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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549




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FORM 10-Q



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(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, 2003

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)
|                                         |  |                       
|1200 Bridge Parkway, Redwood City, CA    |  | 94065                 
|(Address of principal executive offices) |  | (Zip Code)            

Registrants telephone number including area code: (650) 637-4777

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 10,027,980 shares of the Companys Common Stock, par value $.0001,
outstanding on October 31, 2003.



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TABLE OF CONTENTS



|                              |                                                                                               |                                            |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS                                                    
|                              |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                              | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II. OTHER INFORMATION   
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURE                    
|EXHIBIT INDEX                
|EXHIBIT 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 
|EXHIBIT 32.2                 



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##### Table of Contents



COSINE COMMUNICATIONS, INC.

FORM 10-Q

Quarter ended September 30, 2003

TABLE OF CONTENTS

|                                                                                              |  |                                                                                                                     |  |     
|--------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                              |  |                                                                                                                     |  | Page
|                                                                                              |  |                                                                                                                     |  |     
|                                                                                              |  | PART I                                                                                                              |  |     
|Item 1. Consolidated Financial Statements:                                                   
|                                                                                              |  | Consolidated Balance Sheets as of September 30, 2003 and
December 31, 2002                                          |  | 3   
|                                                                                              |  | Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2003 and September 30, 2002 |  | 4   
|                                                                                              |  | Consolidated Statements of Cash Flows for Nine Months Ended September 30, 2003
and September 30, 2002               |  | 5   
|                                                                                              |  | Notes to Consolidated Financial Statements                                                                          |  | 6   
|Item 2. Managements Discussion and Analysis
of Financial Condition and Results
of Operations |  | 13                                                                                                                 
|Item 3. Quantitative and Qualitative
Disclosures About Market Risk                            |  | 28                                                                                                                 
|Item 4. Controls and Procedures                                                               |  | 28                                                                                                                 
|                                                                                              |  | PART II                                                                                                             |  |     
|Item 1. Legal Proceedings                                                                     |  | 29                                                                                                                 
|Item 2. Changes in Securities and
Use of Proceeds                                             |  | 29                                                                                                                 
|Item 6. Exhibits and Reports on Form 8-K                                                      |  | 30                                                                                                                 
|Signature                                                                                     |  | 31                                                                                                                 
|Exhibit
Index                                                                                 |  | 32                                                                                                                 
|Certifications                                                                                |  |                                                                                                                    

PAGE 2 OF 32



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PART I. FINANCIAL INFORMATION




ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS




COSINE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share data)

|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |              |       |         |  | 
|-------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------ | ----- | ------------- | ------- | ------------ | ----- | ------- |  | 
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       | September 30, |         | December 31,
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       | 2003          |         | 2002        
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       | (Unaudited)   |         | (1)         
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            | ASSETS                               |       |               |         |              |       |         |  | 
|Current assets:                                          |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         | Cash and cash equivalents                                                                                                                                                       |                                                                                                                           | $                          | 19,241                               |       |               | $       | 9,230        |      
|                                                         | Short-term investments                                                                                                                                                          |                                                                                                                           |                            | 47,651                               |       |               |         | 92,237       |      
|                                                         | Accounts receivable:                                                                                                                                                            |                                                                                                                           |                            |                                      |       |               |         |              |      
|                                                         |                                                                                                                                                                                 | Trade (net of allowance for doubtful accounts of $180 and $233
at September 30, 2003 and December 31, 2002, respectively) |                            |                                      | 3,487 |               |         |              | 6,373 |        
|                                                         |                                                                                                                                                                                 | Other                                                                                                                     |                            |                                      | 456   |               |         |              | 679   |        
|                                                         | Inventory                                                                                                                                                                       |                                                                                                                           |                            | 4,026                                |       |               |         | 3,175        |      
|                                                         | Prepaid expenses and other current assets                                                                                                                                       |                                                                                                                           |                            | 3,440                                |       |               |         | 4,054        |      
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |              |      
|                                                         |                                                                                                                                                                                 |                                                                                                                           | Total current assets       |                                      |       | 78,301        |         |              |       | 115,748 | 
|                                                         | Property and equipment, net                                                                                                                                                     |                                                                                                                           |                            | 2,658                                |       |               |         | 2,816        |      
|                                                         | Long-term deposits                                                                                                                                                              |                                                                                                                           |                            | 737                                  |       |               |         | 997          |      
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         |                                                                                                                                                                                 | $                                                                                                                         | 81,696                     |                                      |       | $             | 119,561 |             
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            | LIABILITIES AND STOCKHOLDERS EQUITY |       |               |         |              |       |         |  | 
|Current liabilities:                                     |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         | Accounts payable                                                                                                                                                                |                                                                                                                           | $                          | 2,735                                |       |               | $       | 2,493        |      
|                                                         | Provision for warranty claims                                                                                                                                                   |                                                                                                                           |                            | 683                                  |       |               |         | 1,103        |      
|                                                         | Accrued other liabilities                                                                                                                                                       |                                                                                                                           |                            | 2,213                                |       |               |         | 13,362       |      
|                                                         | Accrued compensation                                                                                                                                                            |                                                                                                                           |                            | 2,301                                |       |               |         | 1,708        |      
|                                                         | Deferred revenue                                                                                                                                                                |                                                                                                                           |                            | 1,647                                |       |               |         | 1,444        |      
|                                                         | Current portion of equipment and working capital loans                                                                                                                          |                                                                                                                           |                            | 415                                  |       |               |         | 1,865        |      
|                                                         | Current portion of obligations under capital lease                                                                                                                              |                                                                                                                           |                            |                                     |       |               |         | 1,905        |      
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |              |      
|                                                         |                                                                                                                                                                                 |                                                                                                                           | Total current liabilities  |                                      |       | 9,994         |         |              |       | 23,880  | 
|Long-term portion of equipment and working capital loans |                                                                                                                                                                                 |                                                                                                                           |                           |                                      |       |               | 131     |             
|Accrued rent                                             |                                                                                                                                                                                 |                                                                                                                           | 2,061                      |                                      |       |               | 2,069   |             
|Stockholders equity:                                    |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         | Preferred stock, 3,000,000 authorized, none issued and outstanding                                                                                                              |                                                                                                                           |                            |                                     |       |               |         |             |      
|                                                         | Common stock, $.0001 par value, 300,000,000 shares authorized;
10,000,130 and 9,959,092 shares issued and outstanding at
September 30, 2003 and December 31, 2002, respectively |                                                                                                                           |                            | 1                                    |       |               |         | 1            |      
|                                                         | Additional paid-in capital                                                                                                                                                      |                                                                                                                           |                            | 545,634                              |       |               |         | 549,243      |      
|                                                         | Notes receivable from stockholders                                                                                                                                              |                                                                                                                           |                            | (7,564                               | )     |               |         | (10,531      | )    
|                                                         | Accumulated other comprehensive income                                                                                                                                          |                                                                                                                           |                            | 393                                  |       |               |         | 532          |      
|                                                         | Deferred compensation                                                                                                                                                           |                                                                                                                           |                            | (569                                 | )     |               |         | (2,274       | )    
|                                                         | Accumulated deficit                                                                                                                                                             |                                                                                                                           |                            | (468,254                             | )     |               |         | (443,490     | )    
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         |                                                                                                                                                                                 |                                                                                                                           | Total stockholders equity |                                      |       | 69,641        |         |              |       | 93,481  | 
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             
|                                                         |                                                                                                                                                                                 | $                                                                                                                         | 81,696                     |                                      |       | $             | 119,561 |             
|                                                         |                                                                                                                                                                                 |                                                                                                                           |                            |                                      |       |               |         |             

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, 2002.

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COSINE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share data)
(Unaudited)

|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |        |        | 
|------------------------------------------- | ------------------------------------ | ----------------------------- | ------ | ------------------ | ------ | ----------------- | ------ | ----- | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                            |                                      |                               |        | Three Months Ended |        | Nine Months Ended
|                                            |                                      |                               |        | September 30,      |        | September 30,    
|                                            |                                      |                               |        |                    |        |                  
|                                            |                                      |                               |        | 2003               |        | 2002              |        | 2003  |        | 2002
|                                            |                                      |                               |        |                    |        |                   |        |       |        |     
|Revenue                                     |                                      | $                             | 4,024  |                    |        | $                 | 5,245  |       |        | $    | 12,244  |        |        | $ | 18,404  |       
|                                            | Cost of goods sold1                  |                               |        | 1,798              |        |                   |        | 2,231 |        |      |         | 5,335  |        |   |         | 11,586 |       
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Gross profit                                |                                      |                               | 2,226  |                    |        |                   | 3,014  |       |        |      | 6,909   |        |        |   | 6,818   |       
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Operating expenses:                         |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|                                            | Research and development2            |                               |        | 5,485              |        |                   |        | 4,050 |        |      |         | 15,920 |        |   |         | 27,185 |       
|                                            | Sales and marketing3                 |                               |        | 3,191              |        |                   |        | 5,721 |        |      |         | 10,310 |        |   |         | 24,349 |       
|                                            | General and administrative4          |                               |        | 1,817              |        |                   |        | 2,345 |        |      |         | 5,643  |        |   |         | 9,405  |       
|                                            | Restructuring and impairment charges |                               |        | 14                 |        |                   |        | 693   |        |      |         | 351    |        |   |         | 24,739 |       
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|                                            |                                      | Total operating expenses      |        |                    | 10,507 |                   |        |       | 12,809 |      |         |        | 32,224 |   |         |        | 85,678 | 
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Loss from operations                        |                                      |                               | (8,281 | )                  |        |                   | (9,795 | )     |        |      | (25,315 | )      |        |   | (78,860 | )     
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Other income (expenses):                    |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|                                            | Interest income and other            |                               |        | 137                |        |                   |        | 1,090 |        |      |         | 851    |        |   |         | 3,318  |       
|                                            | Interest expense5                    |                               |        | (25                | )      |                   |        | (227  | )      |      |         | (214   | )      |   |         | (794   | )     
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|                                            |                                      | Total other income (expenses) |        |                    | 112    |                   |        |       | 863    |      |         |        | 637    |   |         |        | 2,524  | 
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Loss before income tax provision            |                                      |                               | (8,169 | )                  |        |                   | (8,932 | )     |        |      | (24,678 | )      |        |   | (76,336 | )     
|                                            | Income tax provision                 |                               |        | 15                 |        |                   |        | 82    |        |      |         | 86     |        |   |         | 381    |       
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Net loss                                    |                                      | $                             | (8,184 | )                  |        | $                 | (9,014 | )     |        | $    | (24,764 | )      |        | $ | (76,717 | )     
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Basic and diluted net loss per common share |                                      | $                             | (0.84  | )                  |        | $                 | (0.93  | )     |        | $    | (2.54   | )      |        | $ | (7.94   | )     
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       
|Shares used in computing per share amounts  |                                      |                               | 9,797  |                    |        |                   | 9,689  |       |        |      | 9,753   |        |        |   | 9,660   |       
|                                            |                                      |                               |        |                    |        |                   |        |       |        |      |         |        |        |   |         |       



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|1 Cost of goods sold includes $40 and ($494) for the three months ended
September 30, 2003 and 2002, respectively, and $135 and $136 for the nine
months ended September 30, 2003 and 2002, respectively, of non-cash charges
(credits) related to equity issuances.                   
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                       
|2 Research and development expenses include $159 and ($1,954) for the three
months ended September 30, 2003 and 2002, respectively, and $345 and ($314) for
the nine months ended September 30, 2003 and 2002, respectively, of non-cash
charges (credits) related to equity issuances.
|                                                                                                                                                                                                                                                                                       
|3 Sales and marketing expenses include $86 and ($544) for the three months
ended September 30, 2003 and 2002, respectively, and ($15) and ($214) for the
nine months ended September 30, 2003 and 2002, respectively, of non-cash
charges (credits) related to equity issuances.       
|                                                                                                                                                                                                                                                                                       
|4General and administrative expenses include ($60) and ($246) for the three
months ended September 30, 2003 and 2002, respectively, and $209 and $744 for
the nine months ended September 30, 2003 and 2002, respectively, of non-cash
(credits) charges related to equity issuances.  
|                                                                                                                                                                                                                                                                                       
|5 Interest expense includes $0 and $31 for the three months ended September 30,
2003 and 2002, respectively, and $30 and $101 for the nine months ended
September 30, 2003 and 2002, respectively, of non-cash charges related to
equity issuances.                                    

