**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





________________





**FORM
      10-Q**


________________




**(MARK
      ONE)**


[X]
            **QUARTERLY****REPORT
                PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
                1934**





**FOR
      THE QUARTERLY PERIOD ENDED** **SEPTEMBER 30, 2005**





**OR**





[   ]
            **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)***560
                South Winchester Blvd., Suite 500, San Jose, CA**
            **95128***(Address
                of principal executive offices)*
            *(Zip
                Code)*





**Registrant's
      telephone number including area code: (408) 236-7518**





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 [   ]





Indicate
      by check mark whether the registrant is an accelerated filer (as defined in
      Rule
      12b-2 of the Exchange Act).


Yes
      [ ]
      No [X]




**There
      were 10,090,635 shares of the Company's Common Stock, par value $.0001,
      outstanding on October 15, 2005.**










**COSINE
      COMMUNICATIONS, INC.**





**FORM
      10-Q**





**Quarter
      ended September 30, 2005**





**TABLE
      OF CONTENTS**




**PART
                I**
            PageFINANCIAL
                INFORMATIONItem
                1. Condensed Consolidated Financial Statements:Condensed
                Consolidated Balance Sheets as of September 30, 2005 and December
                31,
                2004
            1Condensed
                Consolidated Statements of Operations for the Three and Nine Months
                Ended
                September 30, 2005 and 2004
            2Condensed
                Consolidated Statements of Cash Flows for the Nine Months Ended September
                30, 2005 and 2004
            3Notes
                to Condensed Consolidated Financial Statements
            4Item
                2. Management's Discussion and Analysis of Financial Condition and
                Results
                of Operations
            11Item
                3. Quantitative and Qualitative Disclosures About Market
                Risk
            26Item
                4. Controls and Procedures
            26**PART
                II**OTHER
                INFORMATIONItem
                1. Legal Proceedings
            27Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            28Item
                6. Exhibits
            28Signature
            29Exhibit
                Index
            30Certifications
            31














**PART
      I. FINANCIAL INFORMATION**





**ITEM
      1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**COSINE
      COMMUNICATIONS, INC.**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**** (In
      thousands, except for par value and share data)





**September
                30,**
              **2005**
            
            **December
                31,**
              **2004****(Unaudited)**
            
            **(1)**ASSETSCurrent
                assets:Cash
                and cash equivalents
            
            $
            12,113
            
            $
            9,203Short-term
                investments
            
            
            10,864
            
            
            15,710Accounts
                receivable:Trade
                (net of allowance for doubtful accounts of $56 at September 30, 2005
                and
                $90 at December 31, 2004)
            
            
            171
            
            
            1,328Other
                receivables
            
            
            162
            
            
            483Prepaid
                expenses and other current assets
            
            
            416
            
            
            949Total
                current assets
            
            
            23,726
            
            
            27,673Long-term
                deposits and other assets
            
            
            310
            
            
            150$
            24,036
            
            $
            27,823LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                liabilities:Accounts
                payable
            
            $
            243
            
            $
            252Provision
                for warranty claims
            
            
            43
            
            
            157Accrued
                other liabilities
            
            
            1,011
            
            
            3,129Accrued
                compensation
            
            
            —
            
            
            412Deferred
                revenue
            
            
            469
            
            
            509Total
                current liabilities
            
            
            1,766
            
            
            4,459Total
                liabilities
            
            
            1,766
            
            
            4,459Stockholders'
                equity:Preferred
                stock, 3,000,000 authorized, none issued and outstanding
            
            
            —
            
            
            —Common
                stock, $.0001 par value, 300,000,000 shares authorized; 10,090,635
                and
                10,159,790 shares issued and outstanding at September 30, 2005 and
                December 31, 2004, respectively
            
            
            1
            
            
            1Additional
                paid-in capital
            
            
            538,947
            
            
            540,028Notes
                receivable from stockholders
            
            
            —
            
            
            (1,520
            )Accumulated
                other comprehensive income
            
            
            623
            
            
            614Accumulated
                deficit
            
            
            (517,301
            )
            
            (515,759
            )Total
                stockholders' equity
            
            
            22,270
            
            
            23,364$
            24,036
            
            $
            27,823





See
      accompanying notes.





________________________________




(1)
      The
      information in this column was derived from the Company's audited consolidated
      financial statements for the year ended December 31, 2004.





1





**COSINE
      COMMUNICATIONS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


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


**(Unaudited)**





**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004**
            
            ******2005**
            
            ******2004**Revenue:Product
            
            $
            —
            
            $
            452
            
            $
            216
            
            $
            5,989Service
            
            
            785
            
            
            636
            
            
            2,165
            
            
            2,122Total
                revenue
            
            
            785
            
            
            1,088
            
            
            2,381
            
            
            8,111Cost
                of revenue1
            
            
            702
            
            
            4,441
            
            
            1,545
            
            
            7,373Gross
                profit (loss)
            
            
            83
            
            
            (3,353
            )
            
            836
            
            
            738Operating
                expenses:Research
                and development2
            
            
            —
            
            
            3,709
            
            
            103
            
            
            13,316Sales
                and marketing3
            
            
            —
            
            
            3,056
            
            
            105
            
            
            9,594General
                and administrative4
            
            
            422
            
            
            1,721
            
            
            2,825
            
            
            4,626Restructuring
                and impairment charges
            
            
            —
            
            
            2,871
            
            
            (91
            )
            
            5,214Total
                operating expenses
            
            
            422
            
            
            11,357
            
            
            2,942
            
            
            32,750Loss
                from operations
            
            
            (339
            )
            
            (14,710
            )
            
            (2,106
            )
            
            (32,012
            )Interest
                income and other
            
            
            191
            
            
            82
            
            
            470
            
            
            304Loss
                before income tax provision (benefit)
            
            
            (148
            )
            
            (14,628
            )
            
            (1,636
            )
            
            (31,708
            )Income
                tax provision (benefit)
            
            
            (117
            )
            
            (9
            )
            
            (94
            )
            
            2Net
                loss
            
            $
            (31
            )
            $
            (14,619
            )
            $
            (1,542
            )
            $
            (31,710
            )Basic
                and diluted net loss per share
            
            $
            (0.00
            )
            $
            (1.47
            )
            $
            (0.15
            )
            $
            (3.17
            )Shares
                used in computing per share amounts
            
            
            10,091
            
            
            9,945
            
            
            10,095
            
            
            9,998







See
      accompanying notes.




1  Cost
        of
        revenues includes non-cash (credits) charges related to equity issuances
        of $279
        and $4 for the three months ended September 30, 2005 and 2004, respectively,
        and
        $279 and ($65) for the nine months ended September 30, 2005 and 2004,
        respectively.
 2  Research
        and development expenses include non-cash (credits) charges related to equity
        issuances of nil and $1 for the three months ended September 30, 2005 and
        2004,
        respectively, and nil and ($213) for the nine months ended September 30,
        2005
        and 2004, respectively.
 3  Sales
        and
        marketing expenses include non-cash charges (credits) related to equity
        issuances of nil and ($2) for the three months ended September 30, 2005 and
        2004, respectively, and nil and ($195) for the nine months ended September
        30,
        2005 and 2004, respectively.
 4  General
        and administrative expenses include non-cash charges (credits) of nil and
        ($1)
        for the three months ended September 30, 2005 and 2004, respectively, and
        nil
        and ($402) for the nine month periods ended September 30, 2005 and 2004,
        respectively, related to equity issuances.


2





**COSINE
      COMMUNICATIONS, INC.**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**(In
      thousands)**


**(Unaudited)**





**Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004****Operating
                activities:**Net
                loss
            
            
            ($1,542
            )
            
            ($31,710
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
            
            
            —
            
            
            1,398Allowance
                for doubtful accounts
            
            
            —
            
            
            14Non-cash
                charges related to inventory write-down
            
            
            —
            
            
            4,220Write-down
                of property and capital equipment
            
            
            —
            
            
            2,308Amortization
                of warrants issued for services
            
            
            279
            
            
            78Amortization
                of deferred stock compensation
            
            
            —
            
            
            (971
            )Reversal
                of amortization in excess of vesting
            
            
            —
            
            
            (185
            )Other
                non-cash restructuring items
            
            
            —
            
            
            75Bonus
                awarded in shares of common stock
            
            
            —
            
            
            228Other,
                net
            
            
            —
            
            
            123Change
                in operating assets and liabilities:Accounts
                receivable, trade
            
            
            1,157
            
            
            4,273Other
                receivables
            
            
            321
            
            
            (192
            )Inventory
            
            
            —
            
            
            (313
            )Prepaid
                expenses and other current assets
            
            
            533
            
            
            (641
            )Long-term
                assets
            
            
            1
            
            
            245Accounts
                payable
            
            
            (9
            )
            
            (598
            )Provision
                for warranty claims
            
            
            (114
            )
            
            (181
            )Accrued
                other liabilities
            
            
            (2,118
            )
            
            (344
            )Accrued
                compensation
            
            
            (412
            )
            
            1,671Deferred
                revenue
            
            
            (40
            )
            
            (2,594
            )Accrued
                rent
            
            
            —
            
            
            (29
            )Net
                cash used in operating activities
            
            
            (1,944
            )
            
            (23,125
            )**Investing
                activities:**Capital
                expenditures
            
            
            —
            
            
            (1,053
            )Purchase
                of short-term investments
            
            
            (12,275
            )
            
            (34,480
            )Proceeds
                from sales and maturities of short-term investments
            
            
            17,129
            
            
            50,267Net
                cash provided by investing activities
            
            
            4,854
            
            
            14,734**Financing
                activities:**Principal
                payments of equipment and working capital loans and capital
                leases
            
            
            —
            
            
            (129
            )Proceeds
                from issuance of common stock, net
            
            
            —
            
            
            226Net
                cash provided by financing activities
            
            
            —
            
            
            97Net
                increase (decrease) in cash and cash equivalents
            
            
            2,910
            
            
            (8,294
            )Cash
                and cash equivalents at the beginning of the period
            
            
            9,203
            
            
            19,719Cash
                and cash equivalents at the end of the period
            
            $
            12,113
            
            $
            11,425**Supplemental
                information:**Cash
                paid for interest
            
            $
            —
            
            $
            3Income
                taxes paid
            
            $
            23
            
            $
            53Cancellation
                of notes receivable due to repurchase of unvested stock
            
            $
            1,520
            
            $
            3,531Issuance
                of warrant to reseller and revaluation
            
            $
            439
            
            $
            48Re-measurement
                of deferred stock compensation
            
            $
            —
            
            $
            251Net
                transfer from inventory to property and equipment
            
            $
            —
            
            $
            173





See
      accompanying notes.





