416
Unrealized gain on investments, net of tax		—			—		—			—			(2	)		—			(2	)
Total comprehensive income ( loss)		—			—		—			—			(2	)		416			414
Balance at December 31, 2007		10,090,635		$	1	$	539,026		$	—		$	15		$	(516,112	)	$	22,930

See accompanying notes to consolidated financial statements.

26

COSINE COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Year Ended December 31,
	2007			2006			2005
Operating activities:
Net income (loss)	$	416		$	449		$	(1,218	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Allowance for doubtful accounts		—			—			(90	)
Gain on sale of fixed assets		—			—			(67	)
Stock compensation expense		39			40			—
Amortization of warrants issued for services		—			100			339
Gain on liquidation of foreign subsidiaries		—			(640	)		—
Other		—			—			18
Change in operating assets and liabilities:
Accounts receivable (trade)		55			41			1,322
Other receivables		(5	)		141			274
Prepaid expenses and other current assets		20			63			830
Long-term deposits and other assets		(3	)		150			—
Accounts payable		(116	)		83			(15	)
Provision for warranty liability		—			—			(157	)
Accrued compensation		—			—			(412	)
Accrued other liabilities		(142	)		(635	)		(2,255	)
Deferred revenue		—			(126	)		(383	)
Net cash generated (used) in operating activities		264			(334	)		(1,814	)
Investing activities:
Proceeds from sale of property and equipment		—			—			67
Purchase of short-term investments		(27,318	)		(20,013	)		(14,089	)
Proceeds from sales and maturities of short-term investments		34,556			13,137			19,050
Net cash provided by (used in) investing activities		7,238			(6,876	)		5,028
Net (decrease) increase in cash and cash equivalents		7,502			(7,210	)		3,214
Cash and cash equivalents at the beginning of the period		5,207			12,417			9,203
Cash and cash equivalents at the end of the period	$	12,709		$	5,207		$	12,417
Supplemental information:
Cash paid for interest	$	—		$	4		$	—
Income taxes paid	$	—		$	—		$	7
Cancellation of notes receivable due to repurchase of unvested stock	$	—		$	—		$	1,520

See accompanying notes to consolidated financial statements.

27

COSINE COMMUNICATIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

Description of Business

CoSine Communications, Inc. ("CoSine" or the "Company," which may be referred to as "we," "us," or "our") was incorporated in California on April 14, 1997 and in August 2000 was reincorporated in the State of Delaware. We were a provider of carrier network equipment products and services until the fourth quarter of fiscal year 2004 during which time we discontinued our product lines, took actions to lay off most of our employees, terminated contract manufacturing arrangements, contractor and consulting arrangements and various facility leases, and sold, scrapped or wrote-off our inventory, property and equipment. As a result of these activities, our business consisted primarily of a customer support capability for our discontinued products provided by a third party. We continued such support activities through December 31, 2006, at which time we ceased all customer support services. In 2006 we sold our patent portfolio and the intellectual property related to our carrier products and service business. We continue to seek to redeploy our existing resources to identify and acquire one or more new business operations with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards ("NOLs").

Liquidity and Redeployment Strategy

The accompanying financial statements have been prepared in conformity with U.S. generally accepted accounting principles, which contemplate continuation of the Company as a going concern. However, at December 31, 2007, we have an accumulated deficit of $516 million. As of December 31, 2006, we ceased our customer service capability. Our actions in the fourth quarter of fiscal year 2004 to terminate most of our employees and discontinue production activities in an effort to conserve cash raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects relating to the recoverability and classification of the recorded asset amounts or amounts and classification of liabilities that might result from the outcome of this uncertainty.

In July 2005, we completed a comprehensive review of strategic alternatives, including a sale of CoSine, a sale or licensing of intellectual property, a redeployment of our assets into new business ventures, or a winding-up and liquidation of the business and a return of capital. The board of directors approved a plan to redeploy our existing resources to identify and acquire one or more new business operations, while continuing to support our existing customers and continuing to offer our intellectual property for license or sale. We continued to provide customer support services through December 31, 2006, at which time we terminated customer support operations. During 2006, we sold the rights to our patent portfolio and the intellectual property related to our carrier products and service business. We continue to pursue our redeployment strategy, which involves the acquisition of one or more operating businesses with existing or prospective taxable earnings that can be offset by use of our NOLs.

Basis of Consolidation

The consolidated financial statements include all of the accounts of CoSine and our wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. Actual results could differ from these estimates. Estimates are used in accounting for, but are not limited to, revenue recognition, allowance for doubtful accounts, inventory valuations, long-lived asset valuations, accrued liabilities including warranties, and equity issuances. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period of determination.

28

Significant Concentrations

Financial instruments that potentially subject us to concentrations of credit risk primarily consist of cash, cash equivalents, and short-term investments. We mitigate investment risk by investing only in government and high quality corporate securities and by limiting the amount of exposure to any one issuer.Deposits held with financial institutions may exceed the amount of insurance provided on such deposits. We are exposed to credit risks in the event of default by these institutions to the extent of the amount recorded on the balance sheet. We have not experienced any material losses on deposits of cash and cash equivalents.

We ceased all customer service operations effective December 31, 2006. For the year ended December 31, 2006, we recognized revenue from three customers who accounted for 58%, 19% and 11% of total revenue, respectively. At December 31, 2006 we had two customers who accounted for 67% and 27% of total trade accounts receivable, respectively. For the year ended December 31, 2005, we recognized revenue from two customers who accounted for 43% and 15% of total revenue, respectively. At December 31, 2005, we had three customers who accounted for 52%, 28% and 14% of total accounts receivable, respectively. We do not require collateral and maintain adequate reserves for potential credit losses.

Guarantees

We may enter into certain types of contracts that require that we indemnify parties against certain third party claims that may arise. These contracts primarily relate to: (i) certain agreements with our officers, directors and employees, under which we may be required to indemnify such persons for liabilities arising out of their employment relationship, (ii) contracts under which we may be required to indemnify customers against loss or damage to property or persons as a result of willful or negligent conduct by our employees or sub-contractors, (iii) contracts under which we may be required to indemnify customers against third party claims that our product infringes a patent, copyright or other intellectual property right and, (iv) procurement or license agreements under which we may be required to indemnify licensors or vendors for certain claims that may be brought against them arising from our acts or omissions with respect to the supplied products or technology.

Generally, a maximum obligation is not explicitly stated. Because the obligated amounts associated with this type of agreement are not explicitly stated, the overall maximum amount of the obligation cannot be reasonably estimated. Historically, we have not been obligated to make payments for these obligations, and no liabilities have therefore been recorded for these obligations on our consolidated balance sheets as of December 31, 2007, 2006, and 2005.

