**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, 2007**
 
 **OR**
 
 o
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
 
 **For
        the transition period from ____________ to ____________.**
 
 **Commission
        File Number 000-30715**
 
 **COSINE
        COMMUNICATIONS, INC.**
 *(Exact
        name of Registrant as specified in its charter)*
 
 **Delaware**
              **94-3280301***(State
                  or other jurisdiction of*
              *(I.R.S.
                  Employer**Incorporation
                  or organization)*
              *Identification
                  Number)***61
                  East Main Street, Suite B Los Gatos, CA**
              **95031***(Address
                  of principal executive offices)*
              *(Zip
                  Code)*
 
 **Registrant's
        telephone number including area code: (408) 399-6494**
 
 Indicate
        by check mark whether the Registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports), and (2) has been subject to such filing requirements
        for
        the past 90 days. Yes x  No o
 
 Indicate
        by check mark whether the Registrant is a large accelerated filer, an
        accelerated filer or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check
        one):
 
 Large
        accelerated filer o     Accelerated
        filer
o
        Non-accelerated filer x
 
 Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 Yes
x 
No
o
 
 **There
        were 10,090,635 shares of the Registrant’s Common Stock, par value $.0001,
        outstanding on September 30, 2007.**
  
 
 
 **COSINE
        COMMUNICATIONS, INC.**
 
 **FORM
        10-Q**
 
 **Quarter
        ended September 30, 2007**
 
 **TABLE
        OF CONTENTS**
  **PART
                    I**
                PageFINANCIAL
                    INFORMATIONItem
                    1.
                Condensed
                    Consolidated Financial Statements:Condensed
                    Consolidated Balance Sheets as of September 30, 2007 and December
                    31,
                    2006
                3Condensed
                    Consolidated Statements of Operations for the Three and Nine
                    Month Periods
                    Ended September 30, 2007 and 2006
                4Condensed
                    Consolidated Statements of Cash Flows for the Nine Months Ended
                    September
                    30, 2007 and 2006
                5Notes
                    to Condensed Consolidated Financial Statements
                6Item
                    2.
                Management's
                    Discussion and Analysis of Financial Condition and Results of
                    Operations
                12Item
                    3.
                Quantitative
                    and Qualitative Disclosures About Market Risk
                17Item
                    4.
                Controls
                    and Procedures
                18**PART
                    II**OTHER
                    INFORMATIONItem
                    1.
                Legal
                    Proceedings
                19Item
                    2.
                Unregistered
                    Sales of Equity Securities and Use of Proceeds
                19Item
                    4.
                Submission
                    of Matters to a Vote of Security Holders
                20Item
                    6.
                Exhibits
                20Signature
                20Exhibit
                    Index
                21Certifications
                22
 
 2
 
 **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,**
                **2007**
              
              **December
                  31,**
                **2006****(Unaudited)**
              
              **(1)**ASSETSCurrent
                  assets:Cash
                  and cash equivalents
              
              $
              6,259
              
              $
              5,207Short-term
                  investments
              
              
              16,766
              
              
              17,650Accounts
                  receivable:Trade
                  (net of allowance for doubtful accounts of nil at September 30,
                  2007 and
                  December 31, 2006)
              
              
              —
              
              
              55Other
              
              
              59
              
              
              68Prepaid
                  expenses and other current assets
              
              
              50
              
              
              56Total
                  current assets
              
              
              23,134
              
              
              23,036Long-term
                  deposit
              
              
              3
              
              
              —$
              23,137
              
              $
              23,036LIABILITIES
                  AND STOCKHOLDERS' EQUITYCurrent
                  liabilities:Accounts
                  payable
              
              $
              240
              
              $
              320Accrued
                  other liabilities
              
              
              50
              
              
              239Total
                  current liabilities
              
              
              290
              
              
              559Stockholders'
                  equity:Preferred
                  stock, 3,000,000 authorized, none issued and outstanding
              
              
              —
              
              
              —Common
                  stock, $.0001 par value, 22,000,000 shares authorized; 10,090,635
                  shares
                  issued and outstanding at September 30, 2007 and December 31,
                  2006
              
              
              1
              
              
              1Additional
                  paid-in capital
              
              
              539,016
              
              
              538,987Accumulated
                  other comprehensive income
              
              
              15
              
              
              17Accumulated
                  deficit
              
              
              (516,185
              )
              
              (516,528
              )Total
                  stockholders' equity
              
              
              22,847
              
              
              22,477$
              23,137
              
              $
              23,036
 
 See
        accompanying notes to condensed consolidated financial statements.
 
 _____________________________
 (1)
        The
        information in this column was derived from the Company's audited consolidated
        financial statements for the year ended December 31, 2006.
  3
  **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****,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Revenue:Product
              
              $
              **—**
              
              $
              -
              
              $
              **—**
              
              $
              -Service
              
              
              **—**
              
              
              134
              
              
              **—**
              
              
              1,233Total
                  revenue
              
              
              **—**
              
              
              134
              
              
              **—**
              
              
              1,233Cost
                  of revenue1
              
              
              **—**
              
              
              366
              
              
              **—**
              
              
              1,469Gross
                  profit (loss)
              
              
              **—**
              
              
              (232
              )
              
              **—**
              
              
              (236
              )Operating
                  expenses:Research
                  and development
              
              
              **—**
              
              
              **—**
              
              
              **—**
              
              
              **—**Sales
                  and marketing
              
              
              **—**
              
              
              **—**
              
              
              **—**
              
              
              **—**General
                  and administrative2
              
              
              175
              
              
              295
              
              
              542
              
              
              906Total
                  operating expenses
              
              
              175
              
              
              295
              
              
              542
              
              
              906Loss
                  from operations
              
              
              (175
              )
              
              (527
              )
              
              (542
              )
              
              (1,142
              )Interest
                  income and other
              
              
              302
              
              
              302
              
              
              885
              
              
              996Income
                  (loss) before income tax provision
              
              
              127
              
              
              (225
              )
              
              343
              
              
              (146
              )Income
                  tax provision
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  income (loss)
              
              $
              127
              
              $
              (225
              )
              $
              343
              
              $
              (146
              )Basic
                  net income (loss) per share
              
              $
              0.01
              
              $
              (0.02
              )
              $
              0.03
              
              $
              (0.01
              )Diluted
                  net income per share
              
              $
              0.01
              
              $
              (0.02
              )
              $
              0.03
              
              $
              (0.01
              )Shares
                  used in computing per share amounts:Basic
              