3





**COSINE
      COMMUNICATIONS, INC.**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





1.
      BASIS
      OF PRESENTATION





*Description
      of Business*





CoSine
      Communications, Inc. (“the Company” or “CoSine”) was incorporated in California
      on April 14, 1997 and in August 2000 was reincorporated in the State of
      Delaware. CoSine was engaged in the development and sale of network-based,
      high-performance Internet service delivery platforms for the global business
      Internet Protocol Service Provider market. CoSine’s business currently consists
      primarily of a customer service capability operated under contract by a third
      party.





*Liquidity
      and Strategic Alternatives*





The
      accompanying financial statements have been prepared in conformity with US
      generally accepted accounting principles, which contemplate continuation of
      the
      Company as a going concern. However, at September 30, 2005, the Company has
      an
      accumulated deficit of $517,301,000, has sold substantially all of its operating
      assets and continues to incur losses and negative cash flow from operating
      activities. As of December 31, 2004 and September 30, 2005, the Company’s
      business consisted primarily of a customer service capability operated under
      contract by a third party. 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. 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.





On
      July
      29, 2004, CoSine announced that it was exploring various strategic alternatives
      and that the Company had hired an investment bank as its financial advisor.





On
      September 8, 2004, CoSine announced that after an extensive evaluation of
      strategic alternatives, the Company initiated actions to lay-off most of its
      employees, retaining a limited team of employees to provide customer support
      and
      handle matters related to the ongoing exploration of strategic alternatives.
      Since September 8, 2004, the Company has taken a number of actions to reduce
      its
      operating expenses and conserve its cash. CoSine has notified its existing
      customers that the CoSine products are now formally discontinued and that
      existing customers may place “lifetime buy” orders to support their platform
      transition plans. The Company has sold, scrapped or written its inventory down
      to estimated net realizable value at December 31, 2004 and September 30, 2005.
      The Company has taken steps to terminate contract manufacturing arrangements,
      contractor and consulting arrangements and facility leases. These activities
      continued through September 30, 2005. CoSine’s business currently consists
      primarily of a customer service capability operated under contract by a third
      party.





On
      January 7, 2005, the Company entered into an Agreement and Plan of Merger with
      Tut Systems, Inc. (“Tut”). The proposed merger was structured as a
      stock-for-stock transaction. Upon closing, the Company’s shareholders were to
      receive approximately 6.0 million shares of Tut common stock in exchange for
      all
      the outstanding shares of the Company. The merger was terminated on May 16,
      2005.





In
      June
      2005, the Company was informed that its stock would be de-listed from the Nasdaq
      National Market System pursuant to Nasdaq Marketplace Rules 4300 and 4330
      (a)(3). The Company’s stock was de-listed on June 16, 2005 and now trades in the
      over the counter market under the symbol “COSN.PK.”




In
      July
      2005, the Company completed a comprehensive review of strategic alternatives,
      including a sale of the Company, a sale or licensing of intellectual property,
      a
      redeployment of the Company’s assets into new business ventures, or a winding-up
      and liquidation of the business and a return of capital. The board of directors
      has approved a plan to redeploy CoSine’s existing resources to identify and
      acquire one or more new business operations, while continuing to support
      CoSine’s existing customers and continuing to offer CoSine’s intellectual
      property for license or sale. CoSine’s 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 the Company’s net operating loss
      carry-forwards (“NOLs”). As of this date, no candidate has been identified, and
      no assurance can be given that the Company will find suitable candidates, and
      if
      it does, that the Company will be able to utilize its existing NOLs. The Company
      will continue to prepare its financial statements on the assumption that it
      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 the Company’s assessment of its strategic alternatives. If at some
      point the Company were to decide to pursue alternative plans, the Company may
      be
      required to present the financial statements on a different basis. As an
      example, if the Company 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.





4





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





The
      unaudited condensed consolidated financial statements have been prepared by
      CoSine Communications, Inc. pursuant to instructions to Form 10-Q and Article
      10
      of Regulation S-X and include the accounts of CoSine Communications, Inc. and
      its wholly owned subsidiaries ("CoSine" or collectively, the "Company"). Certain
      information and footnote disclosures normally included in financial statements
      prepared in accordance with generally accepted accounting principles have been
      condensed or omitted pursuant to the Securities Exchange Commission’s rules and
      regulations. In the opinion of management, all adjustments (consisting of normal
      recurring items) necessary for a fair presentation have been included. The
      results of operations for the three and nine months ended September 30, 2005
      are
      not necessarily indicative of the results to be expected for any subsequent
      quarter or for the entire year. The condensed consolidated balance sheet at
      December 31, 2004 has been derived from the audited financial statements as
      of
      that date. These unaudited condensed consolidated financial statements should
      be
      read in conjunction with the audited consolidated financial statements and
      the
      notes included in CoSine's Annual Report filed on Form 10-K for the year ended
      December 31, 2004.





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





*Use
      of Estimates*





The
      preparation of consolidated financial statements in conformity with US 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 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.





*Pro
      Forma Stock Compensation Information*





CoSine
      has elected to continue to follow Accounting Principles Board Opinion 25 (“APB
      25”), “Accounting for Stock Issued to Employees,” and related interpretations to
      account for employee stock options. The alternative fair value method of
      accounting prescribed by Statement of Financial Accounting Standards 123 (“SFAS
      123”), “Accounting for Stock-Based Compensation,” as amended by SFAS 148,
“Accounting for Stock-Based Compensation - Transition and Disclosure” requires
      the use of option valuation. Under APB 25, no compensation expense is recognized
      when the exercise price of employee stock options equals the market price of
      the
      underlying stock on the date of grant.





5





The
      following table illustrates the effect on CoSine’s net loss and net loss per
      share if CoSine had applied the fair value recognition provisions of SFAS 123
      to
      stock-based employee compensation (in thousands, except per share
      data):


**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,********2005**
            
            ******2004**
            
            ******2005**
            
            ******2004**Net
                loss, as reported
            
            
            ($31
            )
            
            ($14,619
            )
            
            ($1,542
            )
            
            ($31,710
            )Add:
                Stock-based employee compensation expense (credit), net of tax, included
                in reported net loss
            
            
            —
            
            
            4
            
            
            —
            
            
            (743
            )Deduct:
                Reversal of amortization in excess of vesting, net of tax
            
            
            —
            
            
            (21
            )
            
            —
            
            
            (184
            )Deduct:
                Stock-based employee compensation expense determined under fair value
                method for all stock option grants, net of tax
            
            
            —
            
            
            (179
            )
            
            —
            
            
            (716
            )Pro
                forma net loss
            
            
            ($31
            )
            
            ($14,457
            )
            
            ($1,542
            )
            
            ($33,353
            )Basic
                and diluted net loss per share, as reported
            
            
            ($0.00
            )
            
            ($1.47
            )
            
            ($0.15
            )
            
            ($3.17
            )Pro
                forma basic and diluted net loss per share
            
            
            ($0.00
            )
            
            ($1.45
            )
            
            ($0.15
            )
            
            ($3.34
            )





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


**Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**Dividend
                  yield
              
              
              0.0%
              
              
              —
              
              
              0.0%
              
              
              0.0%Volatility
              
              
              0.95
              
              
              —
              
              
              0.95
              
              
              0.97Risk
                  free interest rate
              
              
              2.6%
              
              
              —
              
              
              2.6%
              
              
              2.5%Expected
                  life
              
              
              4
                  years
              
              
              —
              
              
              4
                  years
              
              
              4
                  years





In
      the three and nine months ended September 30, 2005, no shares were issued under
      the Employee Stock Purchase Plan and the plan has been terminated. The estimated
      weighted-average fair value of shares issued under the Employee Stock Purchase
      Plan in 2004 was $4.09, using a volatility of 64%, risk-free interest rate
      of 2%
      and an expected life of one year.





*Guarantees*





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





6





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,
      CoSine has not been obligated to make payments for these obligations, and no
      liabilities have therefore been recorded for these obligations on its condensed
      consolidated balance sheet as of September 30, 2005.








2.
      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
      officers 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. The
      settlement is subject to a number of conditions, including final court approval,
      which cannot be assured. 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.
      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.





On
      January 18, 2005, CoSine and its officers and directors were named as defendants
      in a securities class action lawsuit filed in San Mateo County Superior Court.
      The suit requested that a proposed acquisition of CoSine by Tut Systems, Inc
      be
      enjoined due to alleged self-dealing and breach of fiduciary duties by CoSine’s
      officers and directors. This suit was dismissed in May 2005 at the request
      of
      the plaintiffs.