Cash, Cash Equivalents and Short-Term Investments

We consider all highly liquid investments purchased with original maturities of three months or less from the date of purchase to be cash equivalents. Investments with maturities in excess of three months and less than one year are considered to be short-term investments. We determine the appropriate classification of cash equivalents and investment securities at the time of purchase. We have classified our marketable securities as available-for-sale securities in the accompanying consolidated financial statements. Available-for-sale securities are carried at fair value, with unrealized gains and losses reported in a separate component of stockholders’ equity. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for-sale securities are included in interest income. Interest on securities classified as available-for-sale is also included in interest income. The cost of securities sold is based on the specific identification method.

We invest excess cash in U.S. government and agency securities, debt instruments of financial institutions and corporations, and money market funds with strong credit ratings. We have established guidelines about the diversification of our investments and their maturities.

29

Short-term investments including cash equivalents and short-term investments were as follows (in thousands):

	December 31,
	2007			2006
Money market funds	$	12,635		$	5,079
Corporate obligations		4,227			16,150
Commercial paper		6,183			—
Government securities		—			1,500
		23,045			22,729
Amounts classified as cash equivalents		(12,635	)		( 5,079	)
	$	10,410		$	17,650

As of December 31, 2007 and 2006, there were net unrealized gains of $15,000 and $17,000, respectively. All available-for-sale securities have contractual maturities of one year or less.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to pay their invoices. In order to estimate the appropriate level of this allowance, we analyze historical bad debts, customer concentrations, current customer credit-worthiness, current economic trends, and changes in customer payment patterns.

Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method. The Company’s consolidated financial statements as of December 31, 2007 and 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the years ended December 31, 2007 and 2006 was $39,000 and $40,000 respectively, which consisted of stock-based compensation expense related to employee stock options. No stock-based compensation expense related to employee stock options was recognized for the year ended December 31, 2005.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated statements of operations. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s consolidated statements of operations because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized during the current period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company’s consolidated statements of operations for the year ended December 31, 2007 and 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). As stock-based compensation expense recognized in the consolidated statement of operations for the year ended December 31, 2007 and 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company’s pro forma information required under SFAS 123 for the periods ended prior to January 1, 2006, the Company accounted for forfeitures as they occurred.

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Upon adoption of SFAS 123(R), the Company selected the Black-Scholes option-pricing model (“Black-Scholes model”) to determine the fair value of share-based awards granted beginning in fiscal 2006, the same model which was previously used for the Company’s pro forma information required under SFAS 123. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Expected volatilities are based on the historical volatility of the Company’s common stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of the options granted represents the period of time that options are expected to be outstanding, based on historical information. The risk-free interest rate is based on the U.S Treasury zero-coupon issues with remaining terms similar to the expected term of the Company’s equity awards. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore used an expected dividend yield of zero. All of our stock compensation is accounted for as an equity instrument.

Prior to the Adoption of SFAS 123(R)

In 2005, the Company accounted for stock-based employee compensation arrangements in accordance with provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”), as interpreted by FASB Interpretation No. 44 (“FIN 44”), Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB 25, Emerging Issues Task Force No. 00-23 (“EITF 00-23”), Issues related to the Accounting for Stock Compensation under APB 25 and FIN 44, and Financial Accounting Standards Board Interpretation (“FIN”) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, and complied with the disclosure provisions of SFAS 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS 123 (“SFAS 148”). Under APB 25, compensation expense was based on the difference, if any, on the date of the grant, between the fair value of the Company’s stock and the exercise price. SFAS 123, Accounting for Stock Based Compensation, (“SFAS 123”) as amended by SFAS 148 requires a “fair value” based method of accounting for an employee stock option or similar equity instrument. Had compensation cost for the Company’s stock-based compensation plan been determined based on the fair value at the grant date for awards for 2005 consistent with the provisions of SFAS 123, the Company’s net loss would have been increased to the pro forma amounts indicated below (in thousands, except per share data):

	Year Ended December 31, 2005
Net loss, as reported	$	(1,218	)
Add: Stock-based employee compensation expense, net of tax, included in reported net loss		—
Deduct: Stock-based employee compensation expense determined under fair value method for all stock option grants (SFAS 123 expense), net of tax		(43	)
Pro forma net loss	$	(1,261	)
Basic and diluted net loss per share, as reported	$	(0.12	)
Pro forma basic and diluted net loss per share	$	(0.12	)

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Revenue Recognition

In 2005 and 2006, our revenues were earned primarily from our customer service contracts. We recognize product revenue at the time of shipment, assuming that persuasive evidence of an arrangement exists, the sales price is fixed or determinable and collection is probable, unless we have future obligations for installation or require customer acceptance, in which case revenue is deferred until these obligations are met. Our product incorporates software that is not incidental to the related hardware and, accordingly, we recognize revenue in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2 “Software Revenue Recognition.” For arrangements that include the delivery of multiple elements, the revenue is allocated to the various products based on “vendor-specific objective evidence (“VSOE”)” of fair value. We establish VSOE based on either the price charged for the product when the same product is sold separately or for products not yet sold separately, based on the list prices of such products individually established by management with the relevant authority to do so.

Revenue from perpetual software licenses is recognized upon shipment or acceptance, if required. Revenue from one-year term licenses is recognized on a straight-line basis over the one-year license term. Post delivery technical support, such as on-site service, phone support, parts and access to software upgrades, when and if available, is provided by us under separate support services agreement. In cases where the support service is sold as part of an arrangement including multiple elements, we allocate revenue to the support service based on the VSOE of the services and recognize it on a straight-line basis over the service period. Revenue from consulting and training services is recognized as the services are provided.

Amounts billed in excess of revenue recognized are included as deferred revenue in the accompanying consolidated balance sheets.

Cost of Revenue

Cost of revenue is comprised primarily of material, labor, overhead, shipping costs, subcontractor costs, warranty costs, and inventory write-downs. In addition, cost of revenue includes non-cash charges or credits related to equity issuances.

Research and Development

Research and development expenditures, consisting primarily of materials, labor and overhead costs for the development and testing of prototypes, and salaries and related personnel costs associated with independent research, are generally charged to operations as incurred.

Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” requires the capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on our product development process, technological feasibility is established upon the completion of a working model. We ceased all research and development activities in March 2005. Capitalizable costs incurred after achieving technological feasibility have not been significant for any development project. Accordingly, we have charged all such costs to research and development expense in the periods they were incurred.