              
              10,091
              
              
              10,091
              
              
              10,091
              
              
              10,091Diluted
              
              
              10,114
              
              
              10,091
              
              
              10,118
              
              
              10,091
 
 See
        accompanying notes to condensed consolidated financial statements.
  _____________________________ 1  Cost
          of
          revenue includes non-cash (credits) charges related to equity issuances
          of $10
          for the three months ended September 30, 2006 and $130 for the nine months
          ended
          September 30, 2006.
 2 General
          and administrative expenses include non-cash charges related to equity
          issuances
          of $10 and $29, for the three month and nine month periods ended September
          30,
          2007, respectively.
  4
  **COSINE
        COMMUNICATIONS, INC.**
 **CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS**
 **(In
        thousands)**
 **(Unaudited)**
 
 **Nine
                  Months Ended**
                **September
                  30,****2007**
              
              **2006****Operating
                  activities:**Net
                  income (loss)
              
              $
              343
              
              $
              (146
              )Adjustments
                  to reconcile net income to net cash provided by (used in) operating
                  activities:Amortization
                  of warrants issued for services
              
              
              **—**
              
              
              100Stock
                  compensation expense
              
              
              29
              
              
              30Change
                  in operating assets and liabilities:Accounts
                  receivable, trade
              
              
              55
              
              
              **—**Other
                  receivables
              
              
              9
              
              
              190Prepaid
                  expenses and other current assets
              
              
              6
              
              
              5Other
                  assets
              
              
              (3
              )
              
              150Accounts
                  payable12
              
              
              (80
              )
              
              175Accrued
                  other liabilities
              
              
              (189
              )
              
              (664
              )Deferred
                  revenue
              
              
              —
              
              
              (39
              )Net
                  cash provided by (used in) operating activities
              
              
              170
              
              
              (198
              )**Investing
                  activities:**Purchase
                  of short-term investments
              
              
              (22,236
              )
              
              (8,792
              )Proceeds
                  from sales and maturities of short-term investments
              
              
              23,118
              
              
              12,313Net
                  cash (used in) provided by investing activities
              
              
              882
              
              
              3,521Net
                  increase in cash and cash equivalents
              
              
              1,052
              
              
              3,323Cash
                  and cash equivalents at the beginning of the period
              
              
              5,207
              
              
              12,417Cash
                  and cash equivalents at the end of the period
              
              $
              6,259
              
              $
              15,740
 
 See
        accompanying notes to condensed consolidated financial statements.
 
 5
 
 **COSINE
        COMMUNICATIONS, INC.**
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 
 1.
        BASIS
        OF PRESENTATION
 
 ***Description
        of Business***
 
 CoSine
        Communications, Inc. ("CoSine" or the "Company," which may be referred to
        as
        "we," "us" or "our") was incorporated in California on April 14, 1997 and
        in
        August 2000 was reincorporated in the State of Delaware. We were a provider
        of
        carrier network equipment products and services until the fourth quarter
        of
        fiscal year 2004 during which time we discontinued our product lines, took
        actions to lay-off most of our employees, terminated contract manufacturing
        arrangements, contractor and consulting arrangements and various facility
        leases, and sold, scrapped or wrote-off our inventory, property and equipment.
        As a result of these activities, our business consisted primarily of a customer
        support capability for our discontinued products provided by a third party.
        We
        continued such support activities through December 31, 2006, at which time
        we
        ceased all customer support services. In 2006 we sold our patent portfolio
        and
        the intellectual property related to our carrier products and service business.
        We continue to seek to redeploy our existing resources to identify and acquire
        one or more new business operations with existing or prospective taxable
        earnings that can be offset by use of our net operating loss carry-forwards
        ("NOLs").
 
 ***Liquidity
        and Redeployment Strategy***
 
 The
        accompanying financial statements have been prepared in conformity with U.S.
        generally accepted accounting principles, which contemplate continuation
        of the
        Company as a going concern. However, at September 30, 2007, we have an
        accumulated deficit of $516 million. As of December 31, 2006, we ceased our
        customer service capability. Our actions in the fourth quarter of fiscal
        year
        2004 to terminate most of our employees and discontinue production activities
        in
        an effort to conserve cash raise substantial doubt about our ability to continue
        as a going concern. The financial statements do not include any adjustments
        to
        reflect the possible future effects relating to the recoverability and
        classification of the recorded asset amounts or amounts and classification
        of
        liabilities that might result from the outcome of this uncertainty.
 
 In
        July
        2005, we completed a comprehensive review of strategic alternatives, including
        a
        sale of CoSine, a sale or licensing of intellectual property, a redeployment
        of
        our assets into new business ventures, or a winding-up and liquidation of
        the
        business and a return of capital. The board of directors approved a plan
        to
        redeploy our existing resources to identify and acquire one or more new business
        operations, while continuing to support our existing customers and continuing
        to
        offer our intellectual property for license or sale. We continued to provide
        customer support services through December 31, 2006, at which time we terminated
        customer support operations. During 2006, we sold the rights to our patent
        portfolio and the intellectual property related to our carrier products and
        service business. We continue to pursue our redeployment strategy, which
        involves the acquisition of one or more operating businesses with existing
        or
        prospective taxable earnings that can be offset by use of our NOLs.
 
 ***Basis
        of Consolidation***
 
 The
        consolidated financial statements include all of the accounts of CoSine and
        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 U.S.
        generally accepted accounting principles requires management to make estimates
        and assumptions that affect the amounts reported in the consolidated financial
        statements and the accompanying notes. Actual results could differ from these
        estimates. Estimates are used in accounting for, but 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.
  6
  The
        unaudited condensed consolidated financial statements have been prepared
        by us
        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 U. S. 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 month periods ended September
        30,
        2007 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, 2006 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 our Annual Report filed on Form 10-K
        for
        the year ended December 31, 2006.
 
 ***Stock
        Compensation***
 
 Effective
        January 1, 2006, we adopted the provisions of Statement of Financial Accounting
        Standards No. 123 (R), “ *Share-Based
        Payment”* (“SFAS No. 123 (R).” SFAS No. 123 (R) establishes accounting for stock-based
        awards exchanged for employee services. Accordingly, stock-based compensation
        cost is measured at grant date, based on the fair value of the award, and
        is
        recognized as expense over the employee requisite service period. All of
        our
        stock compensation is accounted for as an equity instrument.
 