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




3.
      BALANCE SHEET DETAILS





*Inventory*





In
      the
      quarter ended September 30, 2004, the Company announced that it had discontinued
      its products and accordingly wrote its inventory down to net realizable value.
      At December 31, 2004 and September 30, 2005, all inventory had been sold,
      scrapped or written-off and there was no inventory awaiting customer acceptance.





7





During
      the three and nine months ended September 30, 2005, $25,000 of previously
      written-down inventory was sold. During the three months ended September 30,
      2004, no previously written-down inventory was sold and $3.5 million of
      inventory was written down.





During
      the nine months ended September 30, 2004, $0.3 million of previously
      written-down inventory was sold and $4.1 million of inventory was written-down.
      In addition, charges of $375,000 were recorded in the nine months ended
      September 30, 2004 in connection with excess purchase commitments at CoSine’s
      contract manufacturers and with the termination of the contract manufacturing
      agreements.





*Warranty*





CoSine
      provided a basic limited warranty, including repair or replacement of parts,
      and
      technical support for products sold on or before September 30, 2004. The
      specific terms and conditions of those warranties varied depending on the
      customer or region in which CoSine did business. CoSine estimated the costs
      that
      may be incurred under its basic limited warranty and recorded a liability in
      the
      amount of such costs at the time product revenue was recognized. CoSine’s
      warranty obligation is affected by the number of installed units, product
      failure rates, materials usage and service delivery costs incurred in correcting
      product failures. CoSine periodically assesses the adequacy of its recorded
      warranty liabilities and adjusts the amounts as necessary.





Changes
      in CoSine’s warranty liability were as follows, in thousands:





**Nine
                Months Ended September 30,****2005**
            
            **2004**Beginning
                balance
            
            $
            157
            
            $
            464Warranty
                charged to cost of revenue
            
            
            —
            
            
            150Utilization
                of warranties
            
            
            —
            
            
            (313
            )Changes
                in estimated liability based on experience
            
            
            (114
            )
            
            (18
            )Ending
                balance
            
            $
            43
            
            $
            283








4.
      NET
      LOSS PER COMMON SHARE




Basic
      net
      loss per common share is calculated based on the weighted-average number of
      common shares outstanding during the periods presented, less weighted-average
      shares outstanding that are subject to CoSine's right of repurchase. Common
      stock equivalents consisting of stock options and warrants (calculated using
      the
      treasury stock method), have been excluded from the diluted net loss per common
      share computations, as their inclusion would be antidilutive. These securities
      amounted to 107,000 shares and 1,182,044 shares for the nine months ended
      September 30, 2005 and 2004, respectively.




The
      calculations of basic and diluted net loss per share are shown below, in
      thousands, except per share data:


**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                loss
            
            
            ($
                31
            )
            
            ($14,619
            )
            
            ($1,542
            )
            
            ($31,710
            )Basic
                and diluted:Weighted-average
                shares of common stock outstanding
            
            
            10,091
            
            
            10,177
            
            
            10,095
            
            
            10,199Weighted-average
                shares subject to repurchase
            
            
            —
            
            
            (232
            )
            
            —
            
            
            (201
            )Weighted-average
                shares used in basic and diluted net loss per share
            
            
            10,091
            
            
            9,945
            
            
            10,095
            
            
            9,998Basic
                and diluted net loss per share
            
            
            ($0.00
            )
            
            ($1.47
            )
            
            ($0.15
            )
            
            ($3.17
            )





5.
      COMPREHENSIVE LOSS





The
      components of comprehensive loss are shown below, in thousands:





8








**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004**Net
                loss
            
            
            ($31
            )
            
            ($14,619
            )
            
            ($1,542
            )
            
            ($31,710
            )Other
                comprehensive gain (loss):Unrealized
                gains (losses) on investments
            
            
            (2
            )
            
            17
            
            
            8
            
            
            (48
            )Currency
                translation adjustment
            
            
            —
            
            
            18
            
            
            —
            
            
            3Total
                other comprehensive gain (loss)
            
            
            (2
            )
            
            35
            
            
            8
            
            
            (45
            )Comprehensive
                loss
            
            
            ($33
            )
            
            ($14,584
            )
            
            ($1,534
            )
            
            ($31,755
            )





6.
      SEGMENT REPORTING




CoSine
      operates in only one operating segment, and substantially all of CoSine’s assets
      are located in the United States.




Revenues
      from customers by geographic region for the three and nine months ended
      September 30, 2005 and 2004, respectively, were as follows, in
      thousands:


**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004****Region**North
                America
            
            $
            457
            
            $
            342
            
            $
            1,320
            
            $
            3,033Italy
            
            
            57
            
            
            52
            
            
            166
            
            
            804France
            
            
            63
            
            
            350
            
            
            216
            
            
            1,286South
                Korea
            
            
            11
            
            
            18
            
            
            42
            
            
            1,580Japan
            
            
            108
            
            
            50
            
            
            422
            
            
            664Other
                EMEA.
            
            
            89
            
            
            266
            
            
            215
            
            
            714Other
                Asia/Pacific
            
            
            —
            
            
            10
            
            
            —
            
            
            30Total
            
            $
            785
            
            $
            1,088
            
            $
            2,381
            
            $
            8,111




7.
      RESTRUCTURING CHARGES





*December
      2004 Restructuring*





In
      the
      quarter ended December 31, 2004, CoSine continued its previously announced
      actions to terminate the remainder of its workforce, terminated the lease of
      its
      facilities in Redwood City, California, and terminated its office lease in
      Japan. In addition, CoSine accrued for the termination of non-cancelable
      software license agreements, as the licenses were not expected to be used in
      the
      ongoing operations.





Activity
      related to the December 2004 restructuring for the nine months ended September
      30, 2005 is as follows (in thousands):





Worldwide
              workforce
              reduction
            
            Lease
              Terminations
            
            Software
              License
              Terminations
            
            TotalProvision
                balance at December 31, 2004
            
            $
            553
            
            $
            —
            
            $
            1,037
            
            $
            1,590Cash
                payments
            
            
            (543
            )
            
            —
            
            
            (564
            )
            
            (1,107
            )Write
                offs
            
            
            —
            
            
            —
            
            
            (23
            )
            
            (23
            )Provision
                balance at September 30, 2005
            
            $
            10
            
            $
            —
            
            $
            450
            
            $
            460




9





*September
      2004 Restructuring*





In
      September 2004, CoSine announced actions to terminate most of its 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 included workforce reductions, announced discontinuance of
      the
      CoSine products, a charge for unrecoverable royalties, and termination of third
      party manufacturing agreements.





Effective
      September 23, 2004, CoSine approved severance agreements to Stephen Goggiano,
      its president and chief executive officer, and Terry Gibson, its 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 CoSine as it 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. Both Mr.
      Goggiano's and Mr. Gibson's employment with CoSine terminated in January 2005.
      Also in exchange for their continued service during this time period, CoSine
      agreed to pay for the cost of Mr. Goggiano's, Mr. Gibson's and their families'
      health care coverage for a period of 12 months after termination of their
      respective employment. These amounts were charged to restructuring in December
      2004.





Activity
      related to the September 2004 restructuring for the nine months ended September
      30, 2005 is as follows (in thousands):





Worldwide
                workforcereduction
            
            Write-down
                of inventory and prepaidroyalty
            
            Manufacturing
                agreementtermination
            
            TotalProvision
                balance at December 31, 2004
            
            $
            424
            
            $
            —
            
            $
            —
            
            $
            424Cash
                payments
            
            
            (424
            )
            
            —
            
            
            —
            
            
            (424
            )Write
                offs
            
            
            —
            
            
            —
            
            
            —
            
            
            —Provision
                balance at September 30, 2005
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —




8.
            RELATED
                PARTY TRANSACTIONS





In
      August
      2005, our board of directors worked with Steel Partners II, L.P. (“Steel
      Partners”), an entity that owns 24% of CoSine’s common stock, to conduct a
      review of CoSine’s historical net operating losses and review ownership changes
      since CoSine’s inception. The study was initiated to determine the effect, if
      any, of such ownership changes on the availability of CoSine’s net operating
      loss carry-forwards. Steel Partners incurred direct expenses, primarily outside
      legal fees, in the amount of $40,728, in connection with the study and CoSine
      has agreed to reimburse such costs. As of September 30, 2005 accounts payable
      included $22,045 owed to Steel Partners in connection with the tax
      study.





In
      October 2005, Mr. Gibson, who has served as a consultant to the Company from
      January 2005 through October 2005, rejoined as an employee, serving as
      president, chief executive officer and chief financial officer. Mr. Gibson
      was
      granted options to purchase 100,000 shares of CoSine common stock, priced at
      market value at the date of grant, in connection with his
      re-employment.




9.
            RECENT
                ACCOUNTING PRONOUNCEMENTS





*Statement
      of Financial Accounting Standards Number 154*





In
      May
      2005, SFAS No. 154, “Accounting Changes and Error Corrections,” was issued. This
      statement applies to all voluntary changes in accounting principle and requires
      retrospective application to prior periods’ financial statements of changes in
      accounting principle, unless this would be impracticable. This statement also
      makes a distinction between “retrospective application” of an accounting
      principle and the “restatement” of financial statements to reflect the
      correction of an error. This statement is effective for accounting changes
      and
      corrections of errors made in fiscal years beginning after December 15, 2005.
      The Company is evaluating the effect the adoption of this interpretation will
      have on its financial position, cash flows and results of operations.