Advertising Expense

Advertising costs are expensed as incurred. For the years ended December 31, 2007, 2006, and 2005, we incurred no expense for advertising.

Income Taxes

We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. We adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109, on January 1, 2007.  This Interpretation clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in our consolidated financial statements.  The Interpretation also provides guidance for the measurement and classification of tax positions, interest and penalties, and requires additional disclosure on an annual basis.  The cumulative effect of the change had no impact on the consolidated balance sheet or statement of operations. Following implementation, the ongoing recognition of changes in measurement of uncertain tax positions will be reflected as a component of income tax expense. Interest and penalties incurred associated with unresolved income tax positions will continue to be included in other income (expense). 

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Net Income (Loss) Per Share

Basic net income (loss) per share is calculated based on the weighted average number of common shares outstanding during the periods presented, less the weighted average shares outstanding that are subject to our right of repurchase. Diluted net loss per share gives effect to the dilutive effect of common stock equivalents consisting of stock options and warrants (calculated using the treasury stock method) and convertible preferred stock.

The following table presents the calculation of basic and diluted net loss per share for each year (in thousands, except per share data):

	Year ended December 31,
	2007		2006		2005
Numerator:
Net income (loss)	$	416	$	449	$	(1,218	)
Denominator:
Weighted average shares outstanding for basic income (loss) per share		10,091		10,091		10,094
Add: effect of dilutive securities – stock options		24		5		—
Weighted average shares used in basic and diluted net income (loss) per share		10,115		10,096		10,094
Basic net income (loss) per share	$	0.04	$	0.04	$	(0.12	)
Diluted net income (loss) per share	$	0.04	$	0.04	$	(0.12	)

During all periods presented, we had stock options and warrants outstanding that could potentially dilute earnings per share in the future, but were excluded from the computation of diluted net loss per share, as their effect would have been antidilutive. These shares amounted to 35,000, 26,000, and 436,000 for the years ended December 31, 2007, 2006, and 2005 respectively.

Segment Reporting

We operate in only one segment: IP Service Delivery Platforms. Substantially all of our assets are located in the United States.

Revenues from customers by geographic region for the years ended December 31, 2007, 2006, and 2005 were as follows (in thousands):

Region	Revenue
2007
Europe	$	—
Japan		—
North America		—
	$	—
2006
Europe	$	150
Japan		—
North America		1,211
	$	1,361
2005
Europe	$	797
Japan		527
South Korea		90
North America		1,901
	$	3,315

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Recent Accounting Pronouncements

In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, or SFAS 157. The standard provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. SFAS 157 must be adopted prospectively as of the beginning of the year it is initially applied. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are still evaluating the impact this standard will have on our financial position or results of operations

In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 creates a “fair value option” under which an entity may elect to record certain financial assets or liabilities at fair value upon their initial recognition. Subsequent changes in fair value would be recognized in earnings as those changes occur. The election of the fair value option would be made on a contract-by-contract basis and would need to be supported by concurrent documentation or a preexisting documented policy. SFAS 159 requires an entity to separately disclose the fair value of these items on the balance sheet or in the footnotes to the financial statements and to provide information that would allow the financial statement user to understand the impact on earnings from changes in the fair value. SFAS 159 is effective for us beginning with fiscal year 2008. We are currently evaluating the impact that the adoption of SFAS 159 will have on our consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations(“SFAS 141(R)”). SFAS 141(R) changes accounting for acquisitions that close beginning in 2009. More transactions and events will qualify as business combinations and will be accounted for at fair value under the new standard. SFAS 141(R) promotes greater use of fair values in financial reporting. Some of the changes will introduce more volatility into earnings. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. We are currently assessing the impact that SFAS 141(R) may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”), an amendment of ARB No. 51. SFAS 160 will change the accounting and reporting for minority interests which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. We are currently assessing the impact that SFAS 160 may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued EITF Issue 07-1 Accounting for Collaborative Arrangements (EITF 07-1). Collaborative arrangements are agreements between parties to participate in some type of joint operating activity. The task force provided indicators to help identify collaborative arrangements and provides for reporting of such arrangements on a gross or net basis pursuant to guidance in existing authoritative literature. The task force also expanded disclosure requirements about collaborative arrangements. Conclusions within EITF 07-1 are to be applied retrospectively. We are currently assessing the impact that EITF 07-1 may have on our financial position, results of operations, and cash flows.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. The reclassification had no effect on total assets or net loss.

2. Leases

We lease our facilities under an operating lease which expires in late April, 2009 with annual rental of $40,000. Effective July 1, 2007 our lease payments are made by SP Corporate Services LLC, an affiliated company, in connection with a management services agreement (See Note 6).

Rent expense was $20,000, $55,000 and $83,000 for the years ended December 31, 2007, 2006, and 2005, respectively, and is calculated on a straight-line basis.

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3. Commitments and Contingencies

On November 15, 2001, we, along with certain of our officers and directors, were named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned in re CoSine Communications, Inc. Initial Public Offering Securities Litigation, Case No. 01 CV 10105. The complaint generally alleges that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in our initial public offering. The complaint brings claims for the violation of several provisions of the federal securities laws against those underwriters, and also against us and each of the directors and officers who signed the registration statement relating to the initial public offering. The plaintiffs seek unspecified monetary damages and other relief. Similar lawsuits concerning more than 300 other companies' initial public offerings were filed during 2001, and this lawsuit is being coordinated with those actions in the Southern District of New York before Judge Shira A. Scheindlin.

On or about July 1, 2002 an omnibus motion to dismiss was filed in the coordinated litigation on behalf of the issuer defendants, of which we and our named officer and directors are a part, on common pleading issues. In October 2002, pursuant to stipulation by the parties, the Court entered an order dismissing our named officers and directors from the action without prejudice. On February 19, 2003, the Court dismissed the Section 10(b) and Rule 10b-5 claims against us but did not dismiss the Section 11 claims against us.

In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including us, was submitted to the court for approval. The terms of the settlement, if approved, would dismiss and release all claims against the participating defendants (including us). In exchange for this dismissal, D&O insurance carriers would agree to guarantee a recovery by the plaintiffs from the underwriter defendants of at least $1 billion, and the issuer defendants would agree to an assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. On August 31, 2005, the Court issued an order granting preliminary approval of the settlement. On April 24, 2006, the Court held a fairness hearing in connection with the motion for final approval of the settlement but has yet to rule on this motion.