See accompanying notes.

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COSINE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

|                                                                             |                                                     |                                           |         |                   |         |      |         |        |        |  
|---------------------------------------------------------------------------- | --------------------------------------------------- | ----------------------------------------- | ------- | ----------------- | ------- | ---- | ------- | ------ | ------ | -
|                                                                             |                                                     |                                           |         | Nine Months Ended
|                                                                             |                                                     |                                           |         | September 30,    
|                                                                             |                                                     |                                           |         |                  
|                                                                             |                                                     |                                           |         | 2003              |         | 2002
|                                                                             |                                                     |                                           |         |                   |         |     
|Operating activities:                                                        |                                                     |                                           |         |                   |         |      |         |       
|Net loss                                                                     |                                                     | ($                                        | 24,764  | )                 |         | ($   | 76,717  | )     
|Adjustments to reconcile net loss to net cash used in operating
activities:  |                                                     |                                           |         |                   |         |      |         |       
|                                                                             | Depreciation                                        |                                           |         | 2,003             |         |      |         | 9,673  |       
|                                                                             | Allowance for doubtful accounts                     |                                           |         | 88                |         |      |         | 296    |       
|                                                                             | Non-cash charges related to inventory write-down    |                                           |         | 61                |         |      |         | 1,780  |       
|                                                                             | Write-down of property and capital equipment        |                                           |         |                  |         |      |         | 18,761 |       
|                                                                             | Amortization of warrants issued for services        |                                           |         | 75                |         |      |         | 148    |       
|                                                                             | Amortization of deferred stock compensation         |                                           |         | 1,431             |         |      |         | 6,649  |       
|                                                                             | Reversal of amortization in excess of vesting       |                                           |         | (802              | )       |      |         | (6,344 | )     
|                                                                             | Non-cash restructuring items                        |                                           |         | 12                |         |      |         |       |       
|                                                                             | Other, net                                          |                                           |         | (139              | )       |      |         | 160    |       
|                                                                             | Change in operating assets and liabilities:         |                                           |         |                   |         |      |         |        |       
|                                                                             |                                                     | Accounts receivable, trade                |         |                   | 2,798   |      |         |        | 8,712  |  
|                                                                             |                                                     | Other receivables                         |         |                   | 223     |      |         |        | 687    |  
|                                                                             |                                                     | Inventory                                 |         |                   | (738    | )    |         |        | (890   | )
|                                                                             |                                                     | Prepaid expenses and other current assets |         |                   | 539     |      |         |        | (17    | )
|                                                                             |                                                     | Long-term deposits                        |         |                   | 252     |      |         |        | 175    |  
|                                                                             |                                                     | Other assets                              |         |                   |        |      |         |        | 168    |  
|                                                                             |                                                     | Accounts payable                          |         |                   | 242     |      |         |        | (1,623 | )
|                                                                             |                                                     | Provision for warranty claims             |         |                   | (420    | )    |         |        | (1,262 | )
|                                                                             |                                                     | Accrued other liabilities                 |         |                   | (11,149 | )    |         |        | (2,723 | )
|                                                                             |                                                     | Accrued compensation                      |         |                   | 593     |      |         |        | (829   | )
|                                                                             |                                                     | Deferred revenue                          |         |                   | 203     |      |         |        | (1,299 | )
|                                                                             |                                                     | Accrued rent                              |         |                   | (8      | )    |         |        | 221    |  
|                                                                             |                                                     | Other liabilities                         |         |                   |        |      |         |        | 2      |  
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Net cash used in operating activities                                        |                                                     |                                           | (29,500 | )                 |         |      | (44,272 | )     
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Investing activities:                                                        |                                                     |                                           |         |                   |         |      |         |       
|Capital expenditures                                                         |                                                     |                                           | (2,023  | )                 |         |      | (3,038  | )     
|Purchase of short-term investments                                           |                                                     |                                           | (58,828 | )                 |         |      | (69,779 | )     
|Proceeds from sales and maturities of short-term investments                 |                                                     |                                           | 103,414 |                   |         |      | 67,207  |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|                                                                             | Net cash provided by (used in) investing activities |                                           |         | 42,563            |         |      |         | (5,610 | )     
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Financing activities:                                                        |                                                     |                                           |         |                   |         |      |         |       
|Principal payments of equipment and working capital loans and
capital leases |                                                     |                                           | (3,486  | )                 |         |      | (4,604  | )     
|Proceeds from issuance of common stock, net                                  |                                                     |                                           | 471     |                   |         |      | 623     |       
|Proceeds from notes receivable from stockholders                             |                                                     |                                           | 31      |                   |         |      | 234     |       
|Repurchase of common stock                                                   |                                                     |                                           | (68     | )                 |         |      | (133    | )     
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|                                                                             | Net cash used in financing activities               |                                           |         | (3,052            | )       |      |         | (3,880 | )     
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Net increase (decrease) in cash and cash equivalents                         |                                                     |                                           | 10,011  |                   |         |      | (53,762 | )     
|Cash and cash equivalents at the beginning of the period                     |                                                     |                                           | 9,230   |                   |         |      | 73,868  |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Cash and cash equivalents at the end of the period                           |                                                     | $                                         | 19,241  |                   |         | $    | 20,106  |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Supplemental information:                                                    |                                                     |                                           |         |                   |         |      |         |       
|Cash paid for interest                                                       |                                                     | $                                         | 184     |                   |         | $    | 693     |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Income taxes paid                                                            |                                                     | $                                         | 86      |                   |         | $    | 381     |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       
|Cancellation of notes receivable due to repurchase of unvested stock         |                                                     | $                                         | 2,936   |                   |         | $    | 10,029  |       
|                                                                             |                                                     |                                           |         |                   |         |      |         |       

See accompanying notes.

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COSINE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The unaudited consolidated financial statements have been prepared by
CoSine Communications, Inc. pursuant to the rules and regulations of the
Securities and Exchange Commission 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 such
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, 2003 are not necessarily indicative of the results to be expected
for the entire year. These unaudited 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, 2002.

Pro Forma Information

CoSine has elected to continue to follow APB 25 to account for employee
stock options because the alternative fair value method of accounting
prescribed by SFAS 123 requires the use of option valuation models that were
not developed for use in valuing employee stock options. 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.

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 |       | Nine Months Ended
|                                                                                                                                    |  | September 30,      |       | September 30,    
|                                                                                                                                    |  |                    |       |                  
|                                                                                                                                    |  | 2003               |       | 2002              |  | 2003 |        | 2002 |  |    |        |  
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |  
|Net loss, as reported                                                                                                               |  | ($                 | 8,184 | )                 |  | ($   | 9,014  | )    |  | ($ | 24,764 | ) |  | ($ | 76,717 | )
|Add: Stock-based employee compensation expense
included in reported net loss                                                        |  |                    | 357   |                   |  |      | 1,296  |      |  |    | 1,431  |   |  |    | 6,649  |  
|Deduct: Reversal of amortization in excess of
vesting                                                                               |  |                    | (147  | )                 |  |      | (4,550 | )    |  |    | (802   | ) |  |    | (6,344 | )
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |   |  |    |        |  
|Deduct: Stock-based employee compensation
expense determined under fair value method for
all stock option grants (SFAS 123 expense) |  |                    | (45   | )                 |  |      | (1,190 | )    |  |    | (1,947 | ) |  |    | (7,241 | )
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |   |  |    |        |  
|Pro forma net loss                                                                                                                  |  | ($                 | 8,019 | )                 |  | ($   | 13,458 | )    |  | ($ | 26,082 | ) |  | ($ | 83,653 | )
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |   |  |    |        |  
|Basic and diluted net loss per share, as reported                                                                                   |  | ($                 | 0.84  | )                 |  | ($   | 0.93   | )    |  | ($ | 2.54   | ) |  | ($ | 7.94   | )
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |   |  |    |        |  
|Pro forma basic and diluted net loss per share                                                                                      |  | ($                 | 0.82  | )                 |  | ($   | 1.39   | )    |  | ($ | 2.67   | ) |  | ($ | 8.66   | )
|                                                                                                                                    |  |                    |       |                   |  |      |        |      |  |    |        |   |  |    |        |  

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 |      | Nine Months Ended |  | Fiscal Year Ended
|                        |  | September 30,      |      | September 30,     |  | December 31,     
|                        |  |                    |      |                   |  |                  
|                        |  | 2003               |      | 2003              |  | 2002             
|                        |  |                    |      |                   |  |                  
|Dividend yield          |  |                    | 0.0  | %                 |  |                   | 0.0  | %     |  |  | 0.0  | %    
|Volatility              |  |                    | 0.84 |                   |  |                   | 0.81 |       |  |  | 0.67 |      
|Risk free interest rate |  |                    | 2.7  | %                 |  |                   | 2.2  | %     |  |  | 3.0  | %    
|Expected life           |  |                    | 4    | years             |  |                   | 4    | years |  |  | 4    | years

The estimated weighted-average fair value of shares granted under the
Employee Stock Purchase Plan in the nine months ended September 30, 2003 was $1.39, using a
volatility of 0.35, risk-free interest rate of 1% and an expected life of six
months.

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The estimated weighted-average fair value of shares granted under the
Employee Stock Purchase Plan in 2002 was $1.60, using a volatility of 0.67, risk-free interest
rate of 1% and an expected life of six months.

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.

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 balance sheet as of September 30, 2003.

2. USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States 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.

3. RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others  an Interpretation of FASB Statements
No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. The
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires a guarantor to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The adoption of FASB
Interpretation No. 45 did not impact CoSines financial
results.