10





**ITEM
      2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**





This
      Management's Discussion and Analysis of Financial Condition and Results of
      Operations 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, the continued downturn in the telecommunications
      industry and slow development of the market for network-based IP services,
      technological changes affecting the value of our intellectual property to the
      extent these conditions impact strategic alternatives available to us, failure
      to achieve revenue growth and profitability, changes in general economic
      conditions and in economic conditions in the customer service market that we
      currently serve, our ability to identify and acquire new business operations
      while continuing to provide support to our existing customers and continuing
      to
      offer our intellectual property for license or sale, 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, competitors,
      customers, employees 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 24 through 28 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.





**OVERVIEW**





Prior
      to
      and during the period ended September 30, 2004, we developed, marketed and
      sold
      a communications platform referred to as our IP Service Delivery Platform.
      Our
      product was designed to enable 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.





Even
      during this period, the market for our IP Service Delivery Platform was still
      in
      the early stages of development, and the volume and timing of orders were
      difficult to predict. A customer’s decision to purchase our platform typically
      involved a significant commitment of its resources and a lengthy evaluation,
      testing and product qualification process. The long sales cycle and the timing
      of our customers’ rollout of services made possible by our platform, which
      affected repeat business, caused our revenue and operating results to vary
      significantly and unexpectedly from quarter to quarter and constrained our
      ability to secure new customers. We had not generated sufficient revenue to
      fund
      our operations and had been unable to increase our revenue in the near term
      in
      order to reduce our cash consumption and remain a viable and competitive
      supplier.





On
      July
      29, 2004, we announced that we were exploring various strategic alternatives
      and
      that we had hired an investment bank as our financial advisor, which had been
      first retained in May 2003.





On
      September 8, 2004, we announced, in connection with our ongoing evaluation
      of
      strategic alternatives, that we had initiated actions to lay-off most of our
      employees, retaining a limited team of employees to provide customer support
      and
      handle matters related to the ongoing exploration of strategic alternatives.
      Since September 8, 2004, we have taken a number of actions to reduce our
      operating expenses and conserve our cash. We have notified our existing
      customers that the CoSine products have been formally discontinued and offered
      existing customers the option to place “lifetime buy” orders to support their
      platform transition plans. We have written our inventory down to estimated
      net
      realizable value at September 30, 2004, December 31, 2004 and September 30,
      2005. We have terminated contract manufacturing arrangements, contractor and
      consulting arrangements, and facility leases.





11





On
      October 28, 2004, we announced that we had signed an agreement for early
      termination of a lease for our headquarters facility in Redwood City,
      California. Pursuant to the agreement, the lease was terminated on
      December 31, 2004.





During
      the quarter ended December 31, 2004, we continued the actions initiated and
      announced in September 2004. Such actions included the termination of all but
      eight of our employees, negotiation of transition support plans for our
      customers, termination of a facility lease in Japan, and termination of
      supplier, contractor and consulting agreements, as well as the initiation of
      liquidation procedures for certain of our foreign operations. We also completed
      the sale, scrap or write-off of our remaining inventory, property and
      equipment.




In
      January 2005, we terminated our remaining employees and retained our chief
      executive officer as a consultant.




On
      January 7, 2005, we entered into an Agreement and Plan of Merger with Tut
      Systems, Inc. (“Tut”). The proposed merger was structured as a stock-for-stock
      transaction. Upon closing, CoSine’s shareholders were to receive approximately
      6.0 million shares of Tut common stock in exchange for all the outstanding
      shares of CoSine. The merger was terminated on May 16, 2005.





In
      June
      2005, we were informed that our stock would be de-listed from the Nasdaq
      National Market System pursuant to Nasdaq Marketplace Rules 4300 and 4330
      (a)(3). Our stock was de-listed on June 16, 2005 and now trades in the over
      the
      counter market under the symbol “COSN.PK.”





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 has 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. 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.





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





As
      of
      December 31, 2004 and September 30, 2005, our business consisted of primarily
      a
      customer service capability operated by a third party.




**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





**General**





Our
      discussion and analysis of our financial condition and results of operations
      are
      based on our condensed consolidated financial statements, which have been
      prepared in accordance U.S. generally accepted accounting principles. The
      preparation of these condensed 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.





12





On
      July
      29, 2004, CoSine announced that it was exploring various strategic alternatives
      and that CoSine had hired an investment bank as its financial advisor, which
      had
      been first retained in May 2003.





On
      September 8, 2004, CoSine announced, in connection with its ongoing evaluation
      of strategic alternatives, that it had initiated actions to lay-off most of
      its
      employees, retaining a limited team of employees to provide customer support
      and
      handle matters related to the ongoing exploration of strategic alternatives.
      Since September 8, 2004, the Company has taken a number of actions to reduce
      its
      operating expenses and conserve its cash. CoSine has notified its existing
      customers that the CoSine products have been formally discontinued and offered
      existing customers the option to place “lifetime buy” orders to support their
      platform transition plans. The company has written its inventory down to
      estimated net realizable value at September 30, 2004, December 31, 2004 and
      September 30, 2005. CoSine has terminated contract manufacturing arrangements,
      contractor and consulting arrangements and facility leases.





On
      October 28, 2004, CoSine announced that it signed an agreement for early
      termination of its lease for its headquarters facility in Redwood City,
      California. Pursuant to the agreement, the lease was terminated on
      December 31, 2004.





During
      the quarter ended December 31, 2004, we continued the actions initiated and
      announced in September 2004. Such actions included the termination of all but
      eight of the remaining employees, negotiation of transition support plans for
      our customers, termination of a facility lease in Japan, and termination of
      supplier, contractor and consulting agreements, as well as the initiation of
      liquidation procedures for certain of our foreign operations. We also completed
      the sale, scrap or write-off of our remaining inventory, property and
      equipment.





In
      January 2005, we terminated our remaining employees and retained our chief
      executive officer as a consultant.




On
      January 7, 2005, we entered into an Agreement and Plan of Merger with Tut
      Systems, Inc. (“Tut”). The proposed merger was structured as a stock-for-stock
      transaction. Upon closing, CoSine’s shareholders were to receive approximately
      6.0 million shares of Tut common stock in exchange for all the outstanding
      shares of CoSine. The merger was terminated on May 16, 2005.





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 has 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. 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.





As
      of
      December 31, 2004 and September 30, 2005, our business consisted of primarily
      a
      customer service capability operated by a third party.





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





**Revenue
      Recognition**





Most
      of
      our sales are generated from complex arrangements. Recognizing revenue in these
      arrangements requires our making significant judgments, particularly in the
      areas of customer acceptance and collectibility.





Certain
      of our sales arrangements require formal acceptance by our customers. In such
      cases, we do not recognize revenue until we have received formal notification
      of
      acceptance. Although we work closely with our customers to help them achieve
      satisfaction with our products prior to and after acceptance, the timing of
      customer acceptance can greatly affect the timing of the recognition of our
      revenue.





13





While
      the
      end user of our product is normally a large network service provider, we also
      sell product and services through small resellers and to small network service
      providers in Asia, Europe and North America. To recognize revenue before we
      receive payment, we are required to assess that collection from the customer
      is
      probable. If we cannot satisfy ourselves that collection is probable, we defer
      revenue recognition until we have collected payment.





**Allowance
      for Doubtful Accounts**





We
      maintain allowances for doubtful accounts in connection with estimated losses
      resulting from the inability of our customers to pay our 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 our customer payment patterns. In future periods,
      if the financial condition of our customers were to deteriorate and affect
      their
      ability to make payments, additional allowances may be required.





**Inventory
      Valuation**





In
      assessing the value of our inventory, we are required to make judgments about
      future demand and then compare that demand with current inventory quantities
      and
      firm purchase commitments. If our inventories and firm purchase commitments
      are
      in excess of forecasted demand, we write down the value of our inventory. We
      generally used a 12-month forecast to assess future demand. Inventory
      write-downs are charged to cost of revenue. At September 30, 2004, in connection
      with our decision to discontinue our products, we recorded a charge of $3.5
      million to write our inventory down to its estimated net realizable value.
      Our
      inventory was either sold, scrapped or fully written-off at December 31, 2004
      and September 30, 2005. During the nine months ended September 30, 2005, we
      sold
      $25,000 of previously written-down inventory. During the nine months ended
      September 30, 2004, we sold $ 0.3 million of previously written-down inventory
      and wrote-off $4.1 million of inventory.





**Long-lived
      assets**





We
      evaluate the carrying value of long-lived assets, consisting primarily of
      property, plant and equipment, whenever certain events or changes in
      circumstances indicate that the carrying amount of these assets may not be
      recoverable. In assessing the recoverability of long-lived assets, we compare
      the carrying value of the assets to the undiscounted future cash flows the
      assets are expected to generate. If the total of the undiscounted future cash
      flows is less than the carrying amount of the assets, the assets will be written
      down to their estimated fair value. Fair value is generally determined by
      calculating the discounted future cash flows using a discount rate based on
      our
      weighted average cost of capital or specific appraisal, as appropriate.
      Significant judgments and assumptions are required in the forecast of future
      operating results used in the preparation of the estimated future **** cash
      flows, including long-term forecasts of overall market conditions and our
      participation in the market. Changes in these estimates could have a material
      adverse effect on the assessment of the long-lived assets such that we may
      be
      required to record further asset write-downs in the future. During 2004 we
      charged $2.3 million to operating expenses as a result of impairments. During
      2004, we had a gain of $0.9 million with the sale of previously written-down
      long-lived assets. At December 31, 2004 and September 30, 2005, all of our
      long-lived assets had been either sold, scrapped or fully
      written-off.