On December 5, 2006, the Court of Appeals for the Second Circuit reversed the court's October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints in the six focus cases, which the defendants in those cases have moved to dismiss.  Plaintiffs have also moved for class certification in the six focus cases, which the defendants in those cases have opposed. It is uncertain whether there will be any revised or future settlement. If the settlement is not consummated, we intend to defend the lawsuit vigorously. However, we cannot predict its outcome with certainty. If we are not successful in our defense of this lawsuit, we could be forced to make significant payments to the plaintiffs and their lawyers, and such payments could have a material adverse effect on our business, financial condition, and results of operations if not covered by our insurance carrier.

On October 9, 2007, a purported CoSine shareholder filed a complaint for violation of Section 16(b) of the Securities Exchange Act of 1934, which prohibits short-swing trading, against the Company's IPO underwriters. The complaint, Vanessa Simmonds v. The Goldman Sachs Group, et al., Case No. C07-1629, in District Court for the Western District of Washington, seeks the recovery of short-swing profits. The Company is named as a nominal defendant. No recovery is sought from the Company.

Even if these claims are not successful, the litigation could result in substantial costs and divert management's attention and resources, which could adversely affect our business, results of operations, and financial position.

In the ordinary course of business, we are involved in legal proceedings involving contractual obligations, employment relationships, and other matters. Except as described above, we do not believe there are any pending or threatened legal proceedings that will have a material impact on our financial position or results of operations.

Our unconditional purchase obligations relate to executive, financial and administrative support services, and personnel provided by SP Corporate Services LLC under an agreement which became effective as of July 1, 2007 (the "Services Agreement"). Under the Services Agreement, we pay SP Corporate Services LLP a monthly fee of $17,000 in exchange for SP Corporate Services LLP’s services. The Services Agreement has a term of one year and automatically renews for successive one year periods unless otherwise terminated by either party.

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4. Stockholders’ Equity

Common Stock

We have authorized shares of common stock for future issuance at each year end as follows (in thousands):

	2007		2006
Stock options:
Options outstanding		153		147
Available for future grants		2,934		2,940
Warrants outstanding		4		4
		3,091		3,091

1997 Stock Option Plan

In October 1997, the board of directors adopted the 1997 Stock Plan (“1997 Plan”) for issuance of common stock and grants of options for common stock to employees, consultants, and directors. Incentive stock options granted under the plan were at prices not less than the fair value of stock at the date of grant, except in the case of a sale to a person who owned stock representing more than 10% of all the voting power of all classes of our stock, in which case the purchase price was 110% of the fair market value of the common stock on the date of grant. Nonstatutory stock options granted under the 1997 Plan were at prices not less than 85% of the fair value of stock at the date of grant, except in the case of a sale to a person who owned stock representing more than 10% of all the voting power of all classes of stock of CoSine, in which case the purchase price was 110% of the fair market value of the common stock on the date of grant. Options granted under the 1997 Plan generally vested over four years at a rate of 25% one year from the grant date and ratably monthly thereafter and were to expire 10 years after the grant, or earlier upon termination. Options could be granted with different vesting terms.

Effective upon the initial public offering, the 1997 Plan was terminated and the shares reserved and unissued under the 1997 Plan were reserved for issuance under the 2000 Plan.

2000 Stock Option Plan

In May 2000, the board of directors adopted the 2000 Stock Plan (“2000 Plan”). The 2000 Plan was approved by our shareholders before the completion of the initial public offering. The 2000 Plan provides for the grant of incentive stock options to employees, and for the grant of nonstatutory stock options and stock purchase rights to employees, directors, and consultants. Incentive stock options granted under the 2000 Plan will be at prices not less than the fair value of the common stock at the date of grant. The term of each option will be determined by the administrator of the plan, generally 10 years or less.

We have authorized 2,215,779 shares of common stock for issuance under the 2000 Plan. At December 31, 2007 and 2006, respectively, a total of 1,924,455 shares were available for future options grants under the 2000 Plan.

2002 Stock Option Plan

In January 2002, the board of directors adopted the 2002 Stock Plan (“2002 Plan”). The purpose of the 2002 Plan is to make available for issuance certain shares of common stock that have been (i) previously issued pursuant to the exercise of stock options granted under the 1997 Plan and (ii) subsequently reacquired by us pursuant to repurchase rights contained in restricted stock purchase agreements or pursuant to optionee defaults on promissory notes issued in connection with the exercise of such options (“Reacquired Shares”). Under the terms of the 1997 Plan and the 2000 Plan, these Reacquired Shares would not otherwise have been available for reissuance. Only shares that were previously issued under the 1997 Plan and subsequently reacquired by us have been or will be reserved for issuance under the 2002 Plan.

We have authorized up to a maximum of 1,000,000 shares of common stock for issuance of Reacquired Shares under the 2002 Plan. At December 31, 2007 and 2006, a total of 1,000,000 shares were available for future options grants under the 2002 Plan, respectively.

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The provisions of the 2002 Plan are substantially similar to those of the 2000 Plan, except that the 2002 Plan does not permit the grant of awards to officers or directors and does not permit the grant of Incentive Stock Options. The 2002 Plan provides for the grant of nonstatutory stock options to employees (excluding officers) and consultants. Stock options granted under the 2002 Plan will be at prices not less than the fair value of the common stock at the date of grant. The term of each option, generally 10 years or less, will be determined by the administrator of the Plan.

2000 Director Option Plan

In May 2000, the board of directors adopted the 2000 Director Option Plan (“Director’s Plan”), which was effective upon the closing of the initial public offering. At December 31, 2007, and 2006, a total of 48,000 shares of common stock have been authorized for issuance under the Director’s Plan. At December 31, 2007 and 2006, a total of 10,000 and 16,000 shares, respectively, were available for future options grants under the Director’s Plan.

The Director’s Plan will automatically grant an option to purchase 8,000 shares of common stock to each non-employee director when he or she is first elected to our board of directors following the initial public offering. The Director’s Plan also provided that each non-employee director who had been a member of the board of directors for at least six months before the date of each annual stockholders’ meeting would receive an automatic annual grant of options to acquire 2,000 shares of common stock.

The options have an exercise price per share equal to the fair market value of common stock at the date of grant and have a term of 10 years. Initial options vest and become exercisable in four equal annual increments immediately following the date of grant. Later additional options granted vest and become exercisable on the fourth anniversary of the date of grant.