In December 2002, the FASB issued Statement Number 148, Accounting for
Stock-Based Compensation  Transition and Disclosure (SFAS 148). SFAS 148
amends Statement Number 123, Accounting for Stock-Based Compensation, (SFAS
123) to provide alternative methods of transition to the SFAS 123 fair value
method of accounting for stock-based employee compensation. In addition, SFAS
148 requires disclosure of the effects of an entitys accounting policy with
respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. As permitted
under SFAS 148, CoSine adopted the disclosure provisions of that accounting
standard and, accordingly, has included such disclosures in the financial
statements for the three and nine months ended September 30, 2003.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, and a subsequent
Modification in November 2003 which requires a company that has a controlling
financial interest in a variable interest entity to consolidate the assets,
liabilities and results of activities of the entity. A variable interest entity
is an entity in which the equity investors do not have a controlling interest
or the equity investment at risk is insufficient to finance the entitys
activities without receiving additional subordinated financial support from
other parties. Interpretation No. 46 is applicable: (i) immediately for all
variable interest entities created
after January 31, 2003; or (ii) in the first fiscal year or interim period
beginning after December 15, 2003 for those created before February 1, 2003.
CoSine has not created any variable entities since January 31, 2003 and does
not have

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any investments acquired prior to February 1, 2003 that are variable
interest entities. Accordingly, adoption of FASB Interpretation No. 46 will not
have a material impact on its financial statements.

In May 2003, the FASB issued Statement Number 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). This Statement establishes standards for classifying and measuring
as liabilities certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. SFAS 150
generally requires liability classification for two broad classes of financial
instruments: (1) instruments that represent, or are indexed to, an obligation
to buy back the issuers shares, and (2) obligations that can be settled in
shares, but are subject to certain conditions. SFAS 150 applies to all
financial instruments created or modified after May 31, 2003, and to other
instruments at the beginning of the first interim period beginning after June
15, 2003. As CoSine has not created or modified any financial instruments
since the effective date of SFAS 150, CoSine does not believe this Statement
will have a material impact on its financial statements.

4. COMMITMENTS AND CONTINGENCIES

As of September 30, 2003, CoSine had commitments of approximately
$1,005,000 relating to purchases of raw materials and semi-finished goods. Of
that amount, $216,000 related to purchase orders in excess of demand was
accrued at September 30, 2003 in accrued other liabilities.

On November 15, 2001, CoSine and certain of its officers and directors
were named as defendants in a securities class action lawsuit filed in the
United States District Court, Southern District of New York. The complaint
generally alleges that various investment bank underwriters engaged in improper
and undisclosed activities related to the allocation of shares in CoSines
initial public offering. The complaint brings claims for the violation of
several provisions of the federal securities laws against those underwriters,
and also against the Company and each of the directors and officers who signed
the registration statement relating to the initial public offering. Various
plaintiffs have filed similar actions asserting virtually identical allegations
against more than 250 other companies. The lawsuit and all other IPO
allocation securities class actions currently pending in the Southern District
of New York have been assigned to Judge Shira A. Scheindlin for coordinated
pretrial proceedings. In October 2002, the individual defendants were dismissed
without prejudice pursuant to a stipulation. The issuer defendants filed a
coordinated motion to dismiss on common pleading issues, which the Court
granted in part and denied in part in an order dated February 19, 2002. The
Courts order dismissed the Section 10(b) and Rule 10b-5 claims against the
Company but did not dismiss the Section 11 claims against the Company.

In June 2003, the plaintiffs in all of the cases presented a settlement
proposal to all of the issuer defendants. Under the proposed settlement, the
plaintiffs will dismiss and release all claims against participating issuer
defendants in exchange for a contingent payment guaranty by the insurance
companies collectively responsible for insuring the issuer defendants in all of
the related cases, and the assignment or surrender to the plaintiffs of certain
claims the issuer defendants may have against the underwriters. Under the
guaranty, the insurers will be required to pay the amount, if any, by which $1
billion exceeds the aggregate amount ultimately collected by the plaintiffs
from the underwriter defendants in all the cases, up to the limits of the
applicable insurance policies. The Company will not be required to make any
cash payments under the settlement, unless the Companys insurer is required to
pay on the Companys behalf an amount that exceeds the Companys insurance
coverage. The Company does not believe that this circumstance will occur. In
July 2003, a special committee of the Companys Board of Directors approved the
proposed settlement. The settlement is subject to acceptance by a substantial
majority of the issuer defendants, and execution of a definitive settlement
agreement. The settlement is also subject to approval of the court, which
cannot be assured. If the settlement is not consummated, the Company intends to
defend the lawsuit vigorously. However, we cannot predict its outcome with
certainty.

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 financial position or results of operations.

5. BALANCE SHEET DETAILS

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Inventory

Net inventories, stated at the lower of cost (first-in, first-out) or
market, consisted of the following, in thousands:

|                    |  |               |       |              |  |   |       | 
|------------------- |  | ------------- | ----- | ------------ |  | - | ----- | 
|                    |  | September 30, |       | December 31,
|                    |  | 2003          |       | 2002        
|                    |  |               |       |             
|                    |  | (unaudited)   |       |              |  |  
|Raw materials       |  | $             | 196   |              |  | $ | 312   | 
|Semi-finished goods |  |               | 3,485 |              |  |   | 1,951 | 
|Finished goods      |  |               | 345   |              |  |   | 912   | 
|                    |  |               |       |              |  |   |       | 
|                    |  | $             | 4,026 |              |  | $ | 3,175 | 
|                    |  |               |       |              |  |   |       | 

Included in net finished goods at September 30, 2003 was $123,000 of goods
awaiting customer acceptance. There were no goods awaiting customer acceptance
at December 31, 2002. Included in net finished goods at September 30, 2003 and
December 31, 2002 were $248,000 and $289,000, respectively, of goods used for
customer evaluation purposes.

During the nine months ended September 30, 2003, $817,000 of written-down
inventory was sold and $61,000 of inventory was written down. During the nine
months ended September 30, 2002, $1,060,000 of written-down inventory was sold
and inventory was written down by $1,465,000.

CoSine periodically reviews the rates used to determine overhead
capitalization applied to inventory. As a result of restructuring activity and
refinements in its business model, the Company adjusted the overhead absorption
rate for raw materials and semi-finished goods downward during the nine months
ended September 30, 2003. This increased cost of goods sold by $369,000 for
the nine months ended September 30, 2003.

Warranty

CoSine provides a basic limited warranty, including repair or replacement
of parts, and technical support. The specific terms and conditions of those
warranties vary depending on the customer or region in which CoSine does
business. CoSine estimates the costs that may be incurred under its basic
limited warranty and records a liability in the amount of such costs at the
time product revenue is 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,
|                                                   |  | 2003                            |       | 2002
|                                                   |  |                                 |       |     
|                                                   |  | (unaudited)                    
|Beginning balance                                  |  | $                               | 1,103 |      |  | $ | 2,505  |  
|Warranty charged to cost of goods sold             |  |                                 | 357   |      |  |   | 281    |  
|Utilization of warranties                          |  |                                 | (680  | )    |  |   | (1,359 | )
|Changes in estimated liability based on experience |  |                                 | (97   | )    |  |   | (184   | )
|                                                   |  |                                 |       |      |  |   |        |  
|Ending balance                                     |  | $                               | 683   |      |  | $ | 1,243  |  
|                                                   |  |                                 |       |      |  |   |        |  

6. 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 1,534,000 shares and 1,812,000 shares for the nine
months ended September 30, 2003 and 2002, respectively.

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

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|                                                    |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |       | 
|--------------------------------------------------- | --------------------------------------------------------------------------- | -- | ------------------ | ----- | ----------------- | -- | ------ | ----- | ---- | -- | ------ | ----- |  | -- | ------ | ----- | 
|                                                    |                                                                             |    | Three Months Ended |       | Nine Months Ended
|                                                    |                                                                             |    | September 30,      |       | September 30,    
|                                                    |                                                                             |    |                    |       |                  
|                                                    |                                                                             |    | 2003               |       | 2002              |    | 2003   |       | 2002
|                                                    |                                                                             |    |                    |       |                   |    |        |       |     
|                                                    |                                                                             |    | (unaudited)       
|Net loss                                            |                                                                             | ($ | 8,184              | )     |                   | ($ | 9,014  | )     |      | ($ | 24,764 | )     |  | ($ | 76,717 | )    
|                                                    |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |      
|Basic and diluted:                                  |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |      
|Weighted-average shares of common stock outstanding |                                                                             |    | 9,995              |       |                   |    | 10,079 |       |      |    | 9,968  |       |  |    | 10,134 |      
|Weighted-average shares subject to repurchase       |                                                                             |    | (198               | )     |                   |    | (390   | )     |      |    | (215   | )     |  |    | (474   | )    
|                                                    |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |      
|                                                    | Weighted-average shares used in basic and
diluted net loss per common share |    |                    | 9,797 |                   |    |        | 9,689 |      |    |        | 9,753 |  |    |        | 9,660 | 
|                                                    |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |      
|Basic and diluted net loss per common share         |                                                                             | ($ | 0.84               | )     |                   | ($ | 0.93   | )     |      | ($ | 2.54   | )     |  | ($ | 7.94   | )    
|                                                    |                                                                             |    |                    |       |                   |    |        |       |      |    |        |       |  |    |        |      

7. COMPREHENSIVE LOSS

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

|                          |                                  |                                       |       |                    |   |                   |       |      |     |      |        |      |      |    |        |      |    | 
|------------------------- | -------------------------------- | ------------------------------------- | ----- | ------------------ | - | ----------------- | ----- | ---- | --- | ---- | ------ | ---- | ---- | -- | ------ | ---- | -- | 
|                          |                                  |                                       |       | Three Months Ended |   | Nine Months Ended
|                          |                                  |                                       |       | September 30,      |   | September 30,    
|                          |                                  |                                       |       |                    |   |                  
|                          |                                  |                                       |       | 2003               |   | 2002              |       | 2003 |     | 2002
|                          |                                  |                                       |       |                    |   |                   |       |      |     |     
|                          |                                  |                                       |       | (unaudited)       
|Net loss                  |                                  | ($                                    | 8,184 | )                  |   | ($                | 9,014 | )    |     | ($   | 24,764 | )    |      | ($ | 76,717 | )   
|Other comprehensive loss: |                                  |                                       |       |                    |   |                   |       |      |     |      |        |      |      |    |        |     
|                          | Unrealized losses on investments |                                       |       | (43                | ) |                   |       | (16  | )   |      |        | (311 | )    |    |        | (118 | ) 
|                          | Translation adjustment           |                                       |       | 43                 |   |                   |       | 1    |     |      |        | 172  |      |    |        | 157  |   
|                          |                                  |                                       |       |                    |   |                   |       |      |     |      |        |      |      |    |        |     
|                          |                                  | Total other comprehensive gain (loss) |       |                    |  |                   |       |      | (15 | )    |        |      | (139 | )  |        |      | 39 | 
|                          |                                  |                                       |       |                    |   |                   |       |      |     |      |        |      |      |    |        |     
|Comprehensive loss        |                                  | ($                                    | 8,184 | )                  |   | ($                | 9,029 | )    |     | ($   | 24,903 | )    |      | ($ | 76,678 | )   
|                          |                                  |                                       |       |                    |   |                   |       |      |     |      |        |      |      |    |        |     

8. 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, 2003 and 2002, respectively, were as follows, in thousands:

|              |       |   |                    |       |                   |   |       |       |      |   |       |        |  |   |       |        | 
|------------- | ----- | - | ------------------ | ----- | ----------------- | - | ----- | ----- | ---- | - | ----- | ------ |  | - | ----- | ------ | 
|              |       |   | Three Months Ended |       | Nine Months Ended
|              |       |   | September 30,      |       | September 30,    
|              |       |   |                    |       |                  
|              |       |   | 2003               |       | 2002              |   | 2003  |       | 2002
|              |       |   |                    |       |                   |   |       |       |     
|              |       |   | (unaudited)       
|Region        |       |   |                    |       |                   |   |       |       |      |   |       |        |  |   |       |       
|United States |       | $ | 726                |       |                   | $ | 515   |       |      | $ | 5,396 |        |  | $ | 6,217 |       
|Asia/Pacific  |       |   | 2,501              |       |                   |   | 2,977 |       |      |   | 4,904 |        |  |   | 6,772 |       
|Europe        |       |   | 797                |       |                   |   | 1,753 |       |      |   | 1,944 |        |  |   | 5,415 |       
|              |       |   |                    |       |                   |   |       |       |      |   |       |        |  |   |       |       
|              | Total |   | $                  | 4,024 |                   |   | $     | 5,245 |      |   | $     | 12,244 |  |   | $     | 18,404 | 
|              |       |   |                    |       |                   |   |       |       |      |   |       |        |  |   |       |       

9. RESTRUCTURING CHARGES

May 2003 Restructuring

In May 2003, CoSines senior management communicated an additional
reduction in its workforce related to employees in its European region. The
employees were notified in May 2003 that their job functions would be
eliminated and that termination benefits would be paid to them. As a result of
the workforce reduction, two employees were designated for termination.
Amounts related to the workforce reduction were paid through July of 2003. The

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restructuring program was an extension of the October 2002 restructuring, which
was implemented to reduce operating expenses and conserve cash.