**Warranties**





Prior
      to
      our announcement in September 2004 that we were discontinuing our products,
      w e
      provided a basic limited warranty, including repair or replacement of parts,
      and
      technical support. The specific terms and conditions of those warranties varied
      depending on the customer or region. We estimated the costs that may be incurred
      under our basic limited warranty and record a liability in the amount of such
      costs at the time product revenue is recognized. Our warranty obligation is
      affected by the number of installed units, product failure rates, materials
      usage and service delivery costs incurred in correcting product failures. Each
      quarter, we assess the adequacy of our recorded warranty liabilities and adjust
      the amounts as necessary. If actual product failure rates, materials usage
      or
      service delivery costs differ from our estimates, adjustments to cost of revenue
      may result.





We
      no
      longer offer warranty on product or service sales.





14





**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,
      stock issued in lieu of cash compensation to suppliers and re-priced stock
      options.





Our
      cost
      of revenue and operating expenses were affected significantly by charges related
      to warrants and options issued for services. Furthermore, some of our employee
      stock option transactions have resulted in deferred compensation, which was
      presented as a reduction of stockholders’ equity prior to our December 31, 2004
      consolidated balance sheet and was amortized over the vesting period of the
      applicable options using the graded vesting method.





The
      deferred compensation and amortization associated with shares and options
      relating to the following transactions is required to be re-measured at the
      end
      of each accounting period, based on the current stock price. The re-measurement
      at the end of each accounting period will result in unpredictable charges or
      credits in future periods, depending on future fluctuations in the market prices
      of our common stock:


•
              Non-recourse
                  promissory notes receivable: During the fourth quarter of 2000,
                  we
                  converted full-recourse promissory notes received from employees
                  upon the
                  early exercise of unvested employee stock options to non-recourse
                  obligations. Accordingly, we are required to re-measure the compensation
                  associated with these shares until the earlier of repayment of
                  the note or
                  default. Deferred compensation expense, which is recorded at each
                  re-measurement, is amortized over the remaining vesting period
                  of the
                  underlying options. The balance of $1.52 million of non-recourse
                  promissory notes receivable due from former employees, including
                  an
                  officer, were cancelled during the quarter ended March 31, 2005
                  in
                  exchange for 69,155 shares of common stock. The notes were written-off
                  to
                  additional paid-in capital during the quarter ended March 31, 2005
                  and the
                  related shares were cancelled.•
              Re-priced
                  stock options:In
                  November 2002, we re-priced 1,091,453 outstanding employee stock
                  options
                  to purchase shares of our common stock with original exercise prices
                  ranging from $5.45 per share to $159.38 per share. These options
                  were
                  re-priced to $5.00 per share, which was higher than the fair market
                  value
                  of the underlying shares on the re-pricing date. In July 2001,
                  we
                  re-priced 722,071 outstanding employee stock options to $15.50
                  per share,
                  the fair market value of the underlying shares on the re-pricing
                  date.
                  These options had previouslybeen
                  granted at prices ranging from $40.00 to $400.00 per share. Compensation
                  will be re-measured for these options until they are exercised,
                  canceled,
                  or expire. At September 30, 2005, no stock options re-priced in
                  November
                  2002 or July 2001were still outstanding.





Some
      of
      the stock options granted to our employees have resulted in deferred
      compensation as a result of stock options having an exercise price below their
      estimated fair value. Deferred compensation is presented as a reduction to
      stockholders’ equity on the consolidated balance sheet and is then amortized
      using an accelerated method over the vesting period of the applicable options.
      When an employee terminates, an expense credit is recorded for any amortization
      that has been previously recorded as an expense in excess of vesting. All
      employees have been terminated as of January 2005. Deferred compensation amounts
      were fully amortized at December 31, 2004 and September 30, 2005, and no
      amortization charges were recorded in the three or nine months ended September
      30, 2005.





**Recent
      Accounting Pronouncements**





*Statement
      of Financial Accounting Standards Number 154*





In
      May
      2005, SFAS No. 154, “Accounting Changes and Error Corrections,” was issued. This
      statement applies to all voluntary changes in accounting principle and requires
      retrospective application to prior periods’ financial statements of changes in
      accounting principle, unless this would be impracticable. This statement also
      makes a distinction between “retrospective application” of an accounting
      principle and the “restatement” of financial statements to reflect the
      correction of an error. This statement is effective for accounting changes
      and
      corrections of errors made in fiscal years beginning after December 15, 2005.
      The Company is evaluating the effect the adoption of this interpretation will
      have on its financial position, cash flows and results of operations.





15





**RESULTS
      OF OPERATIONS**





On
      July
      29, 2004, we announced that we were exploring various strategic alternatives
      and
      that we had hired an investment bank as our financial advisor.





On
      September 8, 2004, we announced that after an extensive evaluation of strategic
      alternatives, we initiated actions to lay-off most of our employees, laying
      off
      100 employees in September 2004 while retaining a limited team of employees
      to
      provide customer support and handle matters related to the ongoing exploration
      of strategic alternatives. Since September 8, 2004, we have taken a number
      of
      actions to reduce our operating expenses and conserve our cash. We have notified
      our existing customers that the CoSine products are now formally discontinued
      and that existing customers may place “lifetime buy” orders to support their
      transition plans. We have written our inventory down to estimated net realizable
      value at September 30, 2004, December 31, 2004 and March 31, 2005.





During
      the quarter ended December 31, 2004, we continued the actions initiated and
      announced in September 2004. Such actions included the termination of all but
      eight employees, negotiation of transition support plans for our customers,
      termination of a facility lease in Japan, and termination of supplier,
      contractor and consulting agreements, as well as the initiation of liquidation
      procedures for certain of our foreign operations. We also completed the sale,
      scrap or write-off of our remaining inventory, property and equipment. These
      activities will continue in 2005.





In
      January 2005, we terminated our remaining employees and retained our chief
      executive officer as a consultant.




On
      January 7, 2005, we entered into an Agreement and Plan of Merger with Tut
      Systems, Inc., (“Tut”). The proposed merger was structured as a stock-for-stock
      transaction. Upon closing, CoSine’s shareholders were to receive approximately
      6.0 million shares of Tut common stock in exchange for all the outstanding
      shares of CoSine. The merger was terminated on May 16, 2005.





In
      June
      2005, we were informed that our stock would be de-listed from the Nasdaq
      National Market System pursuant to Nasdaq Marketplace Rules 4300 and 4330
      (a)(3). Our stock was de-listed on June 16, 2005 and now trades in the over
      the
      counter market under the symbol “COSN.PK.”





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 has 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. 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. 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.





Our
      business currently consists of a customer support capability supported by a
      third party contractor.





**Revenue**





For
      the
      three months ended September 30, 2005, revenue was $785,000, all of which was
      from service. For the three months ended September 30, 2004, revenue was $1.1
      million of which $452,000 or 41% was from product sales and $636,000 or 59%
      was
      from service.




Revenues
      from customers by geographic region for the three and nine months ended
      September 30, 2005 and 2004, respectively, were as follows, in
      thousands:


**Three
                Months Ended**
              **September
                30,**
            
            **Nine
                Months Ended**
              **September
                30,****2005**
            
            **2004**
            
            **2005**
            
            **2004****Region**North
                America
            
            $
            457
            
            $
            342
            
            $
            1,320
            
            $
            3,033Italy
            
            
            57
            
            
            52
            
            
            166
            
            
            804France
            
            
            63
            
            
            350
            
            
            216
            
            
            1,286South
                Korea
            
            
            11
            
            
            18
            
            
            42
            
            
            1,580Japan
            
            
            108
            
            
            50
            
            
            422
            
            
            664Other
                EMEA
            
            
            89
            
            
            266
            
            
            215
            
            
            714Other
                Asia/Pacific
            
            
            —
            
            
            10
            
            
            —
            
            
            30Total
            
            $
            785
            
            $
            1,088
            
            $
            2,381
            
            $
            8,111




16





Revenues
      for the three months ended September 30, 2005 consisted entirely of service
      as
      compared to revenues in the quarter ended September 30, 2004 when we were still
      selling products and services. The decrease in revenue from the three months
      ended September 30, 2005 compared to the three months ended September 30, 2004
      is due primarily to our announcement in September 2004 that we were laying
      off
      all our employees and would no longer offer our product for sale. Our business
      currently consists of a service operation provided by a third party contractor.





Revenues
      for the nine months ended September 30, 2005 consisted of $2,165,000 in service
      and $216,000 in product revenues, as compared to $6.0 million in product sales
      and $2.1 million in service in the nine months ended September 30, 2004. The
      decrease in revenue is due primarily to our announcement in September 2004
      that
      we were laying off all our employees and would no longer offer our product
      for
      sale. Our business currently consists of a service operation provided by a
      third
      party contractor.





**Non-Cash
      Charges Related to Equity Issuances**





During
      the three months ended September 30, 2005 and 2004, we recorded $60,000 and
      $2,000, respectively, of non-cash charges (credits) related to equity issuances
      to cost of revenue and operating expenses. During the nine months ended
      September 30, 2005 and 2004, we recorded $279,000 and ($875,000), respectively,
      of non-cash (credits) charges related to equity issuances to cost of revenue
      and
      operating expenses.