Impact of the Adoption of SFAS No. 123 (R)

We elected to adopt the modified prospective application method as provided by SFAS No. 123 (R). The effect of recording stock-based compensation for the years ended 2007 and 2006 was as follows (in thousands except per share data):

	Year Ended December 31, 2007		Year Ended December 31, 2006
Stock-based compensation expense	$	39	$	40
Tax effect on stock-based compensation		-		-
Net effect on net income	$	39	$	40
Effect on basic and diluted net income per share	$	0.00	$	0.00

Under the 1997, 2000, and 2002 stock option plans, the Board of Directors has the authority to determine the type of option and the number of shares subject to each option. The exercise price is generally equal to fair value of the underlying stock at the date of grant. Options generally become exercisable over a four-year period and, if not exercised, expire ten years from the date of grant. The 1997 Plan was terminated in connection with our initial public offering in 2000, and the shares reserved and unissued under the 1997 Plan were reserved for issuance under the 2000 Plan.

Under the Director’s Option Plan, option grants are made to new non-employee directors and to continuing non-employee directors pursuant to the terms contained in the Director Stock Option Plan Agreement. The exercise price is equal to fair value of the underlying stock at the date of grant. Initial options vest in four equal annual increments immediately following the date of grant and the subsequent options vest on the fourth anniversary of the date of grant. The options, if not exercised, expire ten years from date of grant.

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At December 31, 2007, the Company had the following stock plans:

	Shares Available for Grant		Options Outstanding
2000 Stock Option Plan		1,924,000		117,000
2002 Stock Option Plan		1,000,000		—
Directors’ Option Plan		10,000		36,000
Totals		2,934,000		153,000

As of January 1, 2006, we had an unrecorded deferred stock compensation balance related to stock options of approximately $139,000 before estimated forfeitures. In our pro forma disclosures prior to the adoption of SFAS No. 123 (R), we accounted for forfeitures upon occurrence. SFAS No. 123 (R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on our analysis of historical experience and review of current option holders, we have assumed an annual forfeiture rate of 2.5% for our options. Accordingly, as of January 1, 2006, we estimated that the stock-based compensation for the awards not expected to vest was approximately $13,000, and therefore, the unrecorded deferred stock-based compensation balance related to stock options was adjusted to approximately $126,000 after estimated forfeitures.

As of December 31, 2007, we had an unrecorded deferred stock compensation balance related to stock options of approximately $71,000 before estimated forfeitures. In our pro forma disclosures prior to the adoption of SFAS No. 123 (R), we accounted for forfeitures upon occurrence. SFAS No. 123 (R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on our analysis of historical experience and review of current option holders, we have assumed an annual forfeiture rate of 2.5% for our options. Accordingly, as of December 31, 2007, we estimated that the stock-based compensation for the awards not expected to vest was approximately $1,000, and therefore, the unrecorded deferred stock-based compensation balance related to stock options was adjusted to approximately $70,000 after estimated forfeitures.

During the fiscal year ended December, 31 2007, there were stock option grants for a total of 6,000 shares, with an exercise price of $3.50 per share, the market price on the date of grant.

As of December 31, 2007, the unrecorded stock-based compensation balance related to stock options was $70,000 and will be recognized over an estimated weighted average amortization period of 2 years.

Valuation Assumptions

The fair value of our options was estimated at the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:

	Fiscal Year Ended December 31,			Fiscal Year Ended December 31,			Fiscal Year Ended December 31,
	2007			2006			2005
Weighted average fair value of shares granted	$	1.65		$	1.17		$	1.07
Dividend yield		0.00	%		0.00	%		0.00	%
Volatility		0.39			0.40			0.47
Risk free interest rate		4.89	%		5.00	%		4.02	%
Expected life		6.25 years			6.25 years			4 years

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Summary Stock Option Plan Activity

Stock activity under the Stock Option Plans was as follows (in thousands, except per share data):

				Options Outstanding
	Shares Available for Grant			Shares			Weighted- Average Price Per Share
Balance as of December 31, 2004		2,487			590		$	8.88
Repurchased		10			—
Granted		(112	)		112			2.56
Exercised		0			0
Canceled		555			( 555	)		8.88
Balance as of December 31, 2005		2,940			147			8.37
Granted		(6	)		6			2.45
Canceled		6			(6	)		18.88
Balance as of December 31, 2006		2,940			147			7.69
Granted		(6	)		6			3.50
Balance as of December 31, 2007		2,934			153		$	7.52

The aggregate intrinsic value of stock options outstanding at December 31, 2007 is $23,000. The aggregate intrinsic value of options vested and expected to vest is $23,000 at December 31, 2007 and the weighted average contractual life is 7 years. The aggregate intrinsic value of options exercisable at December 31, 2007 is $18,500 and the weighted average contractual life is 7 years.

The following table summarizes information concerning options outstanding and exercisable at December 31, 2007 (in thousands, except per share data):

	Options Outstanding
			Weighted-				Options Exercisable
			Average		Weighted-				Weighted-
	Number		Remaining		Average		Number		Average
Range of	Of		Contractual		Exercise		Of		Exercise
Exercise Prices	Shares		Life (Years)		Price		Shares		Price
$2.15-2.60		118		7.8	$	2.56		107	$	2.58
3.50		6		9.5		3.50		-		-
5.20		4		5.4		5.20		4		5.20
6.96		12		5.8		6.96		12		6.96
8.80		4		4.4		8.80		4		8.80
22.30		4		3.5		22.30		4		22.30
120.00		5		2.7		120.00		5		120.00
$2.15-120.00		153		7.25	$	7.52		136	$	8.13

Exercisable options at December 31, 2007 and 2006 were 136,000 and 74,000 shares, respectively, at weighted average exercise prices of $8.13 and $12.47 per share, respectively. Options vested and expected to vest at December 31, 2007 were 139,000 at a weighted average exercise price of $7.41.

Warrants

In the second quarter of 2004, we issued to a reseller a warrant to acquire 254,489 shares of our stock at an exercise price of $4.65 per share. The warrant had a two-year term beginning May 28, 2004 and vested ratably over the term. If during the two-year term (1) any person or entity had acquired a greater than 50% interest in CoSine or the ownership or control of more than 50% of the voting stock of CoSine or (2) we had sold substantially all of our intellectual property assets, the warrant would have become fully exercisable. Even if the reseller did not immediately exercise the warrant upon the occurrence of such an event that made the warrant fully exercisable (a “trigger event”), the reseller would have been entitled to securities, cash and property to which it would have been entitled to upon the consummation of the trigger event, less the aggregate price applicable to the warrant. We calculated the fair value of the warrant to be approximately $487,000 using the Black-Scholes valuation method, using a volatility factor of 0.97, a risk-free interest rate of 2.5%, and an expected life of two years. The fair value of the warrant was amortized over the two-year life of the warrant. During the year ended December 31, 2007, 2006, and 2005, we amortized nil, $100,000 and $339,000 to cost of sales, respectively. The fair value of this warrant was fully amortized in 2006 and the warrant expired in May 2006.

