---

---

SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

---

Form 10-Q

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

For the quarterly period ended March 31, 2001

Commission File Number: 000-26223

---

TUMBLEWEED COMMUNICATIONS CORP.(Exact name of registrant as specified in its charter)

DELAWARE(State of other jurisdiction of
incorporation or organization)

94-3336053(I.R.S. Employer Identification No.)


700 SAGINAW DRIVE
REDWOOD CITY, CA 94063(Address of principal executive offices, including zip code)

(650) 216-2000(Registrant's telephone number, including area code)

---

Indicate
by check mark whether the registrant (1) has filed all reports required by Section 13 or 15() 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 / /

The
number of shares of common stock outstanding as of April 30, 2001 was 30,059,376.

---

---

---





This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934, which are subject to the "safe harbor" created by those sections. The forward-looking statements are based on our current
expectations and projections about future events, including, but not limited to, implementing Tumbleweed's business strategy and new pricing models; attracting and retaining customers; obtaining and
expanding market acceptance of the products and services it offers; forecasts of Internet usage and the size and growth of relevant markets; rapid technological changes in its industry and relevant
markets; and competition in its market. Discussions containing such forward-looking statements may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
In some cases, forward-looking statements can be identified by terminology such as "may," "will," "should," "could," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends,"
"plans," "believes," "estimates," and similar expressions. These forward-looking statements involve certain risks and uncertainties that could cause actual results, levels of activity, performance,
achievements and events to differ materially from those implied by such forward-looking statements. These forward-looking statements are made as of the date of this Quarterly Report on
Form 10-Q. Tumbleweed disclaims any obligation to update these statements or to explain the reasons why actual results may differ. Tumbleweed reserves the right to update these
statements for any reason including the occurrence of a material event. The risks and uncertainties under the caption "Management's Discussion and Analysis of Financial Condition and Results of
OperationsRisks and Uncertainties That You Should Consider Before Investing in Tumbleweed" contained herein, among other things, should be considered in evaluating Tumbleweed's prospects
and future financial performance.



|           |  |                                                                                                                             |  | Page
|---------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | ----
|Part I    
|Item 1     |  | Financial Statements                                                                                                        |  | 3   
|           |  | Condensed Consolidated Balance Sheets as of March 31, 2001 (unaudited) and December 31, 2000                                |  | 3   
|           |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2001 and December 31, 2000 (unaudited) |  | 4   
|           |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and 2000 (unaudited)              |  | 5   
|           |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                            |  | 6   
|Item 2     |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                                       |  | 9   
|Item 3     |  | Quantitative and Qualitative Disclosures About Market Risk                                                                  |  | 24  
|Part II   
|Item 1     |  | Legal Proceedings                                                                                                           |  | 25  
|Item 2     |  | Changes in Securities and Use of Proceeds                                                                                   |  | 25  
|Item 6     |  | Exhibits                                                                                                                    |  | 25  
|Signatures |  | 26                                                                                                                         



Tumbleweed®, WorldSecure® and Worldtalk® are registered trademarks and Integrated Messaging Exchange,
IME, Messaging Management System (MMS), Tumbleweed Secure Redirect, Tumbleweed SPN, Tumbleweed Message Monitor, Tumbleweed Web
Filter, WorldSecure/Mail, Secure Inbox, Secure Envelope, Tumbleweed IME Platform, Tumbleweed IME Applications, IME
Statements, Tumbleweed My Copy, Tumbleweed L2i, IME Developer, IME Messenger, IME Personalize, and IME Alert
are our trademarks.