Below
      is
      a reconciliation of non-cash charges related to equity issuances for the three
      and nine months ended September 30, 2005 and 2004, as presented in our statement
      of operations, in thousands:


**Three
                    Months Ended**
                  **September
                    30,**
                
                **Nine
                    Months Ended**
                  **September
                    30,****2005**
                
                **2004**
                
                **2005**
                
                **2004**Amortization
                    of deferred compensation related to stock options granted to
                    employees
                    prior to our initial public offering having an exercise price
                    below fair
                    market value
                
                $
                —
                
                $
                4
                
                $
                —
                
                $
                92Credits
                    related to the reversal of deferred stock compensation amortization
                    in
                    excess of vesting for terminated employees
                
                
                —
                
                
                (21
                )
                
                —
                
                
                (185
                )Amortization
                    of deferred compensation associated with re-pricing
                
                
                —
                
                
                
                
                
                —
                
                
                (1,063
                )Bonus
                    paid in shares of common stock
                
                
                —
                
                
                
                
                
                —
                
                
                228Amortization
                    of charges related to warrants or stock options issued to non-employees
                    in
                    conjunction with lease and debt agreements and re-seller
                    agreement
                
                
                60
                
                
                20
                
                
                279
                
                
                53Net
                    non-cash charges related to equity issuances
                
                $
                60
                
                $
                3
                
                $
                279
                
                
                ($875
                )








17





Under
      the
      stock bonus program, we granted 43,300 shares of CoSine common stock in the
      second quarter of 2004, based on CoSine’s stock price on the grant
      date.





**Cost
      of Revenue**





For
      the
      three months ended September 30, 2005, cost of revenue was $702,000, which
      represented the costs of our third party support contract, amortization of
      $60,000 related to a stock purchase warrant and a $219,000 reclassification
      of
      warrant amortization for the period January 1, 2005 to June 30, 2005, previously
      charged to operating expenses, net of a $57,000 reduction in our warranty
      accrual. For the three months ended September 30, 2004, cost of revenue was
      $4.4
      million, of which $3.5 million represented the write-down of inventory, $0.4
      million represented costs to terminate contract manufacturing agreements, and
      $0.5 million represented materials, labor, production overhead, warranty and
      the
      costs of providing services.




For
      the
      nine months ended September 30, 2005, cost of revenue was $1,545,000, which
      represented costs of our third party support contract and amortization related
      to a stock purchase warrant, net of a reduction of our warranty accrual. For
      the
      nine months ended September 30, 2004, cost of revenue was $7.4 million, of
      which
      $3.9 million represented a restructuring charge, $2.7 million represented
      materials, labor and overhead, warranty and the cost of providing services,
      $0.4
      million represented software royalty expense, $0.7 million represented inventory
      written down, offset by a $0.3 million benefit associated with the sale of
      previously written down inventory.





**Gross
      Profit (Loss)**





For
      the
      three months ended September 30, 2005 and 2004, gross profit (loss) was $83,000
      and ($3.4) million, respectively.





For
      the
      nine months ended September 30, 2005 and 2004, gross profit was $836,000 and
      $738,000, respectively and gross margins were 35% and 9%, respectively. The
      increase in gross margin from 2004 to 2005 is due to the fact that we
      discontinued product sales in September 2004 and recorded significant
      restructuring charges related to inventory write-downs and termination of
      contract manufacturers.





We
      expect
      our gross margin to continue to be affected by the volume of our service
      contract sales and the costs we incur with our third party contractor. We have
      the ability to modify our third party support contract every 90 days but we
      may
      not be able to accurately predict our future service contract sales and
      therefore may experience margin fluctuations, including possibly negative gross
      margins.





**Research
      and Development Expenses**





Research
      and development expenses were nil and $3.7 million for the three months ended
      September 30, 2005 and September 30, 2004, respectively. There were no research
      and development activities in the three months ended September 30, 2005.
      Research and development costs for the nine months ended September 30, 2005
      and
      2004 were $103,000 and $13.3 million, respectively. Such costs for the nine
      months ended September 30, 2005 consisted of consulting expenses as well as
      software license amortization costs and payments. With our announcement in
      September 2004 that we were laying off all employees and discontinuing our
      products, our engineering activities have been limited to providing consulting
      to existing customers and our third party contractor. We expect our research
      and
      development costs to be a minimal amount for the balance of the fiscal year.





**Sales
      and Marketing Expenses**





Sales
      and
      marketing expenses were nil and $3.1 million for the three months ended
      September 30, 2005 and 2004, respectively. Sales and marketing expenses for
      the
      nine months ended September 30, 2005 and 2004 were $105,000 and $9.6 million,
      respectively. With our announcement in September 2004 that we were laying off
      all employees and were discontinuing our products, we have ceased essentially
      all ongoing sales and marketing efforts. Sales and marketing expenses for the
      nine months ended September 30, 2005 consisted of expenses related to foreign
      sales offices, all of which are winding down. The decrease in sales and
      marketing expense from the three and nine months ended September 30, 2004 to
      the
      comparable periods in 2005 is due to our September 2004 announcement. We expect
      sales and marketing expenses to be a minimal amount for the balance of the
      fiscal year.





18





**General
      and Administrative Expenses**





General
      and administrative expenses were $0.4 million and $1.7 million for the three
      months ended September 30, 2005 and 2004, respectively and were $2.8 million
      and
      $4.6 million for the nine month periods ended September 30, 2005 and 2004.
      With
      our announcement in September 2004 that we were laying off all employees and
      discontinuing our products, our general and administrative efforts have been
      focused on restructuring activities and the ongoing evaluation of strategic
      alternatives, as well as the activities related to our proposed merger with
      Tut
      Systems Inc., as announced on January 7, 2005 and terminated on May 16, 2005.
      General and administrative costs for the three months and nine months ended
      September 30, 2005 consisted of costs for consultants and contractors, including
      our chief executive officer, audit and tax services, legal services, insurance
      and banking fees as well as the costs incurred in connection with the proposed
      merger with Tut. General and administrative expenses for the balance of the
      fiscal year should decrease as the merger and restructuring activities have
      been
      substantially completed.





General
      and administrative costs for the three months and nine months ended September
      30, 2004 consisted of the corporate administration, finance, legal, and human
      resource functions, as well as the ongoing costs of evaluating strategic
      alternatives.





**Restructuring
      and Impairment Charges**





*December
      2004 Restructuring*





In
      the
      quarter ended December 31, 2004, CoSine continued its previously announced
      actions to terminate the remainder of its workforce, terminated the lease of
      its
      facilities in Redwood City, California, and terminated its office lease in
      Japan. In addition, CoSine accrued for the termination of non-cancelable
      software license agreements, as the licenses were not expected to be used in
      the
      ongoing operations.





Activity
      related to the December 2004 restructuring for the nine months ended September
      30, 2005 is as follows, (in thousands):





Worldwide
                workforcereduction
            
            LeaseTerminations
            
            Software
                LicenseTerminations
            
            TotalProvision
                balance at December 31, 2004
            
            $
            553
            
            $
            —
            
            $
            1,037
            
            $
            1,590Cash
                payments
            
            
            (543
            )
            
            —
            
            
            (564
            )
            
            (1,107
            )Write
                offs
            
            
            —
            
            
            —
            
            
            (23
            )
            
            (23
            )Provision
                balance at September 30, 2005
            
            $
            10
            
            $
            —
            
            $
            450
            
            $
            460





*September
      2004 Restructuring*





In
      September 2004, CoSine announced actions to terminate most of its 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, announced discontinuance of
      the
      CoSine products, a charge for unrecoverable royalties, and termination of third
      party manufacturing agreements.





Effective
      September 23, 2004, CoSine approved severance agreements to Stephen Goggiano,
      its president and chief executive officer, and Terry Gibson, its 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 CoSine as it 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. Both Mr.
      Goggiano's and Mr. Gibson's employment by us terminated in January 2005. Also
      in
      exchange for their continued service during this time period, we agreed to
      pay
      for the cost of Mr. Goggiano's, Mr. Gibson's and their families' health care
      coverage for a period of 12 months after termination of their respective
      employment. These amounts were charged to restructuring in December 2004.





19





Activity
      related to the September 2004 restructuring for the nine months ended September
      30, 2005 is as follows (in thousands):





Worldwide
                workforcereduction
            
            Write-down
                of inventory and prepaidroyalty
            
            Manufacturing
                agreementtermination
            
            TotalProvision
                balance at December 31, 2004
            
            $
            424
            
            $
            —
            
            $
            —
            
            $
            424Cash
                payments
            
            
            (424
            )
            
            —
            
            
            —
            
            
            (424
            )Write
                offs
            
            
            —
            
            
            —
            
            
            —
            
            
            —Provision
                balance at September 30, 2005
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —





During
      the nine months ended September 30, 2005 we sold previously impaired assets
      for
      a total of $67,000 and settled a software contract at a $23,000 discount to
      our
      restructuring accrual. During the nine months ended September 30, 2004, we
      recorded restructuring and impairment charges of $2.3 million related to our
      determination at June 30, 2004 that we would not be able to recover the carrying
      value of our long term assets.





**Interest
      Income and Other**





For
      the
      three months ended September 30, 2005 and 2004, interest income and other income
      were $191,000 and $82,000, respectively. The increase from September 30, 2004
      to
      September 30, 2005 is due to higher interest rates, partially offset by a lower
      balance of short term investments.





**Income
      Tax Provision**





Provision
      (benefit) for income taxes of ($117,000) and ($9,000) for the three months
      ended
      September 30, 2005 and 2004, respectively, were comprised entirely of foreign
      corporate income taxes and refunds, which are a function of our operations
      in
      subsidiaries in various countries. The provision for income taxes is based
      on
      income taxes on minimum profits the foreign operations generated for services
      they provided to us. Our tax expense for fiscal 2005 will continue to depend
      on
      the amount and mix of income derived from sources subject to corporate income
      taxes of foreign taxing jurisdictions.




**LIQUIDITY
      AND CAPITAL RESOURCES**





Currently,
      we are not generating sufficient revenue to fund our operations. We expect
      our
      operating losses and net operating cash outflows to continue and expect that
      our
      revenue will continue to decline.