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At December 31, 2007, warrants to purchase 3,750 shares of common stock at $80.00 per share were outstanding.

5. Related Parties

During 2006 and 2005, we, working with Steel Partners II, L.P. (“Steel Partners”), an entity that owns or controls 45% of our common stock, conducted a review of our historical net operating losses and a review of our ownership changes since our inception. The study was initiated to determine the effect, if any, of such ownership changes on the availability of our net operating loss carry-forwards. Steel Partners incurred direct expenses, primarily outside legal fees, in the amount of $42,000 and $40,728 in the years ended December 31, 2006 and 2005, respectively, in connection with the study and we have reimbursed them for these costs. At December 31, 2006, there were no amounts due to Steel Partners.

In July 2007, we contracted with SP Corporate Services, LLC, an entity owned by an affiliate of Steel Partners, to provide management and other administrative services, including the services of our Chief Executive and Chief Financial Officer. On approval of the contract by the independent members of our board of directors, our Chief Executive, Chief Financial Officer, and Secretary terminated his employment with us and became a Managing Director of SP Corporate Services LLC, effective July 1, 2007. We paid a total of $ 102,000 for such services for the year ended December 31, 2007 and owed SP Corporate Services LLC $0 at December 31, 2007.

6. Income Taxes

The benefits for income taxes of $(17,000), $(52,000), and $(228,000) for the years ended December 31, 2007, 2006 ,and 2005 respectively, are comprised entirely of foreign corporate income taxes. The difference between the benefit for income taxes and the amounts computed by applying the federal statutory income tax rate to the losses before income taxes are explained below (in thousands):

	2007			2006			2005
U.S. federal tax benefit at federal statutory rate	$	142		$	170		$	(353	)
Loss for which no tax benefit is currently recognizable		—						125
Loss for which a tax benefit is currently recognizable		(142	)		(170	)		—
Non-cash charges related to equity issuances		—			—			—
Reduction of foreign tax accrual		(17	)		(52	)		—
Total provision	$	(17	)	$	(52	)	$	(228	)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets (liabilities) are as follows (in thousands):

	December 31,
	2007			2006
Deferred tax assets (liabilities):
Net operating loss carryforwards	$	133,585			128,632
Equity related charges		(193	)		(193	)
Tax credit carryforwards		8,435			8,435
Inventory reserve		-			157
Capitalized research and development		4,652			5,815
Capital loss carryforward		61,134			61,011
Accruals and reserves not currently deductible		7			26
Total deferred tax assets (liabilities)		207,620			203,883
Valuation allowance		(207,620	)		(203,883	)
Net deferred tax assets (liabilities)	$	—		$	—

The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109” (“FIN 48”), on January 1, 2007. As a result of the implementation of FIN 48, the Company did not recognize any adjustment to the liability for uncertain tax positions and therefore did not record any adjustment to the beginning balance of accumulated deficit on the consolidated balance sheet. As of the date of adoption, the Company recorded no reduction to deferred tax assets for unrecognized tax benefits and therefore did not record any adjustment to the beginning balance of accumulated deficit on the balance sheet.

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The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2007, the Company had no accrued interest and/or penalties. The Company does not anticipate a significant change to its unrecognized tax benefits over the next twelve months. The unrecognized tax benefits may change during the next year for items that arise in the ordinary course of business. The unrecognized tax benefits at the end of December 31, 2007 are currently offset by a full valuation allowance.

Tax years 2004 through 2006 and 2003 through 2006 are subject to examination by the federal and state tax authorities, respectively. There are no income tax examinations currently in process.

Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” provides for the recognition of deferred tax assets if realization of the deferred tax assets is more likely than not. Based upon the weight of available evidence, which includes CoSine’s historical operating performance and the reported cumulative net losses in all prior years, CoSine has provided a full valuation allowance against its net deferred tax assets. The valuation allowance increased by $3,737,000 in 2007 and by $31,510,000 in 2006.

As of December 31, 2007, we had federal net operating loss carryforwards of approximately $353,000,000, which will begin to expire in 2018 if not utilized and state net operating loss carryforwards of approximately $225,000,000, which will begin to expire in 2007 if not utilized. Due to the “change in ownership” provisions of the Internal Revenue Code, the availability of our net operating loss and credit carryforwards may be subject to an annual limitation in future periods. Based on our review of historical “changes of control,” the maximum amount of federal net operating loss carryforwards subject to “change of control” limitations at December 31, 2007 was less than $3.0 million.

As of December 31, 2007 and 2006, we also had federal and state research and development tax credit carryforwards of approximately $7,113,000 and $7,967,000, respectively. The federal tax credit carryforwards will expire at various dates beginning in 2013, if not utilized. The state credits do not expire.

During fiscal 2006, we liquidated various foreign subsidiaries resulting in a capital loss carryforward of approximately $79,152,000. These losses may only be offset against future capital gains and will expire in fiscal 2011 if not utilized. During fiscal 2003, we liquidated a certain subsidiary, resulting in a capital loss carryforward of approximately $73,375,000. These losses may only be offset against future capital gains and will expire in fiscal 2008 if not utilized.

7. Sale of Intellectual Property

In March 2006, we signed agreements to sell the rights to our patent portfolio for $180,000 and in November 2006 we sold the rights to our intellectual property for $80,000. These amounts were recorded as other income for the year ended December 31, 2006.

8. Restructuring and Impairment Charges

Restructuring Charges

December 2004 Restructuring

In the quarter ended December 31, 2004, we continued our previously announced actions to terminate the remainder of our workforce, with a charge of $619,000, terminate the lease of our facilities in Redwood City, California, for a net charge of $2,522,000, representing a cash payment of $3,763,000, forfeiture of a $420,000 lease deposit, plus the write-off of $388,000 unamortized value of warrants issued in connection with the original execution of the lease, net of accrued rent of $2,049,000, and terminated our office lease in Japan for a net charge of $396,000. In addition, we accrued $1,037,000 for the termination of non-cancelable software license agreements, as the licenses were not expected to be used in the ongoing operations.