2

---



Part IFinancial Information

Item 1Financial Statements

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Condensed Consolidated Balance Sheets        (in thousands)

|                                     |                                                | March 31, 2001                             |        | December 31, 2000 |        
|------------------------------------ | ---------------------------------------------- | ------------------------------------------ | ------ | ----------------- | -------
|
|Assets                               |                                                |                                            |        |                   |        
|Current Assets:                      |                                                |                                            |        |                   |        
|                                     | Cash                                           |                                            | $      | 58,046            |        
|                                     | Accounts receivable, net                       |                                            |        | 11,138            |        
|                                     | Prepaid expenses and other current assets      |                                            |        | 3,507             |        
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total current assets                       |        |                   | 72,691 
|Property and equipment, net          |                                                |                                            | 11,431 |                   |        
|Goodwill and intangible assets, net  |                                                |                                            | 10,789 |                   |        
|Other assets                         |                                                |                                            | 5,332  |                   |        
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total assets                               |        | $                 | 100,243
|                                     |                                                |                                            |        |                   |        
|Liabilities and Stockholders' Equity |                                                |                                            |        |                   |        
|Current liabilities:                 |                                                |                                            |        |                   |        
|                                     | Accounts payable                               |                                            | $      | 4,034             |        
|                                     | Current installments of long-term debt         |                                            |        | 530               |        
|                                     | Accrued liabilities                            |                                            |        | 10,720            |        
|                                     | Accrued restructuring                          |                                            |        | 5,639             |        
|                                     | Deferred revenue                               |                                            |        | 5,619             |        
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total current liabilities                  |        |                   | 26,542 
|                                     | Long-term debt, excluding current installments |                                            |        | 227               |        
|                                     | Other long-term liabilities                    |                                            |        | 369               |        
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total liabilities                          |        |                   | 27,138 
|Minority interest                    |                                                |                                            | 505    |                   |        
|Stockholders' equity:                |                                                |                                            |        |                   |        
|                                     | Common stock                                   |                                            |        | 30                |        
|                                     | Additional paid-in capital                     |                                            |        | 294,233           |        
|                                     | Deferred compensation expense                  |                                            |        | (3,991            | )      
|                                     | Accumulated other comprehensive loss           |                                            |        | (299              | )      
|                                     | Accumulated deficit                            |                                            |        | (217,373          | )      
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total stockholders' equity                 |        |                   | 72,600 
|                                     |                                                |                                            |        |                   |        
|                                     |                                                | Total liabilities and stockholders' equity |        | $                 | 100,243
|                                     |                                                |                                            |        |                   |        

3

---

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Condensed Consolidated Statements of Operations        (in thousands, except per share data)    
(unaudited)

|                                                         |                                                | Three Months Ended
March 31, |        
|-------------------------------------------------------- | ---------------------------------------------- | ---------------------------- | -------
|
|Revenue:                                                 |                                                |                              |        
|                                                         | Product                                        |                              | $      
|                                                         | Service                                        |                              |        
|                                                         |                                                |                              |        
|                                                         |                                                | Total revenue                |        
|Cost of revenue(1)                                       |                                                |                              | 3,052  
|                                                         |                                                |                              |        
|Gross profit                                             |                                                |                              | 965    
|Operating expenses:                                      |                                                |                              |        
|                                                         | Research and development(2)                    |                              |        
|                                                         | Sales and marketing(3)                         |                              |        
|                                                         | General and administrative(4)                  |                              |        
|                                                         | Stock-based compensation                       |                              |        
|                                                         | Amortization of goodwill and intangible assets |                              |        
|                                                         | Impairment of goodwill and intangible assets   |                              |        
|                                                         | Merger related and restructuring expenses(5)   |                              |        
|                                                         |                                                |                              |        
|                                                         |                                                | Total operating expenses     |        
|                                                         |                                                |                              |        
|                                                         |                                                | Operating loss               |        
|Other income, net                                        |                                                |                              | 931    
|Minority interest                                        |                                                |                              | (100   
|                                                         |                                                |                              |        
|Net loss before provision for taxes                      |                                                |                              | (82,268
|                                                         | Provision for taxes                            |                              |        
|                                                         |                                                |                              |        
|                                                         | Net loss                                       |                              |        
|Other comprehensive income (loss)translation adjustment |                                                |                              | (238   
|                                                         |                                                |                              |        
|                                                         | Comprehensive loss                             |                              | $      
|                                                         |                                                |                              |        
|Net loss per sharebasic and diluted                     |                                                | $                            | (2.76  
|                                                         |                                                |                              |        
|Weighted average sharesbasic and diluted                |                                                |                              | 29,800 
|                                                         |                                                |                              |        