 **Impact
        of the Adoption of SFAS No. 123 (R)**
 
 The
        effect of recording stock-based compensation for the three and nine month
        periods ended September 30, 2007 was $10,000 and $29,000, respectively, which
        consisted of stock based compensation related to employee stock options.
        The
        effect of recording stock-based compensation for the three and nine month
        periods ended September 30, 2006 was $10,000 and $30,000, respectively, which
        consisted of stock based compensation related to employee stock options.
        As of
        September 30, 2007 we had an unrecorded deferred stock compensation balance
        related to stock options of approximately $79,000 before estimated forfeitures.
        SFAS No. 123 (R) requires forfeitures to be estimated at the time of grant
        and
        revised if necessary in subsequent periods if actual forfeitures differ from
        those estimates. Based on our analysis of historical experience and review
        of
        current option holders, we have assumed an annual forfeiture rate of 2.5%
        for
        our options. Accordingly, as of September 30, 2007, we estimated that the
        stock-based compensation for the awards not expected to vest was approximately
        $3,086, and therefore, the unrecorded deferred stock-based compensation balance
        related to stock options was adjusted to approximately $75.962 after estimated
        forfeitures. This amount will be recognized over an estimated weighted average
        amortization period of 3 years.
  During
        the nine months ended September 30, 2007, there were stock option grants
        for
        6,000 shares, with an exercise price of $3.50 per share, the market price
        on the
        date of grant, and there were no options exercised cancelled or expired.
        During
        the nine months ended September 30, 2006, there were stock option grants
        for
        6,000 shares, with an exercise price of $2.45 per share, the market price
        on the
        date of grant, and 6,000 options were cancelled.
 
 **Valuation
        Assumptions**
 
 **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Dividend
                  yield
              
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %
              
              0.0
              %Volatility
              
              
              0.00
              
              
              0.40
              
              
              0.40
              
              
              0.85Risk
                  free interest rate
              
              
              0
              %
              
              5.0
              %
              
              4.89
              %
              
              4.12
              %Expected
                  life
              
              
              **—**
              
              
              6.25
                  years
              
              
              6.25
                  years
              
              
              4
                  years
 
 7
  The
        dividend yield of zero is based on the fact that we have never paid cash
        dividends and have no present intention to pay cash dividends. Expected
        volatility is based on the historical volatility of our common stock. The
        risk-free interest rates are taken from the Daily Federal Yield Curve Rates
        as
        of the grant dates as published by the Federal Reserve and represent the
        yields
        on actively traded treasury securities for terms equal to the expected term
        of
        the options. The expected term calculation is based on the observed historical
        option exercise behavior and post-vesting forfeitures of our employees and
        an
        analysis of the existing option holders.
 
 Stock
        activity under the Stock Option Plans was as follows (in thousands, except
        per
        share data):
 
 **Shares**
                **Available
                  for**
                **Grant**
              
              **Shares**
              
              **Weighted-**
                **Average**
                **Price
                  Per**
                **Share****Balance
                  as of December 31, 2006**
              
              
              2,940
              
              
              147
              
              $
              7.69Granted
              
              
              6
              
              
              6
              
              
              3.50Exercised
              
              
              —
              
              
              —
              
              
              —Canceled
              
              
              —
              
              
              —
              
              
              —**Balance
                  as of September 30, 2007**
              
              
              2,934
              
              
              153
              
              $
              7.
                  52
 
 The
        following table summarizes information concerning options outstanding and
        exercisable at September 30, 2007 (in thousands, except per share
        data):
 
 **Options
                  Outstanding****Weighted-**
              
              
              
              **Options
                  Exercisable****Average**
              
              **Weighted-**
              
              
              
              **Weighted-****Number**
              
              **Remaining**
              
              **Average**
              
              **Number**
              
              **Average****Range
                  of**
              
              **Of**
              
              **Contractual**
              
              **Exercise**
              
              **Of**
              
              **Exercise****Exercise
                  Prices**
              
              **Shares**
              
              **Life
                  (Years)**
              
              **Price**
              
              **Shares**
              
              **Price**$2.15-2.60
              
              
              118
              
              
              8.0
              
              $
              2.56
              
              
              81
              
              $
              2.573.50
              
              
              6
              
              
              9.6
              
              
              3.50
              
              
              -
              
              
              -5.20
              
              
              4
              
              
              5.6
              
              
              5.20
              
              
              4
              
              
              5.206.96
              
              
              12
              
              
              6.1
              
              
              6.96
              
              
              12
              
              
              6.968.80
              
              
              4
              
              
              4.6
              
              
              8.80
              
              
              4
              
              
              8.8022.30
              
              
              4
              
              
              3.7
              
              
              22.30
              
              
              4
              
              
              22.30120.00
              
              
              5
              
              
              2.9
              
              
              120
              
              
              5
              
              
              120$2.15-120.00
              
              
              153
              
              
              7.5
              
              $
              7.52
              
              
              110
              
              $
              9.41
 
 ***Guarantees***
 
 We may
        enter into certain types of contracts that require that we indemnify parties
        against certain third party claims that may arise. These contracts primarily
        relate to: (i) certain agreements with our officers, directors, employees
        and other service providers, under which we may be required to indemnify
        such
        persons for liabilities arising out of their relationships with us,
        (ii) contracts under which we may be required to indemnify customers against loss
        or
        damage to property or persons as a result of willful or negligent conduct
        by our
        employees or sub-contractors, (iii) contracts under which we may be required
        to
        indemnify customers against third party claims that our product infringes
        a
        patent, copyright or other intellectual property right and (iv) procurement
        or
        license agreements under which we may be required to indemnify licensors
        or
        vendors for certain claims that may be brought against them arising from
        our
        acts or omissions with respect to the supplied products or
        technology.
 
 Generally,
        a maximum obligation is not explicitly stated. Because the obligated amounts
        associated with this type of agreement are not explicitly stated, the overall
        maximum amount of the obligation cannot be reasonably estimated. Historically,
        we have not been obligated to make payments for these obligations, and no
        liabilities have therefore been recorded for these obligations on its
        consolidated balance sheet as of September 30, 2007.
 