Details of the May 2003 restructuring charges for the nine months ended
September 30, 2003 are as follows, unaudited (in thousands):

|                                        |  |           |     |  
|--------------------------------------- |  | --------- | --- | -
|                                        |  | Worldwide
|                                        |  | workforce
|                                        |  | reduction
|Charges                                 |  | $         | 59  |  
|Cash payments                           |  |           | (59 | )
|                                        |  |           |     |  
|Provision balance at September 30, 2003 |  | $         |    |  
|                                        |  |           |     |  

March 2003 Restructuring

In March 2003, CoSines senior management communicated an additional
reduction in its workforce related to the closure of a sales office in the
Asia/Pacific Rim region. The employees were notified in March 2003 that their
job functions would be eliminated and that termination benefits would be paid
to them. As a result of the workforce reduction, three employees were
designated for termination. Amounts related to the workforce reduction and the
other items are expected to be paid through March of 2004. The restructuring
program was an extension of the October 2002 restructuring, which was
implemented to reduce operating expenses and conserve cash.

Details of the March 2003 restructuring charges for the nine months ended
September 30, 2003 are as follows, unaudited (in thousands):

|                                        |  |           |      |             |  |       |    |   |  |   |      |  
|--------------------------------------- |  | --------- | ---- | ----------- |  | ----- | -- | - |  | - | ---- | -
|                                        |  | Worldwide |      | Lease       |  |       |    |  
|                                        |  | workforce |      | termination |  |       |    |  
|                                        |  | reduction |      | and other   |  | Total
|Charges                                 |  | $         | 218  |             |  | $     | 17 |   |  | $ | 235  |  
|Cash payments                           |  |           | (184 | )           |  |       | (4 | ) |  |   | (188 | )
|Non-cash items                          |  |           |     |             |  |       | (4 | ) |  |   | (4   | )
|Accrual adjustment                      |  |           |     |             |  |       | 28 |   |  |   | 28   |  
|                                        |  |           |      |             |  |       |    |   |  |   |      |  
|Provision balance at September 30, 2003 |  | $         | 34   |             |  | $     | 37 |   |  | $ | 71   |  
|                                        |  |           |      |             |  |       |    |   |  |   |      |  

October 2002 Restructuring

In October 2002, CoSines senior management approved a restructuring plan
to reduce its worldwide workforce. Employees were
notified in October 2002 that certain job functions would be eliminated and
that particular termination benefits would be paid to affected employees. As a
result of the workforce reduction, 73 employees were designated for termination
in the restructuring program. Most of the terminations took place in the
fourth quarter of 2002. The employees affected by the workforce reduction were
from all functional groups and were located in offices in the United States,
Europe and Asia. Amounts related to the worldwide workforce reduction were
paid out through
September of 2003. In addition, during the first quarter of 2003, CoSine
concluded negotiations to settle obligations associated with Redwood City,
California leased facilities it exited during 2002 and made a payment of
$8,104,000. The restructuring program was implemented to reduce operating
expenses and conserve cash.

Activity in the October 2002 restructuring accrual for the nine months
ended September 30, 2003 is as follows, unaudited (in thousands):

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|                                        |  |           |      |             |  |       |        |   |  |   |        |  
|--------------------------------------- |  | --------- | ---- | ----------- |  | ----- | ------ | - |  | - | ------ | -
|                                        |  | Worldwide |      | Lease       |  |       |        |  
|                                        |  | workforce |      | termination |  |       |        |  
|                                        |  | reduction |      | and other   |  | Total
|Provision balance at December 31, 2002  |  | $         | 317  |             |  | $     | 8,159  |   |  | $ | 8,476  |  
|Cash payments                           |  |           | (333 | )           |  |       | (8,138 | ) |  |   | (8,471 | )
|Non-cash items                          |  |           |      |             |  |       | (8     | ) |  |   | (8     | )
|Accrual adjustment                      |  |           | 16   |             |  |       | (13    | ) |  |   | 3      |  
|                                        |  |           |      |             |  |       |        |   |  |   |        |  
|Provision balance at September 30, 2003 |  | $         |     |             |  | $     |       |   |  | $ |       |  
|                                        |  |           |      |             |  |       |        |   |  |   |        |  

May 2002 Restructuring and Impairment of Long-Lived Assets

In May 2002, CoSines senior management approved a restructuring plan to
reduce its worldwide workforce, close certain sales offices, exit certain
facilities and dispose of or abandon certain property and equipment. Employees
were notified in May 2002 that certain job functions would be eliminated and
that particular termination benefits would be paid to affected employees. As a
result of the workforce reduction, 146 employees were designated for
termination in the restructuring program. Most of the terminations took place
in the second quarter of 2002, with the remainder taking place in the third quarter of
2002. The employees in the workforce reduction were from all functional groups
and were located in offices in the United States, Europe and Asia. Amounts
related to the worldwide workforce reduction were paid out through December of
2002, and lease commitments and non-cancelable commitments are being paid out
over their respective terms through March 2004. The Company also wrote down
certain property and equipment to its expected realizable value as the assets
have been either sold, disposed of or otherwise abandoned. The restructuring
program was implemented to reduce operating expenses and conserve cash.

Activity in the May 2002 restructuring accrual for the nine months ended
September 30, 2003 is as follows, unaudited (in thousands):

|                                        |  |             |      |  
|--------------------------------------- |  | ----------- | ---- | -
|                                        |  | Lease      
|                                        |  | commitments
|                                        |  | and other  
|Provision balance at December 31, 2002  |  | $           | 815  |  
|Cash payments                           |  |             | (523 | )
|Accrual adjustment                      |  |             | 26   |  
|                                        |  |             |      |  
|Provision balance at September 30, 2003 |  | $           | 318  |  
|                                        |  |             |      |  

Impairment of Long-lived Assets

As a result of CoSines assessment of market conditions and the related
effect on its business plan, the Company concluded that indicators of
impairment of its long-lived assets were present during the second and third
quarters of 2002. Accordingly, the Company performed an impairment test of the
carrying value of its long-lived assets, consisting primarily of property and
equipment in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. Based on an undiscounted cash flow analysis,
the cash flows expected to be generated by CoSines long-lived assets during
their estimated remaining useful lives are not sufficient to recover the net
book value of the assets. Consequently, the Company obtained a valuation
report outlining the estimated fair value of the assets, based on quoted market
prices, from an independent appraiser and recorded an impairment charge of
$15,512,000 to write the carrying value of its long-lived assets held for use
down to their fair values in the second and third quarters of 2002. In
addition, property and equipment that was idled or abandoned was written
down by approximately $3,248,000 to its estimated net realizable value. The
Company has concluded that no indicators of impairment were present in the
first nine months of 2003.

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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, failure
to achieve revenue growth and profitability, product development,
commercialization and technology difficulties, manufacturing costs, the impact
of competitive products, pricing, changing customer requirements, timely
availability and acceptance of new products, changes in economic conditions in
the various markets CoSine serves, and those factors discussed in the section
entitled Managements Discussion and Analysis of Financial Condition and
Results of Operations  Risk Factors. 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.

OVERVIEW

We develop, market and sell a communications platform that we refer to as
our IP Service Delivery Platform. Our product is designed to enable network
service providers to rapidly deliver computer applications and communications
services from within their networks. We market our IP Service Delivery
Platform through our direct sales force and through resellers to network
service providers in Asia, Europe and North America. We provide customer
service and support for our products directly and through support partners.

The market for our IP Service Delivery Platform is new and evolving, and
the volume and timing of orders are difficult to predict. A customers
decision to purchase our platform typically involves a significant commitment
of its resources and a lengthy evaluation, testing and product qualification
process. Long sales and implementation cycles for our platform may cause our
revenue and operating results to vary significantly and unexpectedly from
quarter to quarter.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

General

Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates, including
those related to revenue recognition, inventory valuation, warranties and
allowances for doubtful accounts. 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

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

Assessing the collectibility of amounts invoiced to customers is
particularly critical. 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 recognizing revenue
until we have collected payment.

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Certain of our sales arrangements require formal acceptance by the
customer. 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 affect the timing of
our revenue.

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
could be required.

Inventory Valuation

In assessing the value of our inventory, we are required to make judgments
as to 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 use a 12-month forecast to assess future demand.
Inventory write-downs are charged to cost of sales. During the three and nine
months ended September 30, 2003, we wrote down $61,000 of inventory. If actual
demand for our products is less than our forecasts, additional inventory
write-downs may be required.

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 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 upon 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, thereby requiring us to record further
asset write-downs in the future. During the second and third quarters of 2002,
we charged $18.8 million to operating expenses as a result of impairments. We
have concluded that no additional indicators of impairment were present in the
first nine months of 2003.

Warranties

We provide a basic limited warranty, including repair or replacement of
parts, and technical support. The specific terms and conditions of those
warranties vary depending on the customer or region in which we do business.
We estimate 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. We periodically 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 sales could
result.

Impact of Equity Issuances on Operating Results

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

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Our costs of goods sold and operating expenses are affected by charges
related to warrants and options issued for services. Furthermore, some of our
employee stock option transactions have resulted in deferred compensation,
which is presented as a reduction of stockholders equity on our balance sheet
and is amortized over the vesting period of the applicable options using the
graded vesting method.

The compensation associated with shares and options relating to the
following transactions is required to be remeasured at the end of each
accounting period. The remeasurement 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 remeasure the
compensation associated with these shares until the earlier of the
shares vesting or the note being repaid. Deferred compensation expense,
which is recorded at each remeasurement, is amortized over the remaining
vesting period of the underlying options.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Repriced stock options: In November 2002, we repriced outstanding
employee stock options to purchase 1,091,453 shares of our common stock
with original exercise prices ranging from $5.45 per share to $159.38
per share. These options were repriced to $5.00 per share, which was
higher than the fair market value of the underlying shares on the
repricing date. The repricing requires that compensation be remeasured
for these options until they are exercised or canceled, or expire.                                                    

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 fair value. Deferred compensation is presented as a reduction to
stockholders equity on the 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.