---

4

---



TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Condensed Consolidated Statements of Cash Flows        (in thousands)        (unaudited)

|                                                   |                                                                             | Three months ended
March 31,                                    |                                                    
|-------------------------------------------------- | --------------------------------------------------------------------------- | --------------------------------------------------------------- | ---------------------------------------------------
|
|Cash flows from operating activities:              |                                                                             |                                                                 |                                                    
|                                                   | Net loss                                                                    |                                                                 | $                                                  
|                                                   | Adjustments to reconcile net loss to net cash used in operating activities: |                                                                 |                                                    
|                                                   |                                                                             | Amortization of deferred stock and warrant compensation expense |                                                    
|                                                   |                                                                             | Depreciation and amortization                                   |                                                    
|                                                   |                                                                             | Bad debt expense                                                |                                                    
|                                                   |                                                                             | Minority interest                                               |                                                    
|                                                   |                                                                             | Impairment of goodwill and intangible assets                    |                                                    
|                                                   |                                                                             | Restructuring accrual                                           |                                                    
|                                                   |                                                                             | Loss on disposal of property and equipment                      |                                                    
|                                                   | Changes in operating assets and liabilities                                 |                                                                 |                                                    
|                                                   |                                                                             | Accounts receivable                                             |                                                    
|                                                   |                                                                             | Prepaid expenses and other assets                               |                                                    
|                                                   |                                                                             | Accounts payable and accrued liabilities                        |                                                    
|                                                   |                                                                             | Deferred revenue                                                |                                                    
|                                                   |                                                                             |                                                                 |                                                    
|                                                   |                                                                             |                                                                 | Net cash used in operating activities              
|                                                   |                                                                             |                                                                 |                                                    
|Cash flows from investing activities:              |                                                                             |                                                                 |                                                    
|                                                   | Purchase of property and equipment                                          |                                                                 |                                                    
|                                                   | Other assets                                                                |                                                                 |                                                    
|                                                   |                                                                             |                                                                 |                                                    
|                                                   |                                                                             |                                                                 | Net cash used in investing activities              
|                                                   |                                                                             |                                                                 |                                                    
|Cash flows from financing activities:              |                                                                             |                                                                 |                                                    
|                                                   | Repayments of borrowings                                                    |                                                                 |                                                    
|                                                   | Issuance of common stock upon exercise of stock options                     |                                                                 |                                                    
|                                                   |                                                                             |                                                                 |                                                    
|                                                   |                                                                             |                                                                 | Net cash (used in) provided by financing activities
|Effect of exchange rate fluctuation                |                                                                             |                                                                 | (238                                               
|                                                   |                                                                             |                                                                 |                                                    
|Net decrease in cash and cash equivalents          |                                                                             |                                                                 | (17,451                                            
|Cash and cash equivalents, beginning of period     |                                                                             |                                                                 | 75,497                                             
|                                                   |                                                                             |                                                                 |                                                    
|Cash and cash equivalents, end of period           |                                                                             | $                                                               | 58,046                                             
|                                                   |                                                                             |                                                                 |                                                    
|Supplemental disclosures of cash flow information: |                                                                             |                                                                 |                                                    
|                                                   | Cash paid during the period for interest                                    |                                                                 |                                                    
|                                                   |                                                                             |                                                                 |                                                    
|Non-cash investing and financing activities:       |                                                                             |                                                                 |                                                    
|                                                   | Issuance of warrants and options for services                               |                                                                 |                                                    
|                                                   |                                                                             |                                                                 |                                                    

5

---



TUMBLEWEED COMMUNICATIONS CORP.        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)  Basis of Presentation

The condensed consolidated financial statements as of March 31, 2001 and for the three months ended March 31, 2001 and 2000 are unaudited and
reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary for fair presentation of Tumbleweed Communications Corp.'s ("Tumbleweed" or "the
Company") financial position and operating results for the interim periods presented except as otherwise indicated.