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Activity related to the December 2004 restructuring is as follows (in thousands):

	Worldwide Workforce Reduction			Lease Terminations			Software License Terminations			Total
December 2004 restructuring charges	$	619		$	2,918		$	1,037		$	4,574
Cash payments		(66	)		(3,900	)		—			(3,966	)
Write-offs		—			982			—			982
Provision balance at December 31, 2004		553			—			1,037			1,590
Cash payments		(550	)		—			(564	)		(1,114	)
Accrual adjustments		—			—			(23	)		(23	)
Provision balance at December 31, 2005		3			—			450			453
Cash payments		(3	)		—			(450	)		(453	)
Provision balance at December 31, 2006	$	—		$	—		$	—		$	—

September 2004 Restructuring

In September 2004, we announced actions to terminate most of our workforce, retaining a limited team of employees to provide customer support and handle matters related to the ongoing exploration of strategic alternatives. The specific actions include workforce reductions, with a charge of $2,872,000, announced discontinuance of the CoSine products, with a related charge to cost of sales of $3,466,000 to write inventory down to net realizable value and a $75,000 charge for unrecoverable royalties, and termination of third party manufacturing agreements, with a charge of $375,000.

Effective September 23, 2004, we approved severance agreements to Stephen Goggiano, our President and Chief Executive Officer, and Terry Gibson, our Chief Financial Officer, covering the period of August 1, 2004 through the earlier of (i) December 31, 2004 or (ii) the termination of their respective employments due to the elimination of their respective jobs if caused by a merger, sale, acquisition, liquidation, dissolution, consolidation, or similar corporate transaction, in exchange for their continued service to us as we explored strategic alternatives, including a sale of the Company, a sale or licensing of products, intellectual property, or individual assets, or a winding-up and liquidation of the business. In exchange for their continued service during this time period, Mr. Goggiano and Mr. Gibson each received a retention bonus equal to 100% of their base 2004 annual salary paid in January 2005. In addition, upon completion of these services, we agreed to pay for the cost of Mr. Goggiano's and Mr. Gibson's family health care coverage for a period of up to 12 months after termination of their respective employment. These amounts were accrued in the December 31, 2004 restructuring. These amounts were charged to restructuring in December 2004 and were paid in 2005.

Activity related to the September 2004 restructuring is as follows (in thousands):

	Worldwide Workforce Reduction			Write-down of Inventory and Prepaid royalty			Manufacturing Agreement Termination			Total
September 2004 restructuring charges	$	2,872		$	3,541		$	375		$	6,788
Cash payments		(2,448	)		—			(278	)		(2,726	)
Write offs		—			(3,541	)		(97	)		(3,638	)
Provision balance at December 31, 2004		424			—			—			424
Cash payments		(424	)		—			—			(424	)
Provision balance at December 31, 2005	$	—		$	—		$	—		$	—

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Impairment of Long-lived Assets

At December 31, 2006 and 2005, we had sold or scrapped all of our long-lived assets. During 2005, we had gains of $0.1 million from the sale of previously written-down long-lived assets.

2004 Impairment Charges

At June 30, 2004, we made an assessment of our business and concluded that indicators of impairment were present at June 30, 2004. Such indicators included ongoing operating losses and inability to achieve sustainable revenue growth, including our failure to attract new customers, and our decision to evaluate strategic alternatives. Accordingly, we performed an impairment test of the carrying value of our long-lived assets, consisting primarily of property and equipment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Based on an undiscounted cash flow analysis, the cash flows expected to be generated by our long-lived assets during their estimated remaining useful lives were not sufficient to recover the net book value of the assets. Consequently, we obtained a valuation report outlining the estimated fair value of the assets, based on quoted market prices, from an independent appraiser and recorded an impairment charge of $2.3 million to write down the carrying value of the long-lived assets held for use to their fair values in the second quarter of 2004.

At September 30, 2004, we concluded that indicators of impairment were again present. Such indicators included ongoing operating losses, inability to achieve sustainable revenue growth, and our decision to evaluate strategic alternatives. Accordingly, we performed an impairment test of the carrying value of our long-lived assets, consisting primarily of property and equipment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Based on an undiscounted cash flow analysis, the cash flows expected to be generated by our long-lived assets during their estimated remaining useful lives were not sufficient to recover the net book value of the assets. Consequently, we obtained competitive bids from qualified prospective purchasers to determine fair values. The fair values of the long-lived assets, as indicated by competitive bids, exceeded the net book value of the long-lived assets at September 30, 2004, accordingly, no further impairment adjustment was made in the third quarter of 2004.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

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Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.    The Securities and Exchange Commission defines the term "disclosure controls and procedures" to mean a company's controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported, within the time periods specified in the Commission's rules and forms. Our Chief Executive Officer and Chief Financial Officer has concluded, based on the evaluation of the effectiveness of the disclosure controls and procedures by our management, with the participation of our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this report, that our disclosure controls and procedures were effective for this purpose, except as noted below under "Changes in Internal Controls."

Managements’ annual report on internal control over financial reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Our management with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework of Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.

This Annual Report does not include an attestation report of the Company’s registered public accounting firm regarding internal controls over financial reporting. Management’s evaluation was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in the Annual Report.

Changes in Internal Controls. With respect to the most recently completed fiscal quarter, we initiated processes that improved our segregation of duties and enhanced our financial statement preparation and review processes. Other than these enhancements, there have been no changes to our internal controls which have materially affected, or are reasonably likely to materially affect our internal controls over financial reporting.

Limitations on Effectiveness of Controls and Procedures.  Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Item 9B. Other Information

None.

PART III

Item 10. Directors and Executive Officers and Corporate Governance

Except as set forth above in Part I under “Executive Officers of the Registrant” and in the paragraph below, the information required by Item 10 has been omitted from this Annual Report on Form 10-K, and is incorporated by reference to the sections “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders, which we will file with the Commission pursuant to Regulation 14A within 120 days after the end of our 2007 fiscal year.

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On March 11, 2008, our Board of Directors adopted an amended and restated Code of Business Conduct and Ethics that applies to our officers, including our principal executive officer, principal financial officer, principal accounting officer and all other officers, directors and employees in compliance with applicable rules of the Securities and Exchange Commission. Our Code of Business Conduct and Ethics is attached as an exhibit to this Annual Report. Stockholders may obtain copies of our Code of Business Conduct and Ethics by contacting the Secretary of CoSine Communications at the address or phone number listed on the cover page of this Annual Report.

Item 11. Executive Compensation

Information required by Item 11 has been omitted from this Annual Report on Form 10-K and is incorporated by reference to the section “Executive Compensation” in our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information required by Item 12 has been omitted from this Annual Report on Form 10-K and is incorporated by reference to the sections “Security Ownership of Management and Certain Beneficial Owners” and “Equity Compensation Plan Information” in our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders.

Item 13. Certain Relationships and Related Transactions and Director Independence

Information required by Item 13 has been omitted from this Annual Report on Form 10-K and is incorporated by reference to the section “Election of Directors” in our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders.

Item 14. Principal Accountant Fees and Services

Information required by Item 14 has been omitted from this Annual Report on Form 10-K and is incorporated by reference to the section “Audit Committee Disclosure” in our definitive Proxy Statement for the 2008 Annual Meeting of Stockholders.