On
      July
      29, 2004, we announced that we were exploring various strategic alternatives
      and
      that we had hired an investment bank as our financial advisor. On September
      8,
      2004, we announced that we were laying-off substantially all of our employees
      and were discontinuing our products while continuing to evaluate strategic
      alternatives. Based on restructuring activities initiated in September 2004
      and
      continued in the quarter ended December 31, 2004, on the costs to complete
      all
      such activities, on the significant reduction in cash usage once such activities
      are completed, and on the costs to extend customer support activities through
      December 2005, 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 the uncertainly
      concerning our ability to implement successfully our redeployment strategy,
      including our ability to find suitable acquisition candidates and utilize our
      existing NOLs, raise substantial doubt as to our ability to continue as a going
      concern. See “Liquidity and Strategic Alternatives” in Note 1 of the Notes to
      the Condensed Consolidated Financial Statements.





On
      September 8, 2004, we announced that after an extensive evaluation of strategic
      alternatives, we had initiated actions to lay-off most of our employees,
      retaining a limited team of employees to provide customer support and handle
      matters related to the ongoing exploration of strategic alternatives. Since
      September 8, 2004, we have taken a number of actions to reduce our operating
      expenses and conserve our cash. We have notified our existing customers that
      the
      CoSine products are now formally discontinued and that existing customers may
      place “lifetime buy” orders to support their transition plans. We have written
      our inventory down to estimated net realizable value at December 31, 2004 and
      September 30, 2005. We have taken steps to terminate contract manufacturing
      arrangements, contractor and consulting arrangements and facility leases. These
      activities continued during the quarter ended December 31, 2004 and nine month
      period ended September 30, 2005, at which time our business consisted primarily
      of a customer support capability supported by a third party contractor.





20





On
      January 7, 2005, we entered into an Agreement and Plan of Merger with Tut
      Systems, Inc., (“Tut”). The proposed merger was structured as a stock-for-stock
      transaction. Upon closing, CoSine’s shareholders were to receive approximately
      6.0 million shares of Tut common stock in exchange for all the outstanding
      shares of CoSine. The merger was terminated on May 16, 2005.





In
      June
      2005, the Company was informed that its stock would be de-listed from the Nasdaq
      National Market System pursuant to Nasdaq Marketplace Rules 4300 and 4330
      (a)(3). The Company’s stock was de-listed on June 16, 2005 and now trades in the
      over the counter market under the symbol “COSN.PK.”





In
      July
      2005, the Company completed a comprehensive review of strategic alternatives,
      including a sale of the Company, a sale or licensing of intellectual property,
      a
      redeployment of the Company’s assets into new business ventures, or a winding-up
      and liquidation of the business and a return of capital. The board of directors
      has approved a plan to redeploy CoSine’s existing resources to identify and
      acquire one or more new business operations, while continuing to support
      CoSine’s existing customers and continuing to offer CoSine’s intellectual
      property for license or sale. CoSine’s 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 the Company’s net operating loss
      carry-forwards (“NOLs”). As of this date, no candidate has been identified, and
      no assurance can be given that the Company will find suitable candidates, and
      if
      it does, that the Company will be able to utilize its existing NOLs. The Company
      will continue to prepare its financial statements on the assumption that it
      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 the Company’s assessment of its strategic alternatives. If at some
      point the Company were to decide to pursue alternative plans, the Company may
      be
      required to present the financial statements on a different basis. As an
      example, if the Company 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.





There
      can
      be no assurance that any transaction or other corporate action will result
      from
      our exploration of strategic alternatives. Further there can be no assurance
      concerning the type, form, structure, nature, results, timing or terms and
      conditions of any such potential action, even if such an action does result
      from
      this exploration.





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





**Cash,
      Cash Equivalents and Short-Term Investments**





At
      September 30, 2005, cash, cash equivalents and short-term investments were
      $23.0
      million. This compares with $24.9 million at December 31, 2004.




21




Operating Activities




We
      used
      $1.9 million and $23.1 million in cash for operations for the nine months ended
      September 30, 2005 and 2004, respectively. The reduced cash usage is due
      primarily to the $30.2 million reduction in net loss from the nine months ended
      September 30, 2005 as compared to the nine months ended September 30, 2004,
      partially offset by the reductions in accrued liabilities, accrued compensation
      and deferred revenue.




**Investing
      Activities**





Investing
      activities generated $4.9 million in cash in the nine months ended September
      30,
      2005 as compared to $14.7 million in cash generated in the nine months ended
      September 30, 2004. There were no capital expenditures in the nine months ended
      September 30, 2005 as compared to $1.0 million in the prior year
      period.





**Financing
      Activities**





There
      were no financing activities in the nine months ended September 30, 2005. In
      the
      nine months ended September 30, 2004, financing activities included final
      payments on working capital loans and capital leases, offset by proceeds from
      issuance of common stock.





**OUTLOOK**





Although
      capital spending in the telecommunications industry has begun to recover, the
      market for network-based IP services continues to develop slowly. We do not
      believe we can achieve the sustainable revenue growth necessary to survive
      as a
      stand-alone entity in that industry. On July 29, 2004, we announced that we
      were
      exploring various strategic alternatives and that we had hired an investment
      bank as our financial advisor. On September 8, 2004, we announced that after
      an
      extensive evaluation of strategic alternatives, we had initiated actions to
      lay-off most of our employees, retaining a limited team of employees to provide
      customer support and handle matters related to the ongoing exploration of
      strategic alternatives. Since September 8, 2004, we have taken a number of
      actions to reduce our operating expenses and conserve our cash. We have notified
      our existing customers that the CoSine products are now formally discontinued
      and that existing customers may place “lifetime buy” orders to support their
      transition plans. Based on our current forecasts for future product demand,
      we
      have written our inventory down to estimated net realizable value at December
      31, 2004 and September 30, 2005. We have taken steps to terminate contract
      manufacturing arrangements, contractor and consulting arrangements and facility
      leases. These activities continued into the quarter ended December 31, 2004
      and
      nine month period ended September 30, 2005, at which time our business consisted
      primarily of a customer support capability supported by a third party
      contractor.





The
      board
      of directors, on completion of a comprehensive review of strategic alternatives,
      has approved a plan to redeploy CoSine’s existing resources to identify and
      acquire one or more new business operations, while continuing to support
      CoSine’s existing customers and continuing to offer CoSine’s intellectual
      property for license or sale. CoSine’s 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 the Company’s net operating loss
      carry-forwards (“NOLs”). As of this date, no candidate has been identified, and
      no assurance can be given that the Company will find suitable candidates, and
      if
      it does, that the Company will be able to utilize its existing NOLs. We will
      continue to support our existing customers through our transition support
      programs as we execute our new strategy.





At
      September 30, 2005, we had $23.0 million in cash, cash equivalents and
      short-term investments. Based on restructuring activities initiated in September
      and December 2004, on the costs to complete all such activities, on the
      significant reduction in cash usage once such activities are completed, and
      on
      the expected net costs to extend customer support activities, 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.




**RISK
      FACTORS**





This
      report (including the "Outlook" section above) 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,
      the
      continued downturn in the telecommunications industry and slow development
      of
      the market for network-based IP services, technological changes affecting the
      value of our intellectual property to the extent these conditions impact
      strategic alternatives available to us, failure to achieve revenue growth and
      profitability, changes in general economic conditions and in economic conditions
      in the customer service market that we currently serve, our ability to identify
      and acquire new business operations while continuing to provide support to
      our
      existing customers and continuing to offer our intellectual property for license
      or sale, 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, competitors, customers, employees and others to our
      strategic direction and to any specific business opportunity selected by us,
      all
      as are discussed in more detail below in this section, as well as the other
      risk
      factors discussed below. 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.





22





The
      following discussion describes certain risk factors related to our business
      as
      well as to our industry in general.





***CoSine
      has ceased substantially all revenue generating operations and sold its
      operating assets.***





CoSine
      has incurred losses since inception and expects that its net losses and negative
      cash flow will continue for the foreseeable future as CoSine evaluates strategic
      alternatives. In September 2004, we announced the termination of most of our
      employees to facilitate the strategic alternatives then in consideration. In
      addition, we continue to expend our remaining cash resources. Further, we may
      incur significant expenses in connection with possible strategic alternatives.
      The board of directors, on completion of a comprehensive review of strategic
      alternatives, has approved a plan to redeploy CoSine’s existing resources to
      identify and acquire one or more new business operations, while continuing
      to
      support CoSine’s existing customers and continuing to offer CoSine’s
      intellectual property for license or sale. CoSine’s 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 the Company’s net
      operating loss carry-forwards (“NOLs”). As of this date, no candidate has been
      identified, and no assurance can be given that the Company will find suitable
      candidates, and if it does, that the Company will be able to utilize its
      existing NOLs.





If
      we
      fail to consummate a strategic alternative or raise additional capital, the
      resulting reduction of our available cash resources could result in CoSine
      ceasing operations and liquidating. In the case of a liquidation or bankruptcy,
      CoSine would need to hold back or distribute assets to cover liabilities before
      paying stockholders and, therefore, stockholders may not receive any proceeds
      for their ownership in CoSine. However, we believe we have adequate cash
      resources to continue to realize our assets and discharge our liabilities as
      a
      Company for the next twelve months.