The
accompanying consolidated financial statements include the accounts of Tumbleweed, its wholly owned subsidiary, Worldtalk Communications Corp. ("Worldtalk"), and the Company's
wholly owned subsidiary in the United Kingdom, which includes the United Kingdom's wholly owned subsidiaries in Germany, the Netherlands, Switzerland, Sweden, France, Australia and Hong Kong. The
results of operations for the Company's majority-owned subsidiary in Japan, Tumbleweed Communications KK ("TKK"), and wholly owned subsidiary, Interface Systems, Inc. ("Interface") are included
in the three months ended March 31, 2001 as they were both acquired subsequent to March 31, 2000.

All
significant intercompany accounts and transactions have been eliminated in consolidation.

(2)  Restructuring

In January 2001, Tumbleweed's Board of Directors approved a restructuring program to focus the Company's efforts towards concentrating on its strongest
opportunities, reducing operating expenses, and improving the Company's allocation of resources. The restructuring involved closing international sales office locations in Paris, France; Chatsworth,
Australia; Stockholm Sweden; and Hong Kong. The restructuring program also realigned the professional services organization, and included a targeted worldwide staff reduction of approximately 100
employees.

Restructuring
and related charges expensed during the quarter ended March 31, 2001 was comprised of the following:

Used

Remaining

ExpenseEmployee separation

$
2,637

$
5

$
2,642Facilities charges and asset impairment


403


5,522


5,925Other


191


112


303Total restructuring charges

$
3,231

$
5,639

$
8,870


Employee
separation benefits include severance, medical and other benefits. As of March 31, 2001, the remaining restructuring accrual is $5.6 million. Of this amount,
approximately $5.3 million represents a non-cash accrual for potential losses on facilities no longer required primarily due to the reduction in headcount. Anticipated sublease
rental income is not expected to cover the rent expense due to rapidly declining office rent rates in and around Silicon Valley. This facility lease commitment lasts through 2004. Tumbleweed expects
to settle the remaining cash payments by June 30, 2001.

(3)  Goodwill Impairment

The Company has performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the acquisition of Interface. The
assessment was performed primarily due to changes in the economy, the overall decline in the industry growth rate, and the

6

---

Company's lower actual and projected operating results including that of the business acquired from Interface. This is supported by the significant sustained decline in the Company's stock price since
the valuation date of the shares issued in the Interface acquisition. As a result of the assessment, the Company recorded a $51 million impairment charge to reduce goodwill and other intangible
assets. The charge was based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 15%. The assumptions supporting the cash flows, including
the discount rate, were determined using the Company's best estimates as of March 31, 2001. The remaining intangible assets balance of approximately $847,000 will be amortized over its
remaining useful life.

Goodwill

$
49,210Developed and core technology


1,127Acquired workforce


646Total impairment

$
50,983


(4)  Net Loss Per Share

Basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares
outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common and potential common shares outstanding during
the period if their effect is dilutive. Potential common shares comprise outstanding shares of common stock issued to certain officers but subject to ratable repurchase by Tumbleweed if such officers
did not remain employees through August 1999, and incremental common and preferred shares issuable upon the exercise of stock options and warrants. The potential common shares issuable under
stock options and the potential warrants to purchase common shares have been excluded from the determination of diluted net loss per share for all periods because the effect of such shares would have
been anti-dilutive.

(5)  Segment Information

Tumbleweed has adopted the provisions of SFAS No. 131,Disclosure About Segments of an Enterprise and Related
Information. SFAS No. 131 establishes standards for the reporting by public business enterprises of information about operating segments, products and services,
geographic areas, and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within Tumbleweed for making operating
decisions and assessing financial performance.

Tumbleweed's
chief operating decision-maker is considered to be the Chief Executive Officer. The CEO reviews financial information presented on a consolidated basis accompanied by
disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed by the CEO
is identical to the information presented in the accompanying consolidated statement of operations. Therefore, Tumbleweed operates in a single operating segment.