RESULTS OF OPERATIONS

For the three months ended September 30, 2003 and 2002, we reported basic
and diluted net losses per common share of $0.84 and $0.93, respectively. The
effect of equity issuances to customers, suppliers, employees and consultants
increased net loss per common share by $0.02 for the three months ended
September 30, 2003 and credits for equity expense resulted in a $0.33 per share
benefit for the three months ended September 30, 2002.

For the nine months ended September 30, 2003 and 2002, we reported basic
and diluted net losses per common share of $2.54 and $7.94, respectively. The
effect of equity issuances to customers, suppliers, employees and consultants
increased net loss per common share by $0.07 and $0.05 per share for the nine
months ended September 30, 2003 and 2002, respectively.

Revenue

For the three months ended September 30, 2003, revenue was $4.0 million of
which 77% was from hardware sales, 2% was from software sales and 21% was from
sales of services. For the three months ended September 30, 2002, revenue was
$5.2 million of which 83% was from hardware sales, 1% was from software sales
and 16% was from sales of services.

For the nine months ended September 30, 2003, revenue was $12.2 million of
which 80% was from hardware sales, 2% was from software sales and 18% was from
sales of services. For the nine months ended September 30, 2002, revenue was
$18.4 million of which 79% was from hardware sales, 9% was from software sales
and 12% was from sales
of services. The decline in revenue in the first nine months of 2003 was
the result of continued weakness in capital spending in the telecommunications
industry. In addition, because the market for network-based IP
services is in the early stages of development, service provider
demand for related products may fluctuate until service providers are
able to further develop enterprise demand for such services and
accelerate revenue growth from the sale of such services.

Non-Cash Charges Related to Equity Issuances

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During the three months ended September 30, 2003, we recorded $0.2 million
and ($3.2) million of non-cash charges (credits) related to equity issuances to
cost of goods sold, operating expenses and interest expense. During the nine
months ended September 30, 2003 and 2002, we recorded $0.7 million and $0.5
million, respectively, of non-cash charges related to equity issuances to cost
of goods sold, operating expenses and interest expense.

Below is a reconciliation of non-cash charges related to equity issuances
for the three and nine months ended September 30, 2003 and 2002, as presented
in our statement of operations, in thousands:

|                                                                                                                                                                          |  |                    |      |                   |  |      |        |      |  |   |       |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---- | ----------------- |  | ---- | ------ | ---- |  | - | ----- | - |  | - | ------ | -
|                                                                                                                                                                          |  | Three Months Ended |      | Nine Months Ended
|                                                                                                                                                                          |  | September 30,      |      | September 30,    
|                                                                                                                                                                          |  | 2003               |      | 2002              |  | 2003 |        | 2002
|                                                                                                                                                                          |  |                    |      |                   |  |      |        |     
|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 |  | $                  | 275  |                   |  | $    | 1,296  |      |  | $ | 1,236 |   |  | $ | 6,445  |  
|Credits related to the reversal of deferred
stock compensation amortization in
excess of vesting for terminated
employees                                                 |  |                    | (147 | )                 |  |      | (4,550 | )    |  |   | (802  | ) |  |   | (6,344 | )
|Amortization of deferred compensation
associated with non-recourse
promissory notes                                                                                       |  |                    |     |                   |  |      |       |      |  |   |      |   |  |   | 177    |  
|Amortization of deferred
compensation associated with
re-pricing                                                                                                          |  |                    | 82   |                   |  |      |       |      |  |   | 195   |   |  |   |       |  
|Charges related to options with
accelerated vesting                                                                                                                       |  |                    |     |                   |  |      |       |      |  |   |      |   |  |   | 27     |  
|Amortization of charges related to
warrants or stock options issued to
non-employees in conjunction with
lease and debt agreements                                        |  |                    | 15   |                   |  |      | 47     |      |  |   | 75    |   |  |   | 148    |  
|                                                                                                                                                                          |  |                    |      |                   |  |      |        |      |  |   |       |   |  |   |        |  
|Net non-cash charges related to
equity issuances                                                                                                                          |  | $                  | 225  |                   |  | ($   | 3,207  | )    |  | $ | 704   |   |  | $ | 453    |  
|                                                                                                                                                                          |  |                    |      |                   |  |      |        |      |  |   |       |   |  |   |        |  

Cost of Goods Sold

For the
three months ended September 30, 2003, cost of goods sold was
$1.8 million, of which $1.9 million represented materials, labor, production overhead,
warranty and the costs of providing services, $0.1 million represented
inventory written down and $0.2 million represented a credit associated with
written-down inventory sold. For the three months ended September 30, 2002,
cost of goods sold was $2.2 million, of which $2.9 million represented
materials, labor, production overhead, warranty and the costs of providing
services, $0.1 million represented inventory written down, $0.5 million
represented a benefit from reversal of amortization of deferred compensation
related to stock options granted to employees in manufacturing operations and
$0.3 million represented a credit associated with written-down inventory sold.

For the nine months ended September 30, 2003, cost of goods sold was $5.3
million, of which $5.6 million represented materials, labor, production
overhead, warranty and the costs of providing services, $0.4 million
represented charges resulting from reductions in inventory overhead
capitalization rates, $0.1 million represented inventory written down and $0.8
million represented a credit associated with fully reserved inventory sold. For
the nine months ended September 30, 2002, cost of goods sold was $11.6 million,
of which $11.1 million represented materials, labor, production overhead,
warranty and the costs of providing services, $1.5 million represented
inventory written down, $0.1 million represented amortization of deferred
compensation related to stock options granted to employees in manufacturing
operations and $1.1 million represented a credit for written-down inventory
sold.

Gross Profit

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For the three months ended September 30, 2003, gross profit was $2.2
million. For the three months ended September 30, 2002, gross profit was $3.0
million.

For the nine months ended September 30, 2003, gross profit was $6.9
million. For the nine months ended September 30, 2002, gross profit was $6.8
million. The gross margin improvement from 37% to 56% was the result of $1.5
million of inventory written down in the first nine months of 2002 compared to
$0.1 million in the first nine months of 2003, an increase in average selling
price due the regional mix of sales and more favorable product configurations
and reductions in maintenance contract support costs due to headcount
reductions.

Research and Development Expenses

Research and development expenses were $5.5 million and $4.1 million for
the three months ended September 30, 2003 and 2002, respectively. This
represents an increase of $1.4 million or 35%. This resulted primarily from an
increase of $2.1 million in non-cash equity charges due to credits for the
reversal of amortization of deferred compensation expense in excess of vesting
in the third quarter of 2002 for employees who were terminated during that
quarter. Expense for contractors and third-party consultants increased $0.5
million due primarily to outsourcing certain activities previously completed by
regular employees beginning in the third quarter of 2003. Partially offsetting
these increases, payroll-related expense declined $0.7 million reflecting lower
headcount in the current period. Facilities and IT infrastructure expense
declined $0.4 million as a result of reductions in workforce and square footage
occupied. Other amounts netted to reduce expenses by an additional $0.1
million.

Research and development expenses were $15.9 million and $27.2 million for
the nine months ended September 30, 2003 and 2002, respectively. This
represents a decrease of $11.3 million or 41%. Payroll-related expense
declined $4.9 million reflecting lower headcount in the current period.
Depreciation expense and expense related to CoSine product used in labs
declined $4.4 million due to the reduced carrying value of assets resulting
from impairment charges recorded in the second and third quarters of 2002.
Facilities and IT infrastructure expense declined $2.3 million as a result of
reductions in workforce and square footage occupied. Contractor and third
party services expenses decreased $0.3 million due to fewer contractors and the
termination of certain outside engineering arrangements. Travel &
entertainment declined $0.2 million due to cost controls. Partially offsetting
the expense reductions, non-cash charges related to equity issuances increased
$0.7 million due to credits for the reversal of amortization of deferred
compensation expense in excess of vesting in the first nine months of 2002 for
employees who were terminated in the third quarter of 2002. Other amounts
netted to reduce expenses an additional $0.1 million.

Sales and Marketing Expenses

Sales and marketing expenses were $3.2 million and $5.7 million for the
three months ended September 30, 2003 and 2002, respectively. This represents
a decrease of $2.5 million or 44%. This resulted partly from payroll-related
expense, which declined $2.0 million, primarily reflecting lower headcount in
the current period. Facilities and IT infrastructure expense declined $0.4
million as a result of reductions in workforce and square footage occupied.
Depreciation expense and expense related to CoSine product used in labs
declined $0.4 million due primarily to the reduced carrying value of assets
resulting from impairment charges recorded in the second and third quarters of
2002 and some assets becoming fully depreciated. Marketing spending on events
and market development declined $0.4 million due to attending fewer tradeshows
and cost saving measures. Travel expense declined $0.2 million due to cost
saving measures and associated reductions in headcount. Partially offsetting
these savings, non-cash charges related to equity issuances increased $0.6
million due to credits for the reversal of amortization of deferred
compensation expense in excess of vesting in the third quarter of 2002 for
employees who were terminated during that quarter. Absorption to cost of goods
sold of spending to support maintenance contracts and warranty declined $0.3
million. Such support costs are initially charged to Sales and Marketing
expense and subsequently reclassified to either cost of sales or the provision
for warranty claims based on associated activity such as product return levels
and technical support case data. Due primarily to a smaller customer installed
base, activity associated with maintenance and warranty was less than in the
prior year.

Sales and marketing expenses were $10.3 million and $24.3 million for the
nine months ended September 30, 2003 and 2002, respectively. This represents a
decrease of $14.0 million or 58%. This resulted partly from payroll-related
expense, which declined $8.2 million reflecting lower headcount in the current
period. Depreciation expense and expense related to CoSine product used in
labs declined $2.6 million due to the reduced carrying value of assets
resulting

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from impairment charges recorded in the second and third quarters of
2002. Facilities and IT infrastructure expense declined $2.4 million as a
result of reductions in workforce and square footage occupied. Travel expense
declined $1.4 million due to cost saving measures and associated reductions in
headcount. Marketing spending on events, collateral and public relations
declined $1.2 million due to attending fewer tradeshows and to implementing
cost saving measures. Freight and related postage expense declined $0.3
million due to cost saving measures. Other amounts netted to decrease expenses
$0.1 million. Partially offsetting these expense reductions, expense
absorption to support maintenance contracts and warranty was $1.6 million
lower. Such support costs are initially charged to Sales and Marketing expense
and subsequently reclassified to either cost of sales or the provision for
warranty claims based on associated activity such as product return levels and
technical support case data. Due primarily to a smaller customer installed
base, activity associated with maintenance and warranty was less than in the
prior year. Non-cash charges related to equity issuances increased $0.2
million due to credits for the reversal of amortization of deferred
compensation expense in excess of vesting in the first nine months of 2002 for
employees who were terminated in the third quarter of 2002. Contractor and
third party consultant expense increased $0.2 million as a result of
outsourcing certain services. Finally, recruiting expense increased $0.2
million due to certain select hiring in 2003.