Item 15. Exhibits and Financial Statement Schedules

(a) The following documents are filed as part of this Annual Report on Form 10-K:

(1)Financial Statements:

	Page
Report of Independent Registered Public Accounting Firm – Burr, Pilger & Mayer LLP	23
Consolidated Balance Sheets — December 31, 2007 and 2006	24
Consolidated Statements of Operations — Years ended December 31, 2007, 2006, and 2005	25
Consolidated Statements of Stockholders’ Equity— Years ended December 31, 2007, 2006, and 2005	26
Consolidated Statements of Cash Flows — Years ended December 31, 2007, 2006, and 2005	27
Notes to Consolidated Financial Statements	28

(2)Financial Statement Schedules:

Schedule II — Valuation and Qualifying Accounts 46

All other schedules are omitted as they are not applicable or the required information is shown in the consolidated financial statements or the notes thereto.

(3)Exhibits:

See Exhibit Index on page 48. The Exhibits listed in the accompanying Exhibit Index are filed as part of this Annual Report on Form 10-K.

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COSINE COMMUNICATIONS, INC.

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

Classification	Balance at Beginning of Year		Charged to Expenses (Credits)			Additions (Deductions)(1)		Balance at End of Year
	(In thousands)
Year ended December 31, 2007
Reserves for accounts receivable	$	—		—			—	$	—
Year ended December 31, 2006:
Reserves for accounts receivable	$	—	$	—			—	$	—
Year ended December 31, 2005:
Reserves for accounts receivable	$	90	$	(90	)	$	—	$	—

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 13, 2008.

COSINE COMMUNICATIONS, INC.
By:	/s/	Terry R. Gibson
		Terry R. Gibson
		Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Terry Gibson his true and lawful attorneys-in-fact and agents, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto and all other documents in connection therewith, with the Securities and Exchange Commission, granting unto each of said attorneys-in-fact, or his substitute or substitutes, and each of them, hereby ratifying and confirming all that such attorneys-in-fact, or any substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 13, 2008 by the following persons in the capacities indicated.

Signature		Title
/s/	TERRY R. GIBSON	Chief Executive Officer, Chief Financial Officer and
	Terry R, Gibson	Director (Principal Executive Officer and Principal Accounting Officer)
/s/	Donald Green	Chairman of the Board and Director
	Donald Green
/s/	Charles J. Abbe	Director
	Charles J. Abbe
/s/	Jack L. Howard	Director
	Jack L. Howard

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EXHIBIT INDEX

Description

3.2*	Fourth Amended and Restated Certificate of Incorporation filed with the Delaware Secretary of State on May 30, 2006 (incorporated by reference to Exhibit 3.1 to Form 10-Q filed August 2, 2006).
3.3*	Bylaws (incorporated by reference to Exhibit 3.3 to Form 8A (file no. 000-30715) filed May 26, 2000).
3.4*	First Amendment to Bylaws dated April 30, 2001 (incorporated by reference to Exhibit 3.3 to Form 10-Q filed August 13, 2001).
3.5*	Second Amendment to Bylaws dated January 28, 2003 (incorporated by reference to Exhibit 3.4 to Form 10-K filed March 27, 2003).
3.6*	Third Amendment to Bylaws dated February 2, 2004 (incorporated by reference to Exhibit 3.5 to Form 10-K filed March 25, 2004).
3.7*	Certificate of Designation of Series A Junior Participating Preferred Stock, as filed with the Secretary of State of Delaware on September 8, 2005 (incorporated by reference to Exhibit 3.1 to Form 8-K filed September 8, 2005).
4.1*	Form of Rights Certificate (incorporated by reference to Exhibit 4.1 to Form 8-K filed September 8, 2005).
4.2*	Rights Agreement, dated as of September 1, 2005, by and between CoSine Communications, Inc. and Mellon Investor Services LLC (incorporated by reference to Exhibit 4.2 to Form 8-K filed September 8, 2005).
4.3*	First Amendment to Rights Agreement by and between CoSine Communications, Inc. and Mellon Investor Services LLC, effective as of August 31, 2007 (incorporated by reference to Exhibit 10.1 to Form 8-K filed September 4, 2007).
4.4*	Form of warrant to purchase common stock issued by the Registrant to Fujitsu Network Communications, Inc. dated as of May 28, 2004 (incorporated by reference to Exhibit 4.1 to Form 10-Q filed August 9, 2004).
10.1*	1997 Stock Plan (as amended and restated) and forms of agreements thereunder (incorporated by reference to Exhibit 10.5 of Registration Statement on Form S-1 filed April 28, 2000).
10.2*	2000 Stock Plan and forms of agreements thereunder (incorporated by reference to Exhibit 10.2 of Amendment No. 1 to Registration Statement on Form S-1 filed June 6, 2000).
10.3*	2000 Employee Stock Purchase Plan and forms of agreements thereunder (incorporated by reference to Exhibit 10.3 of Amendment No. 1 to Registration Statement on Form S-1 filed June 6, 2000).
10.4*	2000 Director Option Plan and forms of agreements thereunder (incorporated by reference to Exhibit 10.4 of Amendment No. 1 to Registration Statement on Form S-1 filed June 6, 2000).
10.5*	2002 Stock Plan and forms of agreements thereunder (incorporated by reference to Exhibit 10.17 to Form 10-K filed March 25, 2002).
10.6*	Form of Severance Agreement extended to Stephen Goggiano, President and Chief Executive Officer of Registrant, and Terry R. Gibson, Chief Financial Officer of Registrant, as of September 23, 2004 (incorporated by reference to Exhibit 10.1 to Form 10-Q filed November 15, 2004).
10.7*	Statement of Work between Registrant and Wipro Limited, dated October 14, 2004 (incorporated by reference to Exhibit 10.2 to Form 10-Q filed November 15, 2004).
10.8*	Services Agreement by and between Cosine Communications, Inc. and SP Corporate Services LLC, effective as of July 1, 2007 (incorporated by reference to Exhibit 10.1 to Form 8K filed June 19, 2007).
14.1	Code of Business Conduct and Ethics, adopted March 11, 2008.
21.1	Subsidiary of the Registrant
23.1	Consent of Independent Registered Public Accounting Firm - Burr, Pilger & Mayer LLP.
31.1	Certification of Terry R. Gibson, Chief Executive Officer and Chief Financial Officer of CoSine Communications, Inc., pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Terry R. Gibson, Chief Executive Officer and Chief Financial Officer of CoSine Communications, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Previously filed.

48