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




CoSine's
      stock price may decline due to any or all of the following potential
      occurrences:





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





·
            CoSine
                may not be able to utilize its existing NOLs to offset future
                earnings;





·
            CoSine
                may have difficulty retaining its key remaining
                employee;





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




***CoSine
      may elect to dissolve and distribute assets to stockholders if CoSine’s board of
      directors determines that such action is in the best interest of the
      stockholders.*** ****





If
      CoSine’s redeployment strategy is deemed unsuccessful, its board of directors
      may deem it advisable to dissolve the company and distribute assets to
      stockholders. Liquidation and dissolution may not create value to CoSine’s
      stockholders or result in any remaining capital for distribution to their
      stockholders. The precise nature, amount and timing of any distribution to
      CoSine’s stockholders would depend on and could be delayed by, among other
      things, sales of the Company’s non-cash assets and claim settlements with
      creditors.





23





***CoSine’s
      customers may sue the Company because CoSine has announced the discontinuance
      of
      its products and may not meet all their contractual
      commitments.*** ****





Certain
      of CoSine’s customer contracts contain provisions relating to the availability
      of products, spare parts and services for periods up to ten years. CoSine is
      in
      discussions with its customers and CoSine and its customers are jointly
      developing alternative plans, but CoSine’s customers may choose to sue CoSine
      for breach of contract.





***The
      outlook for capital spending in the telecommunications industry directly impacts
      CoSine’s ability to sell or license its intellectual
      property.*** ****





Capital
      expenditures within the telecommunications industry have experienced a
      significant downturn since 2001. Capital spending in the industry as a whole
      has
      slowed as a result of a lack of available capital for many emerging service
      providers and a generally cautious approach to capital spending within the
      industry.




While
      the
      industry in general appears to be recovering, the market for network-based
      IP
      services continues to develop slowly. Until the market develops further, demand
      for network-based IP services may not increase significantly, limiting the
      opportunities for CoSine to sell or license its intellectual property and
      thereby causing its stock price to decline.





***CoSine’s
      IP Service Delivery Platform was its only product line, and the availability
      of
      strategic alternatives may depend on its perceived value in the
      telecommunications industry*** **.**





CoSine’s
      IP Service Delivery Platform, which is comprised of hardware and software,
      was
      the only product line that CoSine offered to our customers and has been
      discontinued. CoSine has no plans to offer any other product line. If the
      telecommunications industry does not value CoSine’s intellectual property,
      CoSine will not be successful in its efforts to sell or license the intellectual
      property.





***If
      CoSine’s products contain defects, CoSine may be subject to significant
      liability claims from customers, distribution partners and the end-users of
      CoSine’s products and incur significant unexpected expenses and lost service
      revenue.*** ****





CoSine’s
      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 CoSine’s current products or enhancements after commencement of
      commercial shipments. If this happens, CoSine may experience product returns,
      injury to its reputation, increased service and warranty costs, any of which
      could have a material adverse effect on its business, financial condition and
      results of operations. Moreover, because CoSine’s products are designed to
      provide critical communications services, CoSine may receive significant
      liability claims. CoSine attempted to include in its agreements with customers
      and distribution partners provisions intended to limit CoSine’s exposure to
      liability claims. However, its customers and distribution partners may not
      be
      willing to agree to such provisions, and in any event 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 CoSine’s
      products or from a defect related to the installation or operation of one of
      its
      products. Although CoSine maintains product liability and errors and omissions
      insurance covering certain damages arising from implementation and use of their
      products, CoSine’s insurance may not cover all claims sought against it.
      Liability claims could require it 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 CoSine’s reputation and its business.





***If
      necessary licenses of third-party technology are terminated or become
      unavailable or too expensive, CoSine may be unable to consummate sales or
      licenses of its intellectual property.*** ****





CoSine
      licenses from third-party suppliers certain software applications incorporated
      in its IP Service Delivery Platform. CoSine’s inability to renew or obtain any
      third party license that CoSine needs could require it to obtain substitute
      technology at a lower quality and higher cost. These outcomes could seriously
      impair CoSine’s ability to consummate a sale or license of its intellectual
      property.





24





***If
      CoSine is unable to protect its intellectual property rights, CoSine may be
      unable to sell or license its intellectual property.*** ****





CoSine
      relies on a combination of copyright, trademark, patent and trade secret laws
      and restrictions on disclosure to protect their intellectual property rights.
      Monitoring unauthorized use of CoSine’s products is difficult, and CoSine cannot
      be certain that the steps it has taken will prevent unauthorized use of CoSine’s
      technology. If CoSine is unable to protect its intellectual property rights,
      the
      value of its intellectual property may be impaired, adversely impacting its
      ability to consummate a sale or license.





***If
      CoSine becomes involved in an intellectual property dispute, it could be subject
      to significant liability, the time and attention of CoSine’s management could be
      diverted from pursuing strategic alternatives.*** ****





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





***CoSine
      has a history of losses that may continue, and if it does not achieve
      profitability it may cease operations.***





At
      September 30, 2005, CoSine had an accumulated deficit of $517 million. CoSine
      has incurred net losses since its incorporation. If it does not achieve
      profitability, is unable to obtain additional financing or complete a strategic
      alternative to its current operations, CoSine will cease operations and
      liquidate.





***If
      CoSine 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, CoSine carries insurance protecting its 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. Cosine pays significant premiums
      to
      acquire and maintain this insurance, which is provided by third-party insurers,
      and CoSine agrees 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 the current securities lawsuit
      against CoSine have a $500,000 retention. As a result, the costs CoSine incurs
      in defending this lawsuit will not be reimbursed until they exceed
      $500,000 .
      The policies
      that would cover any future lawsuits may not provide any coverage to CoSine
      and
      may cover the directors and officers only in the event CoSine is unwilling
      or
      unable to cover their costs in defending against and resolving any future
      claims. As a result, CoSine’s costs in defending any future lawsuits could
      increase significantly. Particularly in the current economic environment, CoSine
      cannot assure you that in the future it 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 CoSine’s financial condition in the event that it is
      required to defend against and resolve any future or existing securities class
      actions or other claims made against it or its management arising from the
      conduct of its operations. Further, the inability to obtain such insurance
      in
      adequate amounts may impair CoSine’s future ability to retain and recruit
      qualified officers and directors.





25





**ITEM
      3. 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 credit quality issuers and, by policy, limit the amount
      of
      the credit exposure to any one issuer.





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 investment portfolio as of September
      30, 2005 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 $11,000 decrease in the fair value
      of our investments in debt securities as of September 30, 2005.





**Exchange
      Rate Sensitivity**





Currently,
      all of our revenue and most of our expenses are denominated in U.S. dollars.
      However, since a portion of our operations sales and service activities are
      outside of the U.S., we have entered into transactions in other currencies.
      We
      are primarily exposed to changes in exchange rates for the Euro. Because we
      transact expenses in foreign currency, we are adversely affected by a weaker
      U.S. dollar relative to major currencies worldwide. Additionally, because some
      of our obligations are denominated in foreign currencies, a weaker U.S. dollar
      creates foreign exchange losses. We have not engaged in any foreign exchange
      hedging activities to date.





**ITEM
      4. 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. While our disclosure controls and procedures are designed
      to
      provide reasonable assurance of achieving their objectives, the design of any
      system of controls 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
      regardless of how remote. Our chief executive officer/chief financial officer
      has concluded, based on the evaluation of the effectiveness of the disclosure
      controls and procedures by our management, as of the end of the period covered
      by this report, that our disclosure controls and procedures were generally
      effective for this purpose.




***Changes
      in Internal Controls.*** **** There
      were no changes in our internal control over financial reporting during the
      fiscal quarter ended September 30, 2005 that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.





In
      connection with its audit of our consolidated financial statements for the
      year
      ended December 31, 2004, Burr, Pilger & Mayer LLP identified significant
      deficiencies, which represent material weaknesses. The material weaknesses
      were
      related to a lack of adequate segregation of duties. In addition, significant
      audit adjustments were made to accrued expenses and stockholders’ equity that
      were the result of an insufficient quantity of experienced resources involved
      with the financial reporting and year end closing process resulting from staff
      reductions associated with the downsizing of the Company.





Prior
      to
      the issuance of our consolidated financial statements, we completed the account
      reconciliations, analyses and our management review such that we can certify
      that the information contained in our consolidated financial statements for
      the
      year ended December 31, 2004 and for the three and nine months ended September
      30, 2005, fairly presents, in all material respects, the financial condition
      and
      results of operations of the Company.





26





***Limitations
      on Effectiveness of Controls and Procedures.*** **** Our
      management, including our chief executive officer/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.




**PART
      II. OTHER INFORMATION**





**ITEM
      1. 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
      officers 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. The
      settlement is subject to a number of conditions, including final court approval,
      which cannot be assured. 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.
      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.





On
      January 18, 2005, CoSine and our officers and directors were named as defendants
      in a securities class action lawsuit filed in San Mateo County Superior Court.
      The suit requests that the proposed acquisition of CoSine by Tut Systems, Inc.
      be enjoined due to alleged self-dealing and breach of fiduciary duties by our
      officers and directors. The suit was dismissed in May 2005 at the request of
      the
      plaintiff.





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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 consolidated financial
      position or results of operations.





**ITEM
      2. UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS**





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 of
      underwriting discounts and approximately $3.5 million of 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, to fund our operations, working capital and capital
      expenditures. Pending further use of the net proceeds, we have invested them
      in
      short-term, interest-bearing, investment-grade securities.





**ITEM** **6.** **EXHIBITS**





Exhibit
      Index on page 30.





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**SIGNATURE**





Pursuant
      to the requirements 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.




COSINE
              COMMUNICATIONS, INC.Date: October
              31, 2005
            By:
            /s/ Terry
              GibsonTerry
              GibsonChief
                Executive Officer and Chief Financial Officer
              Principal
                Financial and Accounting
                Officer









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**EXHIBIT
      INDEX**





**Exhibit
                Number**
            **Description**3.1
            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).31.1
            Certification
                of Terry 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 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.





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