General and Administrative Expenses

General and administrative expenses were $1.8 million and $2.3 million for
the three months ended September 30, 2003 and 2002, respectively. This
represents a decrease of $0.5 million or 23%. This resulted partly from
payroll-related expense, which declined $0.3 million reflecting lower headcount
in the current period. Legal and accounting and audit services declined $0.3
million as a result of cost-saving measures. Taxes and filing fees declined
$0.1 million. Communications expense declined $0.1 million due to lower phone
and data services expense. Partially offsetting these expense reductions,
non-cash charges related to equity issuances increased $0.2 million due to
credits for the reversal of amortization of deferred compensation expense in
excess of vesting in the third quarter of 2002 for employees who were
terminated during that quarter. Facilities and IT infrastructure expense
increased $0.1 million due to an increased proportion of space occupied by
General and Administrative personnel as compared to other functions.

General and administrative expenses were $5.6 million and $9.4 million for
the nine months ended September 30, 2003 and 2002, respectively. This
represents a decrease of $3.8 million or 40%. This resulted partly from
payroll-related expense, which declined $1.8 million reflecting lower headcount
in the current period. Depreciation expense declined $0.5 million due to the
reduced carrying value of the underlying fixed assets resulting from impairment
charges recorded in the second and third quarters of 2002. Non-cash charges
related to equity issuances declined $0.5 million due to lower headcount and
our use of an accelerated amortization method, which results in lower charges
in each subsequent period. Legal and accounting and audit services declined
$0.5 million as a result of cost-saving measures. Expense for taxes and filing
fees declined $0.2 million. Bad debt expense declined $0.2 million as a result
of lower revenue. Contractor and third party services expense declined $0.1
million as a result of lower activity and cost saving measures.

Restructuring and Impairment

May 2003 Restructuring

In May 2003, our senior management communicated an additional reduction in
its workforce related to employees in our European region. The employees were
notified in May 2003 that their job functions would be eliminated and that
termination benefits would be paid to them. As a result of the workforce
reduction, two employees were designated for termination. Amounts related to
the workforce reduction were paid through July of 2003. The restructuring
program was an extension of the October 2002 restructuring, which was
implemented to reduce operating expenses and conserve cash.

Details of the May 2003 restructuring charges for the nine months ended
September 30, 2003 are as follows, unaudited (in thousands):

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|                                        |  |           |     |  
|--------------------------------------- |  | --------- | --- | -
|                                        |  | Worldwide
|                                        |  | workforce
|                                        |  | reduction
|Charges                                 |  | $         | 59  |  
|Cash payments                           |  |           | (59 | )
|                                        |  |           |     |  
|Provision balance at September 30, 2003 |  | $         |    |  
|                                        |  |           |     |  

March 2003 Restructuring

In March 2003, our senior management communicated an additional reduction
in its workforce related to the closure of a sales office in the Asia/Pacific
Rim region. The employees were notified in March 2003 that their job functions
would be eliminated and that termination benefits would be paid to them. As a
result of the workforce reduction, three employees were designated for
termination. Amounts related to the workforce reduction and the other items
are expected to be paid through March of 2004. The restructuring program was
an extension of the October 2002 restructuring, which was implemented to reduce
operating expenses and conserve cash.

Details of the March 2003 restructuring charges for the nine months ended
September 30, 2003 are as follows, unaudited (in thousands):

|                                        |  |           |      |             |  |       |    |   |  |   |      |  
|--------------------------------------- |  | --------- | ---- | ----------- |  | ----- | -- | - |  | - | ---- | -
|                                        |  | Worldwide |      | Lease       |  |       |    |  
|                                        |  | workforce |      | termination |  |       |    |  
|                                        |  | reduction |      | and other   |  | Total
|Charges                                 |  | $         | 218  |             |  | $     | 17 |   |  | $ | 235  |  
|Cash payments                           |  |           | (184 | )           |  |       | (4 | ) |  |   | (188 | )
|Non-cash items                          |  |           |     |             |  |       | (4 | ) |  |   | (4   | )
|Accrual adjustment                      |  |           |     |             |  |       | 28 |   |  |   | 28   |  
|                                        |  |           |      |             |  |       |    |   |  |   |      |  
|Provision balance at September 30, 2003 |  | $         | 34   |             |  | $     | 37 |   |  | $ | 71   |  
|                                        |  |           |      |             |  |       |    |   |  |   |      |  

October 2002 Restructuring

In October 2002, our senior management approved a restructuring plan to
reduce our worldwide workforce. Employees were notified
in October 2002 that certain job functions would be eliminated and that
particular termination benefits would be paid to affected employees. As a
result of the workforce reduction, 73 employees were designated for termination
in the restructuring program. Most of the terminations took place in the
fourth quarter of 2002. The employees affected by the workforce reduction were
from all functional groups and were located in offices in the United States,
Europe and Asia. Amounts related to the worldwide workforce reduction were
paid out through September of 2003. In addition, during the first quarter of
2003, we concluded negotiations to settle obligations associated with Redwood
City, California leased facilities we exited during 2002 and made a payment of
$8.1 million. The restructuring program was implemented to reduce operating
expenses and conserve cash.

Activity in the October 2002 restructuring accrual for the nine months
ended September 30, 2003 is as follows, unaudited (in thousands):

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|                                        |  |           |      |             |  |       |        |   |  |   |        |  
|--------------------------------------- |  | --------- | ---- | ----------- |  | ----- | ------ | - |  | - | ------ | -
|                                        |  | Worldwide |      | Lease       |  |       |        |  
|                                        |  | workforce |      | termination |  |       |        |  
|                                        |  | reduction |      | and other   |  | Total
|Provision balance at December 31, 2002  |  | $         | 317  |             |  | $     | 8,159  |   |  | $ | 8,476  |  
|Cash payments                           |  |           | (333 | )           |  |       | (8,138 | ) |  |   | (8,471 | )
|Non-cash items                          |  |           |      |             |  |       | (8     | ) |  |   | (8     | )
|Accrual adjustment                      |  |           | 16   |             |  |       | (13    | ) |  |   | 3      |  
|                                        |  |           |      |             |  |       |        |   |  |   |        |  
|Provision balance at September 30, 2003 |  | $         |     |             |  | $     |       |   |  | $ |       |  
|                                        |  |           |      |             |  |       |        |   |  |   |        |  

May 2002 Restructuring and Impairment of Long-Lived Assets

In May 2002, our senior management approved a restructuring plan to reduce
our worldwide workforce, close certain sales offices, exit certain facilities
and dispose of or abandon certain property and equipment. Employees were
notified in May 2002 that certain job functions would be eliminated and that
particular termination benefits would be paid to affected employees. As a
result of the workforce reduction, 146 employees were designated for
termination in the restructuring program. Most of the terminations took place
in the second quarter of 2002, with the remainder taking place in the third quarter of
2002. The employees in the workforce reduction were from all functional groups
and were located in offices in the United States, Europe and Asia. Amounts
related to the worldwide workforce reduction were paid out through December of
2002, and lease commitments and non-cancelable commitments are being paid out
over their respective terms through March 2004. We also wrote down certain
property and equipment to its expected realizable value as the assets have been
either sold, disposed of or otherwise abandoned. The restructuring program was
implemented to reduce operating expenses and conserve cash.

Activity in the May 2002 restructuring accrual for the nine months ended
September 30, 2003 is as follows, unaudited (in thousands):

|                                        |  |             |      |  
|--------------------------------------- |  | ----------- | ---- | -
|                                        |  | Lease      
|                                        |  | commitments
|                                        |  | and other  
|Provision balance at December 31, 2002  |  | $           | 815  |  
|Cash payments                           |  |             | (523 | )
|Accrual adjustment                      |  |             | 26   |  
|                                        |  |             |      |  
|Provision balance at September 30, 2003 |  | $           | 318  |  
|                                        |  |             |      |  

Impairment of Long-lived Assets

As a result of our assessment of market conditions and the related effect
on its business plan, we concluded that indicators of impairment of its
long-lived assets were present during the second and third quarters of 2002.
Accordingly, we performed an impairment test of the carrying value of its
long-lived assets, consisting primarily of property and equipment in accordance
with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. Based on an undiscounted cash flow analysis, the cash flows expected
to be generated by CoSines long-lived assets during their estimated remaining
useful lives are not sufficient to recover the net book value of the assets.
Consequently, we obtained a valuation report outlining the estimated fair value
of the assets, based on quoted market prices, from an independent appraiser and
recorded an impairment charge of $15.5 million to write the carrying value of
its long-lived assets held for use down to their fair values in the second and
third quarters of 2002. In addition, property and equipment that was idled or
abandoned was written down by approximately $3.2 million to its estimated net
realizable value. We have concluded that no additional indicators of
impairment were present in the first nine months of 2003.

Interest and Other Income

For the three and nine months ended September 30, 2003, interest and other
income was $0.1 million and $1.1 million, respectively, reduced from $0.9
million and $3.3 million for the three and nine months ended September 30,

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2002, respectively. This reflects decreased interest income due to lower
levels of cash and short-term investments and lower interest rates on invested
amounts.

Interest Expense

For the three and nine months ended September 30, 2003, interest expense
was $25,000 and $0.2 million, respectively, reduced from $0.2 million and $0.8
million for the three and nine months ended September 30, 2002, respectively.
The reduction reflects a decline in our debt.

Income Tax Provision

The provisions for income taxes were $15,000 and $0.1 million for the
three months ended September 30, 2003 and 2002, respectively, and $0.1 million
and $0.4 million for the nine months ended September 30, 2003 and 2002,
respectively, and were comprised entirely of foreign corporate income taxes,
which are a function of our operation of subsidiaries in various countries.

LIQUIDITY AND CAPITAL RESOURCES

Prior to our initial public offering in September 2000, we financed our
operations primarily through sales of convertible preferred stock for net
proceeds of $166.6 million, plus equipment and working capital loans and
capital leases. Upon the closing of our initial public offering on September
29, 2000, we received cash proceeds, net of underwriters discounts and
offering expenses, totaling $242.5 million, and all of our convertible
preferred stock was converted into 69.6 million shares of common stock.

We believe that we possess sufficient liquidity and capital resources to
fund our operating and working capital requirements for at least the next 12
months. We may require additional funds to support other purposes and may seek
to raise these additional funds through debt or equity financing or from other
sources. There can be no assurances that additional funding will be available
at all, or that if available, such financing will be obtainable on terms
favorable to us.

Cash, Cash Equivalents and Short-Term Investments

At September 30, 2003, cash, cash equivalents and short-term investments
were $66.9 million. This compares with $101.5 million at December 31, 2002.

Operating Activities

We used $29.5 million and $44.3 million of cash in operations for the nine
months ended September 30, 2003 and 2002, respectively. The decrease in net
cash used in operating activities was primarily the result of a
decrease in operating expenses.

Investing Activities

For the nine months ended September 30, 2003, we generated $42.6 million
in cash from investing activities while for the nine months ended September 30,
2002, we used $5.6 million in cash from investing activities. The change
reflects an increase of $47.2 million for net proceeds from the sale of
short-term investments and a decrease in capital expenditures of $1.0 million.

Financing Activities

For the nine months ended September 30, 2003 and 2002, $3.1 million and
$3.9 million, respectively, were used in financing activities. This primarily
reflects lower principal payments on working capital loans and capital leases,
partially offset by lower collections from stock option exercises and proceeds
from notes receivable from stockholders.