 ***Income
        Taxes***
 
 We
        adopted the provisions of Financial Accounting Standards Board (FASB)
        Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January
        1,
        2007.  This Interpretation clarifies the accounting for income taxes by
        prescribing the minimum recognition threshold a tax position is required
        to meet
        before being recognized in our consolidated financial statements.  The
        Interpretation also provides guidance for the measurement and classification
        of
        tax positions, interest and penalties, and requires additional disclosure
        on an
        annual basis.  The cumulative effect of the change was not material.
        Following implementation, the ongoing recognition of changes in measurement
        of
        uncertain tax positions will be reflected as a component of income tax expense.
        Interest and penalties incurred associated with unresolved income tax positions
        will continue to be included in other income (expense).
  8
  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
        officer
        and directors are a part, on common pleading issues. In October 2002, pursuant
        to stipulation by the parties, the Court entered an order dismissing our
        named
        officers and directors from the action without prejudice. On February 19,
        2003,
        the Court dismissed the Section 10(b) and Rule 10b-5 claims against us but
        did
        not dismiss the Section 11 claims against us.
 
 In
        June
        2004, a stipulation of settlement and release of claims against the issuer
        defendants, including us, was submitted to the court for approval. On August
        31,
        2005, the Court preliminarily approved the settlement. In December 2006,
        the
        appellate court overturned the certification of classes in the six test cases
        that were selected by the underwriter defendants and plaintiffs in the
        coordinated proceedings. Because class certification was a condition of the
        settlement, it was unlikely that the settlement would receive final Court
        approval. On June 25, 2007, the Court entered an order terminating the proposed
        settlement based upon a stipulation among the parties to the settlement.
        Plaintiffs have indicated that they will seek to amend their allegations
        and
        file amended complaints. It is uncertain whether there will be any revised
        or
        future settlement.
 
 If
        a
        settlement is not consummated, we intend to defend the lawsuit vigorously.
        However, we cannot predict its outcome with certainty. If we are not successful
        in our defense of this lawsuit, we could be forced to make significant payments
        to the plaintiffs and their lawyers, and such payments could have a material
        adverse effect on our business, financial condition and results of operations
        if
        not covered by our insurance carrier.
 
 Even
        if
        these claims are not successful, the litigation could result in substantial
        costs and divert management's attention and resources, which could adversely
        affect our business, results of operations and financial position.
 
 In
        the
        ordinary course of business, we are involved in legal proceedings involving
        contractual obligations, employment relationships and other matters. Except
        as
        described above, we do not believe there are any pending or threatened legal
        proceedings that will have a material impact on our financial position or
        results of operations.
 
 3.
        BALANCE SHEET DETAILS
 
 ***Cash***
 
 At
        September 30, 2007, we had deposits with a financial institution that may
        exceed
        the amount of insurance provided on such deposits.
  9
  ***Accounts
        Receivable***
 
 We
        have
        no trade accounts receivable at September 30, 2007. Two customers comprised
        94%
        of total accounts receivable at December 31, 2006.
 
 ***Warranty***
 
 Prior
        to
        discontinuing our products in September 2004, we provided a basic limited
        warranty, including repair or replacement of parts, and technical support
        for
        products sold on or before September 30, 2004. We ceased offering warranties
        in
        2004 in connection with the discontinuance of our products and all warranty
        obligations have expired on or before September 30, 2007. There were no warranty
        activities in the three or nine month periods ended September 30, 2007 and
        2006,
        respectively.
 
 4.
        NET
        INCOME (LOSS) PER COMMON SHARE
  Basic
        net
        income (loss) per share is calculated based on the weighted average number
        of
        common shares outstanding during the periods presented. Diluted net income
        per
        share gives effect to the dilutive effect of common stock equivalents consisting
        of stock options and warrants (calculated using the treasury stock method).
 
 The
        following table presents the calculation of basic and diluted net loss per
        share
        for each year (in thousands, except per share data):
  **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Net
                  income (loss)
              
              $
              127
              
              $
              (225
              )
              $
              343
              
              $
              (146
              )Basic
                  and diluted:Weighted-average
                  shares of common stock outstanding
              
              
              10,091
              
              
              10,091
              
              
              10,091
              
              
              10,091Add:
                  effect of dilutive securities - stock options
              
              
              23
              
              
              —
              
              
              27
              
              
              —Weighted-average
                  shares used in diluted net income per share
              
              
              10,114
              
              
              10,091
              
              
              10,118
              
              
              10,091Basic
                  and diluted net income (loss) per share
              
              $
              0.01
              
              $
              (0.02
              )
              $
              0.03
              
              $
              (0.01
              )
 
 Basic
        net
        income per common share is calculated based on the weighted-average number
        of
        common shares outstanding during the periods presented.
 
 5.
        COMPREHENSIVE INCOME
 
 The
        components of comprehensive income are shown below, in thousands:
 
 **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****200****7**
              
              **2006**
              
              **2007**
              
              **2006**Net
                  income (loss)
              
              $
              127
              
              $
              (225
              )
              $
              343
              
              $
              (146
              )Other
                  comprehensive income:Unrealized
                  gains (losses) on investments
              
              
              (2
              )
              
              6
              
              
              (2
              )
              
              13Currency
                  translation adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              13Total
                  other comprehensive income
              
              
              (2
              )
              
              6
              
              
              (2
              )
              
              26Comprehensive
                  income (loss)
              
              $
              125
              
              $
              (219
              )
              $
              341
              
              $
              (120
              )
 
 10
 
 6.
        SEGMENT REPORTING
  We
        operate in only one operating segment, and substantially all of our assets
        are
        located in the United States.
  We
        had no
        revenues in the three and nine month periods ended September 30, 2007. Revenues
        from customers by geographic region for the three and nine months ended
        September 30, 2006, respectively, were as follows, in thousands:
 
 **Three
                  Months Ended September 30, 2006**
              
              **Nine
                  Months Ended September 30, 2006****Region**North
                  America
              
              $
              100
              
              $
              1,110France
              
              
              27
              
              
              109Other
                  EMEA
              
              
              7
              
              
              14Total
              
              $
              134
              
              $
              1,233
 
 Two
        North
        American customers accounted for 47% and 27% of total revenues, respectively,
        in
        the three months ended September 30, 2006.
 
 7.
        RECENT
        ACCOUNTING PRONOUNCEMENTS
 
 In
        June
        2006, the Financial Accounting Standards Board (“FASB”) issued FASB
        Interpretation No. 48, “Accounting for Uncertainty in Income Taxes —
an interpretation of FASB Statement No. 109” (FIN 48). FIN 48
        prescribes a recognition threshold and measurement attribute for financial
        statement recognition and measurement of a tax position taken or expected
        to be
        taken in a tax return, and also provides guidance on derecognition,
        classification, interest and penalties, accounting in interim periods,
        disclosure, and transition. FIN 48 is effective for fiscal years beginning
        after December 15, 2006. We adopted the provisions of FIN 48 on January 1,
        2007. As a result of the implementation of FIN 48, we recognized no material
        adjustments in the liability for unrecognized income tax benefits. We operated
        in multiple tax jurisdictions both inside and outside the United States.
        With
        few exceptions, we are no longer subject to audits by tax authorities for
        tax
        years prior to 2001. At the adoption date, we did not have any unrecognized
        tax
        benefits and did not have any interest or penalties accrued.
 
