10-Q 1 v073399_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED March 31, 2007

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

For the transition period from ____________ to ____________.

Commission File Number 000-30715

COSINE COMMUNICATIONS, INC.

(Exact name of Registrant as specified in its charter)

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

61 East Main Street, Suite B Los Gatos, CA	95031
(Address of principal executive offices)	(Zip Code)

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes x No o

There were 10,090,635 shares of the Registrant’s Common Stock, par value $.0001, outstanding on April 30, 2007.

COSINE COMMUNICATIONS, INC.

FORM 10-Q

Quarter ended March 31, 2007

TABLE OF CONTENTS

		Page
	PART I
	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements:
	Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006	3
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006	4
	Condensed Consolidated Statements of Cash Flows for Three Months Ended March 31, 2007 and 2006	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4.	Controls and Procedures	17

	PART II
	OTHER INFORMATION

Item 1.	Legal Proceedings	18
Item 1A.	Risk Factors	19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 6.	Exhibits	23
Signature		24
Exhibit Index		25
Certifications

PAGE 2 OF 25

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

COSINE COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

	March 31, 2007			December 31, 2006
	(Unaudited)			(1)
ASSETS
Current assets:
Cash and cash equivalents	$	7,980		$	5,207
Short-term investments		14,915			17,650
Accounts receivable:
Trade (net of allowance for doubtful accounts of nil at March 31, 2007 and December 31, 2006)		6			55
Other		41			68
Prepaid expenses and other current assets		47			56
	$	22,989		$	23,036

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	286		$	320
Accrued other liabilities		122			239
Total current liabilities		408			559


Stockholders' equity:
Preferred stock, 3,000,000 authorized, none issued and outstanding		—			—
Common stock, $.0001 par value, 22,000,000 shares authorized; 10,090,635 shares issued and outstanding at March 31, 2007 and December 31, 2006		1			1
Additional paid-in capital		538,997			538,987
Accumulated other comprehensive income		17			17
Accumulated deficit		(516,434	)		(516,528	)
Total stockholders' equity		22,581			22,477
	$	22,989		$	23,036

See accompanying notes to condensed consolidated financial statements.

(1) The information in this column was derived from the Company's audited consolidated financial statements for the year ended December 31, 2006.

PAGE 3 OF 25

COSINE COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except for per share data)

(Unaudited)

	Three Months Ended March 31,
	2007			2006
Revenue:
Product	$	—		$	—
Service		—			579
Total revenue		—			579
Cost of revenue¹		—			570
Gross profit		—			9

Operating expenses:
Research and development		—			—
Sales and marketing		—			—
General and administrative²		197			377
Restructuring and impairment charges		—			—
Total operating expenses		197			377

Loss from operations		(197	)		(368	)

Other income (expenses):
Interest income and other		291			242
Total other income (expenses)		291			242

Income (Loss) before income tax provision		94			(126	)

Income tax provision		—			—

Net income (loss)	$	94		$	(126	)

Basic net income (loss) per share	$	0.01		$	(0.01	)
Diluted net income (loss) per share	$	0.01		$	(0.01	)

Shares used in computing per share amounts:
Basic		10,091			10,090
Diluted		10,120			10,090

See accompanying notes to condensed consolidated financial statements.

¹ Cost of revenue includes nil and $60 for the three months ended March 31, 2007 and 2006, respectively, of non-cash charges related to equity issuances.

² General and administrative expenses include $10 and $5, for the three months ended March 31, 2007 and 2006, respectively, of non-cash charges related to equity issuances.

PAGE 4 OF 25

COSINE COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

	Three Months Ended March 31,
	2007			2006
Operating activities:
Net income (loss)	$	94		$	(126	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of warrants issued for services		—			60
Expense for option vesting		10			5
Change in operating assets and liabilities:
Accounts receivable, trade		49			(362	)
Other receivables		27			209
Prepaid expenses and other current assets		9			(10	)
Accounts payable		(34	)		17
Accrued other liabilities		(117	)		(147	)
Accrued compensation		—			—
Deferred revenue		—			(64	)
Net cash provided by (used in) operating activities		38			(418	)

Investing activities:
Purchase of short-term investments		(7,213	)		(1,607	)
Proceeds from sales and maturities of short-term investments		9,948			7,702
Net cash provided by investing activities		2,735			6,095

Net increase in cash and cash equivalents		2,773			5,677
Cash and cash equivalents at the beginning of the period		5,207			12,417
Cash and cash equivalents at the end of the period	$	7,980		$	18,094
Supplemental information:
Income taxes paid	$	—		$	—

See accompanying notes to condensed consolidated financial statements.