OUTLOOK

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Beginning in the 2001 fiscal year and continuing through the third quarter
of the 2003 fiscal year, the telecommunications industry has experienced a
significant downturn. The lack of capital availability for many emerging
service providers, combined with the emphasis of larger service providers on
reducing operating expenses, has caused a significant reduction in capital
spending within the industry as a whole. This reduction has had a direct
impact on our operations. We believe that capital spending within the
telecommunications industry will recover in the long-term (two to five years).
However, due to reductions in capital spending plans by our customers and
uncertainty within the telecommunications industry, the outlook for growth in
the remainder of 2003 is not favorable and the outlook for 2004 cannot be
determined with certainty at this time. We anticipate that this capital
spending trend will continue to have a substantial, adverse effect on our
revenue growth for at least the remainder of the 2003 fiscal year. Because
capital continues to be scarce, we believe that pricing will continue to be
under pressure as each potential customer attempts to improve returns on
invested capital. Until capital spending levels within the telecommunications
industry begin to recover, we will focus our efforts on controlling costs and
increasing our market share. However, there can be no assurance that we will
succeed in meeting these objectives. In addition, because the market
for network-based IP services is in the early stages of development,
service provider demand for related products may fluctuate until
service providers are able to further develop enterprise demand for
such services and accelerate revenue growth from the sale of such
services.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others  an Interpretation of FASB Statements
No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. The
Interpretation elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires a guarantor to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The adoption of FASB
Interpretation No. 45 did not impact our financial results.

In December 2002, the FASB issued Statement Number 148, Accounting for
Stock-Based Compensation  Transition and Disclosure (SFAS 148). SFAS 148
amends Statement Number 123, Accounting for Stock-Based Compensation, (SFAS
123) to provide alternative methods of transition to the SFAS 123 fair value
method of accounting for stock-based employee compensation. In addition, SFAS
148 requires disclosure of the effects of an entitys accounting policy with
respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. As permitted
under SFAS 148, we adopted the disclosure provisions of that accounting
standard and, accordingly, have included such disclosures in the financial
statements for the three and nine months ended September 30, 2003.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, and a subsequent
Modification in November 2003 which requires a company that has a controlling
financial interest in a variable interest entity to consolidate the assets,
liabilities and results of activities of the entity. A variable interest entity
is an entity in which the equity investors do not have a controlling interest
or the equity investment at risk is insufficient to finance the entitys
activities without receiving additional subordinated financial support from
other parties. Interpretation No. 46 is applicable: (i) immediately for all
variable interest entities created after January 31, 2003; or (ii) in the first
fiscal year or interim period beginning after December 15, 2003 for those
created before February 1, 2003. We have not created any variable entities
since January 31, 2003 and do not have any investments acquired prior to
February 1, 2003 that are variable interest entities; accordingly, adoption of
FASB Interpretation No. 46 will not have a material impact on our financial
statements.

In May 2003, the FASB issued Statement Number 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS 150). This Statement establishes standards for classifying and measuring
as liabilities certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. SFAS 150
generally requires liability classification for two broad classes of financial
instruments: (1) instruments that represent, or are indexed to, an obligation
to buy back the issuers shares, and (2) obligations that can be settled in
shares, but are subject to certain conditions. SFAS 150 applies to all
financial instruments created or modified after May 31, 2003, and to other
instruments at the beginning of the first interim period beginning after June
15, 2003. As we have not created or modified any financial instruments
since the effective date of SFAS 150, we do not believe this Statement
will have a material impact on our financial statements.

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RISK FACTORS

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

We have a history of losses that we expect will continue, and if we never
achieve profitability we may cease operations.

At September 30, 2003, we had an accumulated deficit of $468.3 million.
We have incurred net losses since our incorporation. We cannot be certain that
our revenue will grow or that we will generate sufficient revenue to become
profitable. If we do not achieve profitability, we may cease operations.

Due to our losses, we could lose major opportunities with large service
providers who are concerned with our long-term financial viability.

Many large telecommunications service providers purchase capital equipment
from vendors with a history of successful operations including positive cash
flow. Our history of losses and use of cash in operations may cause certain
service providers to decide not to purchase our equipment because of concerns
regarding our long-term financial viability and our ability to support their
businesses. Unless we can generate positive cash flows by either increasing
revenues and/or decreasing costs, concerns regarding our long-term financial
viability may cause some potential customers to purchase product from other
larger, more established suppliers including Cisco Systems, Lucent
Technologies, Nortel Networks, Alcatel, Ericsson, Siemens, and Juniper
Networks.

The outlook for capital spending in the telecommunications industry directly
impacts our business.

Our business depends on capital expenditures within the telecommunications
industry, which has 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.

The ultimate severity and duration of this downturn is unknown. Due to
reductions in capital spending plans by our customers and uncertainty within
the telecommunications industry, we anticipate that this trend will continue to
have a substantial, adverse effect on our revenue growth for at least the
remainder of the current fiscal year. No assurance can be given that the
Companys net sales and operating results will not be further adversely
affected by the current downturn or any future downturns

We participate in a competitive marketplace, and our failure to compete
successfully would limit our ability to increase our market share and harm our
business.

Competition in the network infrastructure market is intense, and we expect
that competition in the market for IP networking services will also be intense.
If we are unable to compete effectively, our revenue and market share will be
negatively affected.

We face competition from companies in the network infrastructure market,
including Cisco Systems, Lucent Technologies, Nortel Networks, Alcatel,
Ericsson, Siemens, and Juniper Networks.

We believe that there is likely to be consolidation in our industry. We
currently face competition from larger companies with significantly greater
resources than we have, and we expect to face increased competition from larger
companies in the future.

Some of these larger competitors have pre-existing relationships involving
a range of product lines with the network service providers who are the
principal potential customers for our IP Service Delivery Platform. These
competitors may offer vendor financing, which we generally do not offer,
undercut our prices or use their pre-existing relationships with our customers
to induce them not to use our IP Service Delivery Platform.

The limited sales history of our IP Service Delivery Platform makes forecasting
our revenue difficult, which may impair our ability to manage our business.

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We were founded in April 1997, shipped our first test IP Service Delivery
Platform product in March 1999 and sold our first IP Service Delivery Platform
product in March 2000. We have limited meaningful historical financial data
upon which to forecast our revenue.

If our customers are unable to generate sales of services using our products
and to manage delivery of these services to their customers, we may be unable
to sell our products.

Our future success depends on network service providers, who are our
customers, generating revenue from the sale of services delivered using our
products. Sales of our products may decline or be delayed if our customers do
not successfully introduce commercial services derived from our IP Service
Delivery Platform or if our customers do not generate revenue from these
services sufficient to realize an attractive return on their investment in our
IP Service Delivery Platform. In addition, the long cycle for service
providers to introduce new services made possible by our platform may cause our
revenue and operating results to vary significantly from quarter to quarter.

Our ability to generate future revenue also depends on whether network
service providers successfully forecast market trends and identify customer
demand for the services and features that our products would enable network
service providers to offer their customers.

The market for managed network-based IP services is still in the early stages
of growth. As a result, demand may fluctuate.

The market for managed network-based IP services is still in the early
stages of growth. We believe that the market for these services will grow, but
the timing of this growth is linked to the development of this market by
service providers and the growth of enterprise demand. Until the market
develops further, demand may continue to fluctuate.

Fluctuations in demand can lead to impairment of the value of our long-lived
assets

Fluctuations in demand can also lead to the consideration of asset
impairment charges. The carrying value of property, plant and equipment is
reviewed if the facts and circumstances suggest that property, plant and
equipment may be impaired. An impairment review requires management to make
certain estimates and judgments regarding future cash flows that management
expects to be generated by groups of assets.

We evaluate the carrying value of our 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 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. 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, thereby requiring us to record further asset write-downs in the future.

If our IP Service Delivery Platform does not rapidly achieve market acceptance,
we may be unable to achieve profitability.

Our products offer a new approach for delivering services by network
service providers, who may perceive our products as being more expensive than
the other technologies and products they purchase. If network service
providers do not accept our IP Service Delivery Platform as a method for
delivering services to their customers, our ability to increase our revenue,
achieve profitability and continue operations would be harmed. Our success
also depends on third-party software providers recognizing the advantages of
our service delivery method and on our ability to effectively support their
software development efforts.

Our IP Service Delivery Platform is our only product line, and our future
revenue depends on its commercial success.

Our IP Service Delivery Platform, which is comprised of hardware and
software, is the only product line that we currently offer to our customers.
Our future revenue depends on the commercial success of our IP Service Delivery

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Platform. If customers do not adopt, purchase and successfully implement our
IP Service Delivery Platform in large numbers, our revenue will not grow.

Our products are technically complex and may contain errors or defects that are
not found until our customers put our products to full use. Errors or defects
in our products could seriously harm our reputation and our ability to sell our
products.

Our products are more complicated than most networking products. They can
be adequately tested only when put to full use in large and diverse networks
with high amounts of traffic. Errors or defects in our products could result
in the loss of current customers, the inability to attract new customers and
increased service and warranty costs.

The long sales cycle for our platform may cause our revenue and operating
results to vary significantly from quarter to quarter, and the price of our
stock to decline.

A customers decision to purchase our IP Service Delivery Platform
involves a significant commitment of its resources and a lengthy evaluation,
testing and product qualification process. Network service providers and other
customers with complex networks usually expand their networks in increments on
a periodic basis. We may receive purchase orders for significant dollar
amounts on an irregular and unpredictable basis. These events may cause our
revenue and operating results to vary significantly and unexpectedly from
quarter to quarter, which could cause our stock price to decline.

If we fail to develop new products or features, we will have difficulty
attracting customers.

Based on our prior experience, we expect that our customers will require
product features that our current IP Service Delivery Platform does not have.
Our products are technically complex, and the development of new products or
features is an uncertain, time-consuming and labor-intensive process. We may
experience design, manufacturing or marketing problems with new products. If
we fail to develop new or enhanced products that meet customer requirements,
our ability to attract and retain customers will be hindered.

If we fail to execute new product introductions in a timely manner we may
experience erratic revenue growth, which could negatively affect profitability
and in turn have a negative impact on our stock price. In addition, such a
failure could result in additional costs such as excess inventory, customer
conversion costs, higher than expected product costs and higher than expected
operating expenses in research and development and in sales and marketing.

We rely upon a limited number of customers, and any decrease in revenue from
these customers or failure to increase our customer base could harm our
operating results.

The loss of one or more of our customers, a reduction in purchases of our
products by our customers or the decline of our customers business may limit
our revenue growth and harm our operating results. Our customers may reduce or
discontinue purchases of our products at any time.

Our future success will depend on attracting additional customers.
Failure to increase our customer base would hinder our growth and harm our
operating results.

If we fail to retain key personnel, our operations could suffer and our stock
price could be negatively impacted.

Maintaining key personnel may be difficult for a number of reasons,
including but not limited to market demand, stock price, growth opportunities,
management philosophy, company performance and competitive activity. If we
lose key personnel we may find it difficult and costly to recruit new
management and other personnel and this may have a negative affect on our
performance and in turn on our stock price.

A failure of our contract manufacturers or our sole source and limited source
suppliers to meet our needs would seriously harm our ability to timely fill
customer orders.

If any of our manufacturers terminates its relationship with us or is
unable to produce sufficient quantities of our products in a timely manner and
at satisfactory quality levels, our ability to fill customer orders on time,
our reputation and our operating results will suffer. Our contract
manufacturers do not have a long-term obligation to supply products

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to us. Qualifying new contract manufacturers and starting volume
production is expensive and time consuming and would disrupt our business.