 In
        September 2006, the FASB issued FASB Statement No. 157, Fair Value
        Measurements, or SFAS 157. The standard provides guidance for using fair
        value to measure assets and liabilities. The standard also responds to
        investors’ requests for expanded information about the extent to which companies
        measure assets and liabilities at fair value, the information used to measure
        fair value, and the effect of fair value measurements on earnings. The standard
        applies whenever other standards require or permit assets or liabilities
        to be
        measured at fair value. The standard does not expand the use of fair value
        in
        any new circumstances. SFAS 157 must be adopted prospectively as of the
        beginning of the year it is initially applied. SFAS 157 is effective for
        financial statements issued for fiscal years beginning after November 15,
        2007, and interim periods within those fiscal years. We are still evaluating
        the
        impact of this standard will have on our financial position or results of
        operations.
 
 In
        September 2006, the Securities and Exchange Commission issued Staff Accounting
        Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when
        Quantifying Misstatements in the Current Year Financial Statements” (“SAB 108”).
        SAB 108 addresses how the effects of prior -year uncorrected misstatements
        should be considered when quantifying misstatements in current-year financial
        statements. SAB 108 requires an entity to quantify misstatements using a
        balance
        sheet and income-statement approach and to evaluate whether either approach
        results in quantifying an error that is material in light of relevant
        quantitative and qualitative factors. The guidance is applicable for fiscal
        years ending after November 15, 2006. The adoption of SAB 108 did not have
        a
        material impact on our considered financial statements.
  11
  In
        February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option
        for Financial Assets and Financial Liabilities—Including an amendment of FASB
        Statement No. 115” (“SFAS 159”). SFAS 159 creates a “fair value option” under
        which an entity may elect to record certain financial assets or liabilities
        at
        fair value upon their initial recognition. Subsequent changes in fair value
        would be recognized in earnings as those changes occur. The election of the
        fair
        value option would be made on a contract-by contract basis and would need
        to be
        supported by concurrent documentation or a preexisting documented policy.
        SFAS
        159 requires an entity to separately disclose the fair value of these items
        on
        the balance sheet or in the footnotes to the financial statements and to
        provide
        information that would allow the financial statement user to understand the
        impact on earnings from changes in the fair value. SFAS 159 is effective
        for us
        beginning with fiscal year 2008. We are currently evaluating the impact that
        the
        adoption of SFAS 159 will have on our consolidated financial statements.
 
 8.
        TRANSACTIONS WITH RELATED PERSONS
 
 In
        efforts to reduce our operating expenses, on June 15, 2007, the board of
        directors approved an agreement (the “Services Agreement”) with SP Corporate
        Services, LLC (“SP”) pursuant to which SP provides us, on a non-exclusive basis,
        a full range of executive, financial and administrative support services
        and
        personnel, including the services of a Chief Executive Officer, Chief Financial
        Officer, Secretary, Principal Executive Officer and Principal Accounting
        Officer, maintenance of our corporate office and records, periodic reviews
        of
        transactions in our stock to assist in preservation of our NOLs, and related
        executive, financial, accounting and administrative support services. The
        Service Agreement became effective as of July 1, 2007. Under the Services
        Agreement, we pay SP a monthly fee of $17,000 in exchange for SP's services.
        SP
        is responsible for compensating and providing all applicable employment benefits
        to any SP personnel in connection with providing services under the Services
        Agreement. We reimburse SP for reasonable and necessary business expenses
        of
        ours incurred by SP, and we are responsible payment of fees related to audit,
        tax, legal, stock transfer, insurance broker, investment advisor and banking
        services provided to us by third party advisors. The Services Agreement has
        a
        term of one year and automatically renews for successive one year periods
        unless
        otherwise terminated by either party. The Services Agreement is also terminable
        by us upon the death of Terry R. Gibson or his resignation as our Chief
        Executive Officer, Chief Financial Officer or Secretary of the Company. Under
        the Services Agreement, SP and its personnel are entitled to the same
        limitations on liability and indemnity rights available under our charter
        documents to any other person performing such services for us. During fiscal
        year 2007, prior to the effectiveness of the Services Agreement, we incurred
        approximately $24,500 per month in performing the services which are to be
        performed by SP under the Services Agreement.
 
 SP
        is
        affiliated with Steel Partners II, L.P., our largest stockholder, by virtue
        of
        SP’s President, Warren Lichtenstein, serving as the sole executive officer and
        managing member of Steel Partners, L.L.C., the general partner of Steel Partners
        II, L.P. SP is a wholly owned subsidiary of Steel Partners Ltd., also controlled
        by Mr. Lichtenstein.
 
 Pursuant
        to the Services Agreement, Terry R. Gibson terminated his employment with
        us,
        effective as of June 30, 2007, but continues to serve as our Chief Executive
        Officer, Chief Financial Officer, Secretary, Principal Executive Officer
        and
        Principal Accounting Officer as an employee of SP. SP is responsible for
        compensating Mr. Gibson, including providing him with all applicable employment
        benefits to which he may be entitled, for his serving as our Chief Executive
        Officer, Chief Financial Officer, Secretary, Principal Executive Officer
        and
        Principal Accounting Officer and for any other services he may provide to
        us
        under the Services Agreement.
 