7

---

Revenue information regarding operations in the different geographic regions is as follows (in thousands):

Three months ended
March 31,2001

2000United States

$
2,518

$
4,348Europe


1,024


1,476Asia


475


786Total

$
4,017

$
6,610


Substantially
all of the Company's long-lived assets are located in the United States.

(6)  Contingencies

On July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface and
various additional defendants, including Interface's President and Chief Executive Officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the
Southern District of New York. The three cases contain substantially similar
allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock price. The complaints seek relief under the federal securities laws on behalf
of purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of action. On September 27, 2000 the Company filed (i) a motion to
strike or dismiss for failure to meet certification requirements of the Private Securities Litigation Reform Act, (ii) a motion to dismiss for failure to state a claim, and (iii) a
motion to dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern District of Michigan. The Court has scheduled a hearing on these motions, to occur on
May 25, 2001. The accompanying financial statements do not include any costs for damages, if any, that might result from this uncertainty.

8

---



ITEM 2:MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We are a leading provider of mission-critical messaging solutions that enable organizations to manage and secure online business communications and processes.
Our customers use our solutions to centrally control and monitor the corporate communications stream to comply with policies and government regulations, communicate securely with business partners,
suppliers and customers, and to integrate business communications and processes online. Tumbleweed software creates a foundation for automated legacy data extraction, preparation and secure
two-way communication of sensitive or confidential business information, such as electronic statements and customer service inquiries. Tumbleweed solutions integrate with existing systems
and end user behavior. Tumbleweed solutions are centrally controlled by IT managers while remaining transparent to end userswho do not need to deploy new software or behavior to comply
with corporate security and communications policies.

Tumbleweed's
revenue consists of (i) product revenue and (ii) services revenue. Product revenue consists of initial license fees, subscription fees, the sale of
distribution rights, and transaction revenue. License revenue typically is recognized upon the later of customer acceptance or software shipment. Subscription fees consist of contractually based
amounts paid to entitle customers to product use, support, maintenance, upgrades, and updates and are recognized over the life of the contract. Revenue from the sale of distribution rights is
recognized upon the execution of a distribution agreement. Transaction revenue is based on the volume of transactions by our customers, and the related revenue is recognized based on payment schedules
and transaction reports from our customers. A number of our contracts include minimum transaction volume requirements. In these cases, the minimum guaranteed revenue is recognized when fees are due
and payable during those months where transaction volume does not exceed the designated minimums. Services revenue consists of consulting fees and support and maintenance fees. Consulting fees related
to installation are recognized upon acceptance of the installation, and time and material billing while all other consulting fees are recognized based on percentage of completion. Support and
maintenance fees are paid for ongoing customer support and in some instances for the right to receive future upgrades of our products during the term of the maintenance agreement. Revenue from support
and maintenance is recognized ratably over the period the support is provided.

The
composition of the top 5 customers changes from quarter to quarter. For the three months ended March 31, 2001 and 2000, our top five customers contributed 21% and 30% of
total revenue, respectively.

A
substantial portion of Tumbleweed's revenue relates to international customers or operations. Most of Tumbleweed's contracts are denominated in U.S. dollars, except in Japan, where
they are denominated in Japanese yen. However, in the future, an increasing number of contracts may be denominated in foreign currencies. Tumbleweed currently does not have hedging or similar
arrangements to protect us against foreign currency fluctuations. Therefore, we increasingly may be subject to currency fluctuations, which could harm our operating results in future periods.

Tumbleweed's
future net income and cash flow may be adversely affected by limitations on its ability to apply net operating losses for federal income tax reporting purposes against
taxable income in future periods, including limitations due to ownership changes, as defined in Section 382 of the Internal Revenue Code, arising from issuances of its stock.

In
January 2001 our Board of Directors approved a restructuring program. This restructuring program focuses our efforts towards concentrating on our strongest opportunities,
reducing operating expenses, and improving our allocation of resources. The restructuring involved closing several international sales office locations, realigning our professional services
organization, and reducing

9

---

headcount in most areas of our business. The reduction in force involved approximately 100 employees and total charges incurred as a result of the restructuring were approximately $8.9 million
during the quarter, which includes severance and related charges associated with the reduction in force and charges related to vacating leased facilities domestically and abroad. This charge includes
a $5 million non-cash accrual for potential losses on sub-leased facilities primarily due to reduced sub-lease rental income expectations reflecting rapidly
declining office rent rates in and around Silicon Valley.