We purchase several key components, including field programmable gate
arrays, some integrated circuits and memory devices, and power supplies from a
single source or a limited number of sources. We do not have long-term supply
contracts for these components. If our supply of these components is
interrupted, we may be unable to locate an alternate source in a timely manner
or at favorable prices. Interruption or delay in the supply of these
components could cause us to lose sales to existing and potential customers.

If any of our significant suppliers were to terminate their relationships with
us or compete against us, our revenue and market share would likely be reduced.

Many of our suppliers also have significant development and marketing
relationships with our competitors and have significantly greater financial and
marketing resources than we do. If they develop and market products in the
future in competition with us, or form or strengthen arrangements with our
competitors, our revenue and market share will likely be reduced.

If we fail to predict our manufacturing requirements accurately, we could incur
additional costs or manufacturing delays.

We provide forecasts of our demand to our contract manufacturers up to
twelve months before scheduled delivery of products to our customers. If we
overestimate our manufacturing requirements, we may have excess or obsolete
inventory, which could harm our operating results. If we underestimate our
requirements, our contract manufacturers may have an insufficient inventory,
which could interrupt manufacturing of our products and result in delays in
shipments and revenue. If we do not accurately anticipate lead times for
components, we may experience component shortages.

If necessary licenses of third-party technology are terminated or become
unavailable or too expensive, our competitive position and our product offering
will suffer.

We license from third-party suppliers certain software applications
incorporated in our IP Service Delivery Platform. Also, we may need to license
technology from other third-party suppliers to enable us to develop new
products or features. Our inability to renew or obtain any third-party license
that we need could require us to obtain substitute technology of lower quality
or at greater cost. Either of these outcomes could seriously impair our
ability to sell our products and could harm our operating results.

Insiders continue to have substantial control over us and they could delay or
prevent a change in our corporate control even if our other stockholders wanted
it to occur.

Our executive officers, directors and principal stockholders who hold 5%
or more of the outstanding common stock and their affiliates beneficially own a
significant portion of our outstanding common stock. These stockholders will
be able to exercise significant control over all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions. This could delay or prevent an outside party from
acquiring or merging with us even if our other stockholders wanted it to occur.

If we become subject to unfair hiring claims, we could be prevented from hiring
needed personnel, or from pursuing or implementing our research, and could
incur substantial liabilities or costs.

Companies in our industry whose employees accept positions with
competitors frequently claim that these competitors have engaged in unfair
hiring practices or that the employment of these persons would involve the
disclosure or use of trade secrets or information subject to an obligation of
confidentiality. We have been threatened with claims like these in the past
and may receive claims of this kind in the future. These claims could prevent
us from hiring personnel or from using the knowledge and experience brought to
us by the personnel whom we hire. We could also incur substantial costs and
damages in defending ourselves or our employees against these claims,
regardless of their merits. Defending ourselves against such claims could
divert the attention of our management away from our operations.

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If our products do not work the way our customers expect, orders for our
products may be cancelled and the market perception of our products could be
harmed.

If our products do not work with our customers or their end-users
networks, the market perception of our products could be harmed and orders for
our products could be cancelled. In particular, if an actual or perceived
breach of network security occurs in a customers or its end-users network
that uses our products, we may be subject to lawsuits for losses suffered by
customers or their end-users.

If we have to redesign or modify our products to make them compatible with
a customers or end-users network, our sales cycle could be extended, our
research and development costs may increase and profit margins on our products
may decline.

Because the markets in which we compete are prone to rapid technological change
and the adoption of standards different from those that we use, our products
could become obsolete, and we could be required to incur substantial costs to
modify our products to remain competitive.

The market for our IP Service Delivery Platform is prone to rapid
technological change, the adoption of new standards, frequent new product
introductions and changes in customer and end-user requirements. We may be
unable to respond quickly or effectively to these developments. We may
experience difficulties that could prevent our development of new products and
features. The introduction of new products or technologies by competitors, or
the emergence of new industry standards, could render our products obsolete or
could require us to incur costs to redesign our products.

We rely on our intellectual property rights to be competitive, and if we are
unable to protect these rights, we may never become profitable.

We rely on a combination of copyright, trademark, patent and trade secret
laws and restrictions on disclosure to protect our intellectual property
rights. Monitoring unauthorized use of our products is difficult, and we
cannot be certain that the steps we have taken will prevent unauthorized use of
our technology. If we are unable to protect our intellectual property rights,
our ability to supply our products as they have been designed could suffer, and
our ability to become profitable could be harmed.

If we become involved in an intellectual property dispute, we could be subject
to significant liability, the time and attention of our management could be
diverted and we could be prevented from selling our products.

We may become a party to litigation in the future to protect our
intellectual property or because others may allege infringement of their
intellectual property. These claims and any resulting lawsuit could subject us
to significant liability for damages or invalidate our 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 our infringement of a
third-partys intellectual property also could force us to:



| | - |  | stop selling products or services that use the challenged
intellectual property;                                                                                                   
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | - |  | 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.                                                                                                             

We may have difficulty obtaining director and officer liability insurance in
acceptable amounts for acceptable rates.

Like most other public companies, we carry insurance protecting our
officers and directors against claims relating to the conduct of our business.
This insurance covers, among other things, the costs incurred by companies and
their management to defend against and resolve claims relating to management
conduct and results of operations, such as securities class action claims.
These claims typically are expensive to defend against and resolve. We pay
significant premiums to acquire and maintain this insurance, which is provided
by third-party insurers, and we agree to underwrite a portion of such exposures
under the terms of the insurance coverage. One consequence of the current
economic downturn and decline in stock prices has been a substantial increase
in the number of securities class actions and similar claims brought against
public corporations and their management, including our company and certain of
our current and

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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 lawsuits
against us have a $250,000 retention. As a result, the costs we incur in
defending the current securities lawsuits against us will not be reimbursed
until they exceed $250,000. The policies that would cover any future lawsuits
may not provide any coverage to us and may cover the directors and officers
only in the event we are unwilling or unable to cover their costs in defending
against and resolving any future claims. As a result, our costs in defending
any future lawsuits could increase significantly. Particularly in the current
economic environment, we cannot assure you that in the future we will be able
to obtain sufficient director and officer liability insurance coverage at
acceptable rates and with acceptable deductibles and other limitations. Failure
to obtain such insurance could materially harm our financial condition in the
event that we are required to defend against and resolve any future or existing
securities class actions or other claims made against us or our management
arising from the conduct of our operations. Further, the inability to obtain
such insurance in adequate amounts may impair our future ability to retain and
recruit qualified officers and directors.




ITEM 3. QUALITATIVE AND QUANTITATIVE 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 September 30, 2003 investment
portfolio based on a modeling technique that measures hypothetical fair market
value changes that would result from a parallel shift in the yield curve of
plus 100 basis points. Based on this analysis, a hypothetical 100 basis point
increase in interest rates would result in a $127,000 decrease in the fair
value of our investments in debt securities as of September 30, 2003.

Exchange Rate Sensitivity

Currently, all of our sales and most of our expenses are denominated in
United States dollars. Therefore, we have not engaged in any foreign exchange
hedging activities to date.




ITEM 4. CONTROLS AND PROCEDURES



| | (a) |  | Our President and Chief Executive Officer and our Executive
Vice President and Chief Financial Officer have evaluated our
disclosure controls and procedures as of the end of the period
covered by this report on Form 10-Q, and have concluded that such
controls and procedures are effective.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | During the three months ending September 30, 2003, there were
no changes in our internal control over financial reporting that have
materially affected or are reasonably likely to materially affect our
internal control over financial reporting.                                             

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PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

On November 15, 2001, CoSine and certain of its officers and directors
were named as defendants in a securities class action lawsuit filed in the
United States District Court, Southern District of New York. The complaint
generally alleges that various investment bank underwriters engaged in improper
and undisclosed activities related to the allocation of shares in CoSines
initial public offering. The complaint brings claims for the violation of
several provisions of the federal securities laws against those underwriters,
and also against the Company and each of the directors and officers who signed
the registration statement relating to the initial public offering. Various
plaintiffs have filed similar actions asserting virtually identical allegations
against more than 250 other companies. The lawsuit and all other IPO
allocation securities class actions currently pending in the Southern District
of New York have been assigned to Judge Shira A. Scheindlin for coordinated
pretrial proceedings. In October 2002, the individual defendants were dismissed
without prejudice pursuant to a stipulation. The issuer defendants filed a
coordinated motion to dismiss on common pleading issues, which the Court
granted in part and denied in part in an order dated February 19, 2002. The
Courts order dismissed the Section 10(b) and Rule 10b-5 claims against the
Company but did not dismiss the Section 11 claims against the Company.

In June 2003, the plaintiffs in all of the cases presented a settlement
proposal to all of the issuer defendants. Under the proposed settlement, the
plaintiffs will dismiss and release all claims against participating issuer
defendants in exchange for a contingent payment guaranty by the insurance
companies collectively responsible for insuring the issuer defendants in all of
the related cases, and the assignment or surrender to the plaintiffs of certain
claims the issuer defendants may have against the underwriters. Under the
guaranty, the insurers will be required to pay the amount, if any, by which $1
billion exceeds the aggregate amount ultimately collected by the plaintiffs
from the underwriter defendants in all the cases, up to the limits of the
applicable insurance policies. The Company will not be required to make any
cash payments under the settlement, unless the Companys insurer is required to
pay on the Companys behalf an amount that exceeds the Companys insurance
coverage. The Company does not believe that this circumstance will occur. In
July 2003, a special committee of the Companys Board of Directors approved the
proposed settlement. The settlement is subject to acceptance by a substantial
majority of the issuer defendants and execution of a definitive settlement
agreement. The settlement is also subject to approval of the court. If the
settlement is not consummated, the Company intends to defend the lawsuit
vigorously. However, we cannot predict its outcome with certainty.

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 financial position or results of operations.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS



| | (a) |  | 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 $176 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.                                                                                                                                                                                                                                                                                                                                                                                                           

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibit Index on page 32.                                                                                                                                                                                                           
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Reports on Form 8-K.                                                                                                                                                                                                                
|
| |     |  | On July 22, 2003, the Company issued a press release in which it
reported earnings for the quarter ending June 30, 2003. A copy of such
press release was furnished by the Company with a Form 8-K on July 22,
2003 as Exhibit 99.1.

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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.
|                         |  |                             |  |                                                                                                  
|                         |  | By:                         |  | /s/ Terry Gibson                                                                                 
|                         |  |                             |  | Terry Gibson                                                                                     
|                         |  |                             |  | Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
|                        
|Dated: November 12, 2003 |  |                             |  |                                                                                                  

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EXHIBIT INDEX

|               |  |                                                                                                                                                                                                                             
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                 
|               |  |                                                                                                                                                                                                                             
|31.1           |  | Certification of Stephen Goggiano, President and Chief
Executive 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           
|               |  |                                                                                                                                                                                                                             
|31.2           |  | Certification of Terry Gibson, Executive Vice President 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 Stephen Goggiano, President and Chief
Executive 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           
|               |  |                                                                                                                                                                                                                             
|32.2           |  | Certification of Terry Gibson, Executive Vice President 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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