 **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, failure to achieve revenue growth and profitability, our ability
        to
        identify and acquire new business operations, the time and costs required
        to
        identify and acquire new business operations, management and board interest
        in
        and distraction due to identifying and acquiring new business operations,
        and
        the reactions, either positive or negative, of investors and others to our
        strategic direction and to any specific business opportunity selected by
        us, all
        as are discussed in more detail in the section entitled "Risk Factors" contained
        in our Annual Report on Form 10-K for the year ended December 31, 2006. 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.
  12
  **OVERVIEW**
 
 Until
        December 31, 2006, our business consisted primarily of a customer support
        capability provided by a third party for our discontinued products. We continued
        such support activities through December 31, 2006, at which time we ceased
        all
        customer support services. In 2006, we sold our patent portfolio and the
        intellectual property related to our carrier products and service business.
        Effective July 1, 2007, we are outsourcing our executive, financial and
        administrative support services and personnel requirements to SP Corporate
        Services LLC in efforts to reduce operating costs. See Note 8 to Notes to
        Condensed Consolidated Financial Statements.. We continue to seek to redeploy
        our existing resources to identify and acquire one or more new business
        operations with existing or prospective taxable earnings that can be offset
        by
        use of our net operating loss carry-forwards ("NOLs").
  DUE
        TO
        THE ADOPTION OF OUR REDEPLOYMENT STRATEGY, THE INFORMATION APPEARING BELOW,
        WHICH RELATES TO PRIOR PERIODS, MAY NOT BE INDICATIVE OF THE RESULTS THAT
        MAY BE
        EXPECTED FOR ANY SUBSEQUENT PERIODS. THE NINE MONTH PERIOD ENDED SEPTEMBER
        30,
        2007 PRIMARILY REFLECTS GENERAL AND ADMINISTRATIVE EXPENSES AND TRANSACTION
        EXPENSES ASSOCIATED WITH THE CONTINUING ADMINISTRATION OF THE COMPANY AND
        ITS
        EFFORTS TO REDEPLOY ITS ASSETS.
 
 **CRITICAL
        ACCOUNTING POLICIES AND ESTIMATES**
 
 **General**
 
 Our
        discussion and analysis of our financial condition and results of operations
        are
        based on our consolidated financial statements, which have been prepared
        in
        accordance U.S. generally accepted accounting principles. The preparation
        of
        these consolidated financial statements requires us to make estimates and
        judgments that affect the reported amounts of assets, liabilities, revenue
        and
        expenses, and related disclosures of contingent assets and liabilities. On
        an
        ongoing basis, we evaluate our estimates, including those related to revenue
        recognition, allowance for doubtful accounts, inventory valuation, long-lived
        assets, warranties and equity issuances. Additionally, the audit committee
        of
        our board of directors reviews these critical accounting estimates at least
        annually. We base our estimates on historical experience and on various other
        assumptions that we believe to be reasonable under the circumstances. These
        estimates form the basis for certain judgments about the carrying values
        of
        assets and liabilities that are not readily apparent from other sources.
        Actual
        results may differ from these estimates.
 
 The
        following accounting policies are significantly affected by the judgments
        and
        estimates we use in the preparation of our consolidated financial
        statements.
 
 **Revenue
        Recognition**
 
 Historically,
        prior to discontinuing our products, most of our sales were generated from
        complex arrangements. Recognizing revenue in these arrangements required
        our
        making significant judgments, particularly in the areas of customer acceptance
        and collectibility.
 
 Certain
        of our historic product sales arrangements required formal acceptance by
        our
        customers. In such cases, we did not recognize revenue until we received
        formal
        notification of acceptance. Although we worked closely with our customers
        to
        help them achieve satisfaction with our products prior to and after acceptance,
        the timing of customer acceptance could greatly affect the timing of the
        recognition of our revenue.
 
 While
        the
        end user of our product was normally a large network service provider, we
        also
        sold product and services through small resellers and to small network service
        providers in Asia, Europe and North America. To recognize revenue before
        we
        received payment, we were required to assess that collection from the customer
        was probable. If we could not satisfy ourselves that collection is probable,
        we
        deferred revenue recognition until we collected payment.
  13
  Through
        December 31, 2006, our revenue consisted primarily of customer service revenue.
        We recorded revenue as earned for customer service revenue, once we satisfied
        ourselves that collection was probable. If we could satisfy ourselves that
        collection was probable, we deferred revenue recognition until we 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.
 
 **Warranties**
 
 Prior
        to
        discontinuing our products, we provided a basic limited warranty, including
        repair or replacement of parts, and technical support for our products. The
        specific terms and conditions of those warranties varied depending on the
        customer or region in which we did business. We estimated the costs that
        could
        be incurred under our basic limited warranty and recorded a liability in
        the
        amount of such costs at the time product revenue was 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. In future periods, if actual
        product failure rates, materials usage or service delivery costs differ from
        our
        estimates, adjustments to cost of revenue may result.
 
 We
        ceased
        offering warranty on product or service sales in 2004 and all warranty
        obligations expired prior to December 31, 2006.
 
 **Impact
        of Equity Issuances on Operating Results**
 
 Equity
        issuances have historically had 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, operating expenses and interest expense were affected in prior
        years
        by charges related to warrants and options issued for services. Furthermore,
        some of our employee stock option transactions had resulted in deferred
        compensation, which was presented as a reduction of stockholders’ equity on our
        consolidated balance sheet and was amortized over the vesting period of the
        applicable options using the graded vesting method.
 
 Some
        of
        the stock options granted to our employees prior to our IPO in September
        2000
        had 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.
 
 In
        the
        second quarter of 2004, we issued to a reseller a warrant to acquire 254,489
        shares of our common stock at an exercise price of $4.65 per share. The warrant
        had a two-year term beginning May 28, 2004 and vested ratably over the term.
        If
        during the two-year term (1) any person or entity had acquired a greater
        than
        50% interest in us or the ownership or control of more than 50% of our voting
        stock or (2) we had sold substantially all of our intellectual property assets,
        the warrant would have become exercisable. Even if the reseller had not
        immediately exercised the warrant upon the occurrence of such an event that
        made
        the warrant exercisable (a “trigger event”), the reseller would have been
        entitled to securities, cash and property to which it would have been entitled
        to upon the consummation of the trigger event, less the aggregate price
        applicable to the warrant. We calculated the fair value of the warrant to
        be
        approximately $487,000 using the Black-Scholes option pricing model, using
        a
        volatility factor of .97, a risk-free interest rate of 2.5%, and an expected
        life of two years. The fair value of the warrant has been amortized over
        the
        two-year expected life of the warrant. The warrant was fully amortized at
        December 31, 2006. The warrants have expired and were not exercised. During
        the
        three month and nine month periods ended September 30, 2006 we amortized
        nil and
        $100,000, respectively, to cost of revenue.
  14
  **RESULTS
        OF OPERATIONS**
 
 **Revenue**
 
 Effective
        December 31, 2006, we have ceased all customer service operations and,
        accordingly, there were no revenues recognized for the three and nine month
        periods ended September 30, 2007. Revenues for the three and nine month periods
        ended September 30, 2006 were $134,000 and $1,233,000, respectively, all
        of
        which was earned from service contracts.
 