PAGE 5 OF 25

COSINE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

Description of Business

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

Liquidity and Redeployment Strategy

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

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

Basis of Consolidation

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

Use of Estimates

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

PAGE 6 OF 25

The unaudited condensed consolidated financial statements have been prepared by us pursuant to instructions to Form 10-Q and Article 10 of Regulation S-X and include the accounts of CoSine Communications, Inc. and its wholly owned subsidiaries ("CoSine" or collectively, the "Company"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U. S. generally accepted accounting principles have been condensed or omitted pursuant to the Securities Exchange Commission’s rules and regulations. In the opinion of management, all adjustments (consisting of normal recurring items) necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year. The condensed consolidated balance sheet at December 31, 2006 has been derived from the audited financial statements as of that date. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes included in our Annual Report filed on Form 10-K for the year ended December 31, 2006.

Stock Compensation

Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment” (“SFAS No. 123 (R).” SFAS No. 123 (R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. All of our stock compensation is accounted for as an equity instrument.

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

The effect of recording stock-based compensation for the three months ended March 31, 2007 and 2006 was $10,000 and $5,000, respectively, which consisted of stock based compensation related to employee stock options. As of March 31, 2007 we had an unrecorded deferred stock compensation balance related to stock options of approximately $84,000 before estimated forfeitures. SFAS No. 123 (R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on our analysis of historical experience and review of current option holders, we have assumed an annual forfeiture rate of 2.5% for our options. Accordingly, as of March 31, 2007, we estimated that the stock-based compensation for the awards not expected to vest was approximately $4,000, and therefore, the unrecorded deferred stock-based compensation balance related to stock options was adjusted to approximately $80,000 after estimated forfeitures. This amount will be recognized over an estimated weighted average amortization period of 3 years. .

During the three months ended March 31, 2007 and 2006, respectively, there were no stock options granted, exercised, cancelled or expired.

Valuation Assumptions

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

	Three Months Ended March 31,
	2007			2006
Dividend yield		0.0	%		0.0	%
Volatility		0.40			0.47
Risk free interest rate		5.0	%		4.2	%
Expected life		6.25 years			4 years

The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. Expected volatility is based on the historical volatility of our common stock. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded treasury securities for terms equal to the expected term of the options. The expected term calculation is based on the observed historical option exercise behavior and post-vesting forfeitures of our employees and an analysis of the existing option holders.

PAGE 7 OF 25

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

	Shares Available for Grant		Shares		Weighted- Average Price Per Share
Balance as of December 31, 2006		2,940		147	$	7.69
Granted		—		—		—
Exercised		—		—		—
Canceled		—		—		—
Balance as of March 31, 2007		2,940		147	$	7.69

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

	Options Outstanding
			Weighted-				Options Exercisable
			Average		Weighted-				Weighted-
	Number		Remaining		Average		Number		Average
Range of	Of		Contractual		Exercise		Of		Exercise
Exercise Prices	Shares		Life (Years)		Price		Shares		Price
$2.15-2.60		118		8.3	$	2.56		52	$	2.58
5.20		4		6.1		5.20		-		-
6.96		12		6.6		6.96		9		6.96
8.80		4		5.1		8.80		4		8.80
22.30		4		4.2		22.30		4		22.30
120.00		5		3.4		120.00		5		120.00
$2.15-120.00		147		7.7	$	7.69		74	$	12.47

Guarantees

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

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

PAGE 8 OF 25

Income Taxes

We adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. This Interpretation clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in our consolidated financial statements. The Interpretation also provides guidance for the measurement and classification of tax positions, interest and penalties, and requires additional disclosure on an annual basis. The cumulative effect of the change was not material. Following implementation, the ongoing recognition of changes in measurement of uncertain tax positions will be reflected as a component of income tax expense. Interest and penalties incurred associated with unresolved income tax positions will continue to be included in other income (expense).

2. COMMITMENTS AND CONTINGENCIES

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

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

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

On December 5, 2006, the Court of Appeals for the Second Circuit reversed the court's October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. It is unclear what impact this will have on the case. The settlement is subject to a number of conditions, including final court approval, which cannot be assured. If the settlement is not consummated, we intend to defend the lawsuit vigorously. However, we cannot predict its outcome with certainty. If we are not successful in our defense of this lawsuit, we could be forced to make significant payments to the plaintiffs and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carrier.

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

PAGE 9 OF 25

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

3. BALANCE SHEET DETAILS

Cash

At March 31, 2007, we had deposits with a financial institution that may exceed the amount of insurance provided on such deposits.

Accounts Receivable

One European customer accounted for 100% of total accounts receivable as of March 31, 2007, as compared to two customers comprising 94% of total accounts receivable at December 31, 2006.

Warranty

Prior to discontinuing our products in September 2004, we provided a basic limited warranty, including repair or replacement of parts, and technical support for products sold on or before September 30, 2004. We ceased offering warranties in 2004 in connection with the discontinuance of our products and all warranty obligations have expired on or before March 31, 2007. There were no warranty activities in the three months ended March 31, 2007 and 2006, respectively.

4. NET INCOME (LOSS) PER COMMON SHARE

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

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

	2007		2006
Numerator:
Net income (loss)	$	94	$	(126	)
Denominator:
Weighted average shares outstanding for basic income (loss) per share		10,091		10,090
Add: effect of dilutive securities - stock options		29		—
Weighted average shares used in basic and diluted net income (loss) per share		10,120		10,090
Basic net income (loss) per share	$	0.01	$	(0.01	)
Diluted net income (loss) per share	$	0.01	$	(0.01	)

Basic net income (loss) per common share is calculated based on the weighted-average number of common shares outstanding during the periods presented. 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 in the three months ended March 31, 2006, as their inclusion would be antidilutive. These securities amounted to 147,000 shares for the three months ended March 31, 2006.

PAGE 10 OF 25

5. COMPREHENSIVE INCOME (LOSS)

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

	Three Months Ended March 31,
	2007		2006
Net income (loss)	$	94	$	(126	)
Other comprehensive gain:
Unrealized gains on investments		—		6
Translation adjustment		—		12
Total other comprehensive gain		—		18
Comprehensive income (loss)	$	94		($ 108	)

6. SEGMENT REPORTING

We operate in only one operating segment, and substantially all of our assets are located in the United States.

Revenues from customers by geographic region for the three months ended March 31, 2007 and 2006 were as follows, in thousands:

	Three Months Ended March 31,
	2007		2006
Region
North America	$	—	$	545
Italy		—		—
France		—		—
South Korea		—		—
Europe		—		34
Japan		—		—
Total	$	—	$	579

We had no revenues in the three months ended March 31, 2007. Two North American customers accounted for 74% and 11% of total revenues, respectively, in the three months ended March 31, 2006.

7. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recognized no material adjustments in the liability for unrecognized income tax benefits. We operated in multiple tax jurisdictions both inside and outside the United States. With few exceptions, we are no longer subject to audits by tax authorities for tax years prior to 2001. At the adoption date we did not have any unrecognized tax benefits and did not have any interest or penalties accrued.

PAGE 11 OF 25

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

In September 2006, the FASB issued Statement of Financial Accounting Standards No, 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158). This statement requires balance sheet recognition of the overfunded or underfunded status of pension and postretirement benefit plans. Under SFAS 158, actuarial gains and losses, prior service costs or credits, and any remaining transition assets or obligations that have not been recognized under previous accounting standards must be recognized in Accumulated Other Non-Shareowners’ Changes in Equity, net of tax effects, until they are amortized as a component of net periodic benefit cost. The adoption of SFAS 158 is not expected to have a material impact on the consolidated financial position or results of operations of the Company.

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

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

OVERVIEW

Our business consisted primarily of a customer support capability for our discontinued products provided by a third party. We continued such support activities through December 31, 2006, at which time we ceased all customer support services. In 2006 we sold our patent portfolio and the intellectual property related to our carrier products and service business. We continue to seek to redeploy our existing resources to identify and acquire one or more new business operations with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards ("NOLs").

DUE TO THE ADOPTION OF OUR REDEPLOYMENT STRATEGY, THE INFORMATION APPEARING BELOW, WHICH RELATES TO PRIOR PERIODS, MAY NOT BE INDICATIVE OF THE RESULTS THAT MAY BE EXPECTED FOR ANY SUBSEQUENT PERIODS. THE THREE MONTHS ENDED MARCH 31, 2007 PRIMARILY REFLECTS, AND FUTURE PERIODS PRIOR TO A REDEPLOYMENT OF OUR ASSETS ARE EXPECTED TO PRIMARILY REFLECT, GENERAL AND ADMINISTRATIVE EXPENSES AND TRANSACTION EXPENSES ASSOCIATED WITH THE CONTINUING ADMINISTRATION OF THE COMPANY AND ITS EFFORTS TO REDEPLOY ITS ASSETS.

PAGE 12 OF 25

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

General

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

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

Revenue Recognition

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

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

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

Our current business consists primarily of customer service revenue. We record revenue as earned for customer service revenue, once we satisfy ourselves that collection is probable. If we cannot satisfy ourselves that collection is probable, we defer revenue recognition until we collected payment.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts in connection with estimated losses resulting from the inability of our customers to pay our invoices. In order to estimate the appropriate level of this allowance, we analyze historical bad debts, customer concentrations, current customer credit-worthiness, current economic trends and changes in our customer payment patterns. In future periods, if the financial condition of our customers were to deteriorate and affect their ability to make payments, additional allowances may be required.

Warranties

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

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We ceased offering warranty on product or service sales in 2004.

Impact of Equity Issuances on Operating Results

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

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

Some of the stock options granted to our employees had resulted in deferred compensation as a result of stock options having an exercise price below their estimated fair value. Deferred compensation is presented as a reduction to stockholders’ equity on the consolidated balance sheet and is then amortized using an accelerated method over the vesting period of the applicable options. When an employee terminates, an expense credit is recorded for any amortization that has been previously recorded as an expense in excess of vesting.

In the second quarter of 2004, we issued to a reseller a warrant to acquire 254,489 shares of our common stock at an exercise price of $4.65 per share. The warrant has a two-year term beginning May 28, 2004 and vests ratably over the term. If during the two-year term (1) any person or entity acquires a greater than 50% interest in us or the ownership or control of more than 50% of our voting stock or (2) we sell substantially all of our intellectual property assets, the warrant becomes exercisable. Even if the reseller does not immediately exercise the warrant upon the occurrence of such an event that makes the warrant exercisable (a “trigger event”), the reseller shall be entitled to securities, cash and property to which it would have been entitled to upon the consummation of the trigger event, less the aggregate price applicable to the warrant. We calculated the fair value of the warrant to be approximately $487,000 using the Black-Scholes option pricing model, using a volatility factor of .97, a risk-free interest rate of 2.5%, and an expected life of two years. The fair value of the warrant is being amortized over the two-year expected life of the warrant. The warrant was fully amortized at December 31, 2006. During the three months ended March 31, 2006 we amortized $60,000 to cost of revenue.

RESULTS OF OPERATIONS

Revenue

Effective December 31, 2006, we have ceased all customer service operations, accordingly, there were no revenues recognized for the three months ended March 31, 2007. Revenues for the three months ended March 31, 2006 were $579,000, all of which was from service.

Revenues by geographic region for the three months ended March 31, 2006 were as follows, in thousands:

	2006
Region
North America	$	545
Italy		—
France		—
South Korea		—
Europe-other		34
Japan		—
Total	$	579

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Non-Cash Charges Related to Equity Issuances

During the three months ended March 31, 2007 and 2006, we recorded $10,000 and $65,000, respectively, of non-cash charges related to equity issuances. The charges in 2007 include $10,000 related to the adoption of SFAS No. 123(R). The charges in 2006 relate to stock option expense as well as the amortization of a stock purchase warrant granted to a reseller.

Cost of Revenue

For the three months ended March 31, 2006, cost of revenue was $570,000, which represented costs of our third party support contract as well as amortization of a warrant granted to a sales representative. There was no cost of revenue for the three months ended March 31, 2007 as we closed our customer service business effective December 31, 2006.

Gross Profit

For the three months ended March 31, 2006, gross profit was $9,000. Our gross profit was adversely affected by the declining volume of our service contract sales and the costs we incurred with our third party contractor.

Research and Development Expenses

Research and development expenses were nil for the three months ended March 31, 2007 and 2006, respectively. We discontinued all research and development in connection with our announcement in September 2004 that we were laying off all employees and discontinuing our products. We do not expect to incur research and development costs unless and until we acquire new operating businesses.

Sales and Marketing Expenses

Sales and marketing expenses were nil for the three months ended March 31, 2007 and 2006, respectively. With our announcement in September 2004 that we were laying off all employees and were discontinuing our products, we have ceased essentially all ongoing sales and marketing efforts. We do not expect to incur sales and marketing costs unless and until we acquire new operating businesses.

General and Administrative Expenses

General and administrative expenses were $197,000 and $377,000 for the three months ended March 31, 2007 and 2006, respectively. With our announcement in September 2004 that we were laying off all employees and discontinuing our products, our general and administrative efforts have been focused on restructuring activities, the evaluation of strategic alternatives, as well as the activities related to identifying and acquiring profitable business operations. General and administrative costs for the three months ended March 31, 2007 and 2006 consisted of costs of our employee, contractors, legal and accounting services, insurance and office expenses. General and administrative expenses should remain at approximately the levels reported in the three months ended March 31, 2007 for the quarter ending June 30, 2007.

Interest Income and Other Income (Expense)

For the three months ended March 31, 2007 and 2006, interest income and other income was $291,000 and $242,000, respectively. The increase from March 31, 2006 to March 31, 2007 is due to higher interest rates, partially offset by lower short term investments.

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Income Tax Provision

Provisions for income taxes were nil for the three months ended March 31, 2007 and 2006, respectively. Our tax expense for fiscal 2007 will continue to depend on the amount and mix of income derived from sources subject to corporate income taxes of foreign taxing jurisdictions.

LIQUIDITY AND CAPITAL RESOURCES

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

Through December 31, 2006, our current business consisted primarily of a customer support capability for our discontinued products provided by a third party. In June 2006, we sold the rights to our patent portfolio for cash consideration of $180,000 and in November 2006 we sold the rights to our intellectual property for $80,000. We ceased customer support activities effective December 31, 2006. We have adopted a strategy of seeking to enhance stockholder value by pursuing opportunities to redeploy our assets through an acquisition of one or more operating business with existing or prospective taxable earnings that can be offset by use of our net operating loss carry-forwards. We believe that we possess sufficient liquidity and capital resources to fund our operations and working capital requirements for at least the next 12 months. However, our restructuring activities and our new redeployment of assets strategy raise substantial doubt as to our ability to continue as a going concern.

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

Cash, Cash Equivalents and Short-Term Investments

Cash, cash equivalents and short-term investments were $22.9 million at March 31, 2007 and December 31, 2006.

Operating Activities

We generated $38,000 in cash for operations for the three months ended March 31, 2007 as compared to a usage of $418,000 in cash for operations for the three months ended March 31, 2006. The improvement in 2007 is due to the net income in the three months ended March 31, 2007 as compared to a loss in the prior year period, as well as reductions in receivables, partially offset by reductions in accounts payable and accrued other liabilities.

Investing Activities

Investing activities generated $2.7 million in cash in the three months ended March 31, 2007 as compared to $6.1 million in the three months ended March 31, 2006. There were no capital expenditures in the three months ended March 31, 2007 or 2006, respectively.

Financing Activities

There were no significant financing activities in the three months ended March 31, 2007 or 2006, respectively.

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OUTLOOK

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

At March 31, 2007, we had $22.9 million in cash and short-term investments. We believe we possess sufficient liquidity and capital resources to fund our operations and working capital requirements for at least the next 12 months.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

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

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

A sensitivity analysis was performed on our investment portfolio as of March 31, 2007 based on a modeling technique that measures hypothetical fair market value changes that would result from a parallel shift in the yield curve of plus 100 basis points. Based on this analysis, a hypothetical 100 basis point increase in interest rates would result in a $37,000 decrease in the fair value of our investments in debt securities as of March 31, 2007.

Exchange Rate Sensitivity

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

ITEM 4. CONTROLS AND PROCEDURES

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

Changes in Internal Controls. In connection with its audit of our consolidated financial statements for the year ended December 31, 2006, Burr, Pilger & Mayer LLP identified significant deficiencies, which represent material weaknesses. The material weaknesses were related to a lack of adequate segregation of duties. In addition, significant audit adjustments and financial statement disclosure changes were needed that were the result of an insufficient quantity of experienced resources involved with the financial reporting and year end closing process resulting from staff reductions associated with our downsizing.

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Prior to the issuance of our consolidated financial statements, we completed the needed analyses and our management review such that we can certify that the information contained in our consolidated financial statements for the year ended December 31, 2006 and the three months ended March 31, 2007 fairly presents, in all material respects, our financial condition and results of operations.

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

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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ITEM 1A. RISK FACTORS

Our future results and the market price for our stock are subject to numerous risks, many of which are driven by factors that we cannot control or predict. The following discussion, as well as other sections of this Report on Form 10-Q including Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations, describes certain risk factors related to our business. You should carefully consider the risk factors described below in conjunction of the other information is this document.

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

We have incurred losses since inception and expect that net losses and negative cash flow will continue for the foreseeable future. In September 2004, we announced the termination of most of our employees to facilitate the strategic alternatives then in consideration and ceased all operations other than a customer service and support capability. In July 2005, we completed a comprehensive review of strategic alternatives and approved a plan to redeploy our existing resources to identify and acquire one or more new business operations, while continuing to support our existing customers and continuing to offer our intellectual property for license or sale. If we are not successful in executing this strategy we will continue to incur operating losses and negative cash flow and may at some point decide to liquidate and return the net proceeds to our stockholders. In the case of a liquidation or bankruptcy, we would need to hold back or distribute assets to cover liabilities before paying stockholders, which may therefore reduce or delay the proceeds that stockholders may receive for their ownership in us. However, we believe we have adequate cash resources to continue to realize our assets and discharge our liabilities as a company through 2007.

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

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

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

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

·	We may have difficulty retaining our key remaining employee;

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

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There can be no assurance that we will be able to identify suitable acquisition candidates in connection with our redeployment strategy.

We have incurred recurring operating losses, and operations have not generated positive cash flows since inception. If we are unable to acquire suitable acquisition candidate(s), we will continue to incur operating losses and negative cash flows and may decide to liquidate. In the case of a liquidation, we would need to hold back assets to cover liabilities, which may therefore reduce or delay the proceeds that stockholders may receive.

We may elect to dissolve and distribute assets to stockholders if our board of directors determines that such action is in the best interest of the stockholders.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Our customers may sue us because we have announced the discontinuance of our products and may not meet all our contractual commitments.

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

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

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

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

We may become a party to litigation in the future to protect its intellectual property or because others may allege infringement of their intellectual property. These claims and any resulting lawsuits could subject it to significant liability for damages or invalidate 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:

·	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 have a history of losses that we expect will continue, and if we do not achieve profitability we may cease operations.

At March 31, 2007, we had an accumulated deficit of $516 million. We have incurred net losses since our incorporation. If we do not achieve profitability and are unable to obtain additional financing, we will run out of cash and cease operations.

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

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

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

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

We did not pay directly or indirectly any of the underwriting discounts or other related expenses of the initial public offering to any of our directors or officers, any person owning 10% or more of any class of our equity securities, or any of our affiliates.

We have used approximately $220 million of the funds from the initial public offering to fund our operations. We expect to use the remaining net proceeds for general corporate purposes, to fund our operations, working capital and capital expenditures. Pending further use of the net proceeds, we have invested them in short-term, interest-bearing, investment-grade securities.

ITEM 6. EXHIBITS

Exhibit Index on page 28.

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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 R. Gibson
		Terry R. Gibson
		Chief Executive Officer and Chief Financial Officer

Dated: May 1, 2007

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EXHIBIT INDEX

Exhibit Number		Description

31.1		Certification of Terry R. Gibson, Chief Executive Officer and Chief Financial Officer of CoSine Communications, Inc., pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Terry R. Gibson, Chief Executive Officer and Chief Financial Officer of CoSine Communications, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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