RESULTS OF OPERATIONS

Three Month Periods Ended March 31, 2001 and 2000

Revenue.Revenue is comprised of product and services revenue. Total revenue for the three months ended
March 31, 2001 decreased 39% to $4.0 million from $6.6 million for the same three months in 2000. The decrease in total revenue was expected due to the implementation of the
Company's subscription-based revenue model during the quarter.

Product
revenue for the three months ended March 31, 2001 decreased 67% to $1.7 million from $5.1 million for the same three months in 2000. The decrease in
product revenue was expected due to the implementation of the Company's subscription-based revenue model during the quarter.

Services
revenue for the three months ended March 31, 2001 increased 52% to $2.3 million from $1.5 million for the same three months in 2000. The increase in
services revenue was due to an increase in contract development work by our professional services organization, larger customer base, and, to a lesser extent, increases in maintenance fees.

Cost of Revenue.Cost of revenue is comprised of product license and services costs. Product license cost is primarily
comprised of royalties paid to third parties for software licensed by Tumbleweed for inclusion in our products and bandwidth costs associated with hosting servers for some customers. Services cost is
comprised primarily of personnel and overhead costs related to customer support and contract development projects. Total cost of revenue for the three months ended March 31, 2001 increased 37%
to $3.1 million from $2.2 million for the same three months in 2000. The increase in total cost of revenue was mainly due to an increase in service costs. Professional services costs
increased due to the constant growth that occurred throughout 2000 in our professional services team in order to support our expanding customer base and also as a result of the Interface acquisition
that occurred in September 2000.

Research and Development Expenses.Research and development expenses are comprised of engineering and related costs
associated with the development of Tumbleweed applications, quality assurance and testing. Research and development expenses for the three months ended March 31, 2001 increased 30% to
$3.7 million from $2.8 million for the same three months in 2000. The increase was primarily due to an increase in personnel needed to support ongoing development of Tumbleweed's
products and new applications for our target markets, increases in average salaries for development personnel in order to provide a competitive compensation and increased facilities related expenses.

Sales and Marketing Expenses.Sales and marketing expenses are comprised of salaries, commissions, travel expenses and
costs associated with trade shows, advertising and other marketing efforts. Sales and marketing expenses for the three months ended March 31, 2001 increased 29% to $9.3 million from
$7.2 million for the same three months in 2000. The increase in sales and marketing expenses was primarily due to increased sales staffing, an increase in the number of offices in Europe and
increased incentive compensation costs.

General and Administrative Expenses.General and administrative expenses consist primarily of personnel and support
costs for our finance, legal and human resources departments as well as professional fees. General and administrative expenses for the three months ended March 31, 2001

10

---

increased 37% to $2.2 million from $1.6 million for the same three months in 2000. The increase in general and administrative expenses was primarily due increased staffing expenses and
an increase in allowance for doubtful accounts resulting from the expected effects that current economic conditions will have on our customers.

Stock Compensation Expense.Stock compensation expense was recorded in connection with the amortization of deferred
stock compensation recorded as a result of grants of certain stock options to non-employees and employees at exercise prices less than the deemed fair value on the grant date, the
acceleration of stock options approved for certain employees, and warrants granted to non-employees in exchange for services performed, net of a credit related to stock options granted to
employees who were later terminated. The credit resulted from the deferred stock compensation expense previously recorded for options cancelled which had not vested. During the three months ended
March 31, 2001, we did not record any additional deferred stock compensation. Amortization of deferred stock compensation expense was $1.3 and $1.5 million in the three months ended
March 31, 2001 and 2000, respectively.

Merger Related and Restructuring Expenses.During the quarter, the Board of Directors approved a restructuring program.
This restructuring program focused the Company's efforts towards concentrating on its strongest opportunities, reducing operating expenses, and improving the Company's allocation of resources. This
involved closing international sales office locations in Paris, France; Chatsworth, Australia; Stockholm, Sweden; and Hong Kong. The restructuring program also realigned the professional services
organization, and included a targeted staff reduction of approximately 100 employees. Total charges incurred as a result of the restructuring were approximately $8.9 million for the three
months ended March 31, 2001 and included severance and related charges associated with the reduction in force and charges related to vacating leased facilities domestically and abroad.

Merger
related and restructuring expenses for the three months ended March 31, 2000 were recorded in connection with the acquisition of Worldtalk, and are primarily comprised
of investment banker's fees, legal fees, severance payments and accounting and printer fees. Merger related and restructuring expenses for the three months ended March 31, 2000 were
$10.8 million (including $411,000 in non-cash stock-compensation expense).

Goodwill Impairment.We performed an impairment assessment of the identifiable intangibles and goodwill recorded in
connection with the acquisition of Interface. The assessment was performed primarily due to changes in the economy, the overall decline in the industry growth rates, and the Company's lower actual and
projected operating results including that of the business acquired from Interface. This is supported by the significant sustained decline in the Company's stock price since the
valuation date of the shares issued in the Interface acquisition, which resulted in the Company's net book value of its assets prior to the impairment charge significantly exceeding the Company's
market capitalization. As a result of our review, we recorded a $51 million impairment charge to reduce goodwill and other intangible assets. The charge was determined based upon our estimated
discounted cash flows over the remaining estimated useful life of the goodwill using a discount rate of 15%. The assumptions supporting the cash flows including the discount rate were determined using
our best estimates as of March 31, 2001. The remaining goodwill balance of approximately $847,000 will be amortized over its remaining useful life. We will continue to assess the recoverability
of the remaining goodwill and intangibles periodically in accordance with our policy.

Other Income, Net.Other income, net, is primarily comprised of interest income earned on investment securities. Other
income, net, for the three months ended March 31, 2001 increased 42% to $931,000 from $656,000 for the same three months in 2000. The increase in other income, net, are due to increased cash
balances invested primarily in money market accounts. The increase in cash balances available for investment resulted from proceeds from the issuance of equity securities, mainly common stock issued
in our second public offering completed in August of 2000.

11

---

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the issuance of equity securities. On March 31, 2001, we had approximately
$58.0 million in cash and cash equivalents.

Net
cash used in operating activities for the three months ended March 31, 2001 was approximately $15.6 million. Cash used in operating activities was primarily the
result of net operating losses and a decrease in accrued liabilities, offset by non-cash charges for depreciation and amortization, the non-cash portion of the restructuring
accrual and the expense recognized for goodwill impairment.

Net
cash used in investing activities for the three months ended March 31, 2001 was approximately $1.5 million. Net cash used in investing activities was comprised of
purchases of property and equipment.

Net
cash used in financing activities for the three months ended March 31, 2001 was approximately $110,000. Cash used in financing activities was attributable to the repayments
of credit facilities and capital lease obligations, offset by the issuance of common stock upon exercise of stock options.

As
of March 31, 2001, our principal commitments consisted of obligations outstanding under equipment and operating leases. Our equipment leases require payment of rental fees
to third party leasing providers at interest rates of approximately 8.45%. In most cases, we have no obligations to purchase the equipment at the end of the lease term. We do not anticipate a
substantial increase in capital expenditures in the immediate future.

Our
capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and services, the resources devoted to the
development of our products and services and the resources devoted to sales and marketing. We have experienced a substantial increase in capital expenditures and operating expenses since inception
consistent with relocation and the growth in operations and staffing. However, we do not anticipate that these increases will continue for the foreseeable future. We believe that our existing capital
resources, including the proceeds from our second public offering, will enable us to maintain our current and planned operations for at least the next 12 months. However, we may need to raise
funds prior to that time.

We
will continue to consider future financing alternatives, which may include the incurrence of indebtedness, additional public or private equity offerings or an equity investment by
a strategic partner. However, we have no