 Revenues
        by geographic region for the three and nine month periods ended September
        30,
        2006 were as follows, in thousands:
  **Three
                  Months Ended September 30, 2006**
              
              **Nine
                  Months Ended September 30, 2006****Region**North
                  America
              
              $
              100
              
              $
              1,110France
              
              
              27
              
              
              109Other
                  EMEA
              
              
              7
              
              
              14Total
              
              $
              134
              
              $
              1,233
 
 **Non-Cash
        Charges Related to Equity Issuances**
 
 During
        the three and nine month periods ended September 30, 2007, we recorded $10,000
        and $29,000, respectively, of non-cash charges related to equity issuances.
        During the three and nine month periods ended September 30, 2006, we recorded
        $10,000 and $130,000, respectively, of non-cash charges related to equity
        issuances. The charges in 2007 are due to the adoption of SFAS No. 123(R).
        The
        charges in 2006 relate to stock option expense as well as the amortization
        of a
        stock purchase warrant granted to a reseller.
 
 **Cost
        of Revenue**
 
 **** There
        was
        no cost of revenue for the three and nine month periods ended September 30,
        2007
        as we closed our customer service business effective December 31, 2006. **** For
        the
        three and nine month periods ended September 30, 2006, cost of revenue was
        $366,000 and $1,469,000, respectively, which represented costs of our third
        party support contract as well as amortization of a warrant granted to a
        sales
        representative.
  **Gross
        Profit**
 
 There
        was
        no gross profit for the three and nine month periods ended September 30,
        2007 as
        we closed our customer service business effective December 31, 2006. For
        the
        three and nine month periods ended September 30, 2006, gross profit (loss)
        was
        ($232,000) and $(236,000), respectively. Our gross profit was adversely affected
        during the three and nine month periods ended September 30, 2006 by the
        declining volume of our service contract sales and the costs we incurred
        with
        our third party contractor.
 
 **Research
        and Development Expenses**
 
 Research
        and development expenses were nil for the three and nine month periods ended
        September 30, 2007 and 2006, respectively. We discontinued all research and
        development in connection with our announcement in September 2004 that we
        were
        laying off all employees and discontinuing our products. We do not expect
        to
        incur research and development costs unless and until we acquire new operating
        businesses.
 
 **Sales
        and Marketing Expenses**
 
 Sales
        and
        marketing expenses were nil for the three and nine month periods ended September
        30, 2007 and 2006, 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. We do not expect
        to
        incur sales and marketing costs unless and until we acquire new operating
        businesses.
  15
  **General
        and Administrative Expenses**
 
 General
        and administrative expenses were $175,000 and $542,000 for the three and
        nine
        month periods ended September 30, 2007 as compared to $295,000 and $906,000
        for
        the three and nine month periods ended September 30, 2006, respectively.
        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, the evaluation of strategic alternatives,
        as well as the activities related to identifying and acquiring profitable
        business operations. General and administrative costs for the three and nine
        month periods ended September 30, 2007 and 2006 consisted of costs of
        contractors, legal and accounting services, insurance and office expenses.
        The
        decrease from 2006 to 2007 was due to cost savings resulting from ceasing
        our
        customer support services as of December 31, 2006 and outsourcing our executive,
        financial and administrative support services and personnel requirements
        to SP
        Corporate Services LLC, effective as of July 1, 2007.
 
 General
        and administrative expenses should remain at approximately the levels reported
        in the three months ended September 30, 2007 for the quarter ending December
        31,
        2007.
 
 **Interest
        Income and Other Income (Expense)**
 
 For
        the
        three month and nine month periods ended September 30, 2007, interest income
        and
        other income was $302,000 and $885,000, respectively, as compared to $302,000
        and $996,000 for the three month and nine month periods ended September 30,
        2006. The decrease in other income for the nine months ended September 30,
        2006
        to 2007 is due primarily to the $180,000 one-time sale of patents in the
        prior
        year.
 
 **Income
        Tax Provision**
 
 Provisions
        for income taxes were nil for the three and nine month periods ended September
        30, 2007 and 2006, respectively. Our tax expense for fiscal 2007 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**
  Through
        December 31, 2006, our current business consisted primarily of a customer
        support capability for our discontinued products provided by a third party.
        In
        June 2006, we sold the rights to our patent portfolio for cash consideration
        of
        $180,000 and in November 2006 we sold the rights to our intellectual property
        for $80,000. We ceased customer support activities effective December 31,
        2006.
        Effective July 1, 2007, we outsourcing our executive, financial and
        administrative support services and personnel requirements to SP Corporate
        Services LLC in efforts to reduce operating costs. See Note 8 to Notes to
        Condensed Consolidated Financial Statements. We have adopted a strategy of
        seeking to enhance stockholder value by pursuing opportunities to redeploy
        our
        assets through an acquisition of one or more operating business with existing
        or
        prospective taxable earnings that can be offset by use of our net operating
        loss
        carry-forwards. We believe that we possess sufficient liquidity and capital
        resources to fund our operations and working capital requirements for at
        least
        the next 12 months. However, our restructuring activities and our new
        redeployment of assets strategy raise substantial doubt as to our ability
        to
        continue as a going concern.
 
 We
        will
        continue to prepare our financial statements on the assumption that we will
        continue as a going concern, which contemplates the realization of assets
        and
        liquidation of liabilities in the normal course of business. As such, the
        financial statements do not include any adjustments to reflect possible future
        effects of the recoverability and classification of assets or the amounts
        and
        classification of liabilities that may result from any decisions made with
        respect to an assessment of our strategic alternatives. If at some point
        we were
        to decide to pursue alternative plans, we may be required to present the
        financial statements on a different basis. As an example, if we were to decide
        to pursue a liquidation and return of capital, it would be appropriate to
        prepare and present financial statements on the liquidation basis of accounting,
        whereby assets are valued at their estimated net realizable values and
        liabilities are stated at their estimated settlement amounts.
 
 16
 
 **Cash,
        Cash Equivalents and Short-Term Investments**
 
 Cash,
        cash equivalents and short-term investments were $23.0 million at September
        30,
        2007 and $22.9 million at December 31, 2006.
 
 **Operating
        Activities**
  We
        generated $170,000 in cash for operations for the nine months ended September
        30, 2007 as compared to a usage of $198,000 in cash for operations for the
        nine
        months ended September 30, 2006. The improvement in 2007 is due to decreases
        in
        operating expenses and cost of revenue as a result of ceasing operations
        and
        support services as of the end of 2006 as well as lower payments for short
        term
        liabilities in 2007 as compared to 2006.
  **Investing
        Activities**
 
 **** Investing
        activities provided $882,000 in cash for the nine months ended September
        30,
        2007 as compared to $3.5 million in cash provided by investing activities
        in the
        nine months ended September 30, 2006. There were no capital expenditures
        in the
        nine months ended September 30, 2007 or 2006, respectively.
 
 **Financing
        Activities**
 
 There
        were no financing activities in the nine months ended September 30, 2007
        or
        2006, respectively.
 
 **OUTLOOK**
 
 Our
        board
        of directors, on completion of a comprehensive review of strategic alternatives,
        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.
 
 At
        September 30, 2007, we had $23.0 million in cash and short-term investments.
        We
        believe we possess sufficient liquidity and capital resources to fund our
        operations and working capital requirements for at least the next 12 months.
 
 **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, 2007 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 $37,000 decrease in the fair
        value
        of our investments in debt securities as of September 30, 2007.
  17
  **Exchange
        Rate Sensitivity**
 
 Currently,
        all of our revenue and most of our expenses are denominated in U.S. dollars.
 
 **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. Our chief executive officer and chief financial officer
        has
        concluded, based on the evaluation of the effectiveness of the disclosure
        controls and procedures by our management, with the participation of our
        chief
        executive officer and chief financial officer, as of the end of the period
        covered by this report, that our disclosure controls and procedures were
        effective for this purpose, except as noted below under "Changes in Internal
        Controls."
 
 **Changes
        in Internal Controls** .
        In
        connection with its audit of our consolidated financial statements for the
        year
        ended December 31, 2006, 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 and financial statement disclosure changes were needed
        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 our downsizing.
  Prior
        to
        the issuance of our consolidated financial statements, we completed the needed
        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, 2006 and the three and nine month periods ended September 30, 2007 and
        2006,
        respectively, fairly presents, in all material respects, our financial condition
        and results of operations.
 
 **Limitations
        on Effectiveness of Controls and Procedures** .  Our
        management, including our chief executive officer and chief financial officer,
        does not expect that our disclosure controls and procedures or our internal
        controls will prevent all errors and all fraud. A control system, no matter
        how
        well conceived and operated, can provide only reasonable, not absolute,
        assurance that the objectives of the control system are met. Further, the
        design
        of a control system must reflect the fact that there are resource constraints
        and the benefits of controls must be considered relative to their costs.
        Because
        of the inherent limitations in all control systems, no evaluation of controls
        can provide absolute assurance that all control issues and instances of fraud,
        if any, within the Company have been detected. These inherent limitations
        include, but are not limited to, the realities that judgments in decision-making
        can be faulty and that breakdowns can occur because of simple error or mistake.
        Additionally, controls can be circumvented by the individual acts of some
        persons, by collusion of two or more people, or by management override of
        the
        control. The design of any system of controls also is based in part upon
        certain
        assumptions about the likelihood of future events and there can be no assurance
        that any design will succeed in achieving its stated goals under all potential
        future conditions. Over time, controls may become inadequate because of changes
        in conditions, or the degree of compliance with the policies or procedures
        may
        deteriorate. Because of the inherent limitations in a cost-effective control
        system, misstatements due to error or fraud may occur and not be detected.
 
 18
 
 **P** **ART
        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
        officer
        and directors are a part, on common pleading issues. In October 2002, pursuant
        to stipulation by the parties, the Court entered an order dismissing our
        named
        officers and directors from the action without prejudice. On February 19,
        2003,
        the Court dismissed the Section 10(b) and Rule 10b-5 claims against us but
        did
        not dismiss the Section 11 claims against us.
 
 In
        June
        2004, a stipulation of settlement and release of claims against the issuer
        defendants, including us, was submitted to the court for approval. On August
        31,
        2005, the court preliminarily approved the settlement. In December 2006,
        the
        appellate court overturned the certification of classes in the six test cases
        that were selected by the underwriter defendants and plaintiffs in the
        coordinated proceedings. Because class certification was a condition of the
        settlement, it was unlikely that the settlement would receive final Court
        approval. On June 25, 2007, the Court entered an order terminating the proposed
        settlement based upon a stipulation among the parties to the settlement.
        Plaintiffs have indicated that they will seek to amend their allegations
        and
        file amended complaints. It is uncertain whether there will be any revised
        or
        future settlement.
 
 If
        a
        settlement is not consummated, we intend to defend the lawsuit vigorously.
        However, we cannot predict its outcome with certainty. If we are not successful
        in our defense of this lawsuit, we could be forced to make significant payments
        to the plaintiffs and their lawyers, and such payments could have a material
        adverse effect on our business, financial condition and results of operations
        if
        not covered by our insurance carrier.
 
 Even
        if
        these claims are not successful, the litigation could result in substantial
        costs and divert management's attention and resources, which could adversely
        affect our business, results of operations and financial position.
 
 In
        the
        ordinary course of business, we are involved in legal proceedings involving
        contractual obligations, employment relationships and other matters. Except
        as
        described above, we do not believe there are any pending or threatened legal
        proceedings that will have a material impact on our financial position or
        results of operations.
 
 **ITEM
        2. UNREGISTERED SALES OF EQUITY SECURITIES 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.
  19
  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
        4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**
 
 None.
 
 **ITEM** **6.** **EXHIBITS**
 
 An
        index
        of exhibits filed as part of this Report is on page 21.
 
 
 **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.Dated:
                October 31, 2007
              By:
              /s/
                Terry R. GibsonTerry
                R. GibsonChief
                Executive Officer and Chief Financial
                Officer
  20
  **EXHIBIT
        INDEX**
 
 Exhibit
                  Number
              Description10.1
              Services
                  Agreement by and between CoSine Communications, Inc. and SP Corporate
                  Services, LLC, effective as of July 1, 2007 (incorporated by reference
                  to
                  Exhibit 10.1 to Form 8-K filed June 19, 2007).10.2
              First
                  Amendment to Rights Agreement by and between CoSine Communications,
                  Inc.
                  and Mellon Investor Services LLC, effective as of August 31, 2007
                  (incorporated by reference to Exhibit 10.1 to Form 8-K filed on
                  September
                  4, 2007).31.1
              Certification
                  of Terry R. Gibson, Chief Executive Officer and Chief Financial
                  Officer of
                  CoSine Communications, Inc., pursuant to 15 U.S.C. Section 7241,
                  as
                  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
                  200232.1
              Certification
                  of Terry R. Gibson, Chief Executive Officer and Chief Financial
                  Officer of
                  CoSine Communications, Inc., pursuant to 18 U.S.C. Section 1350,
                  as
                  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
                  2002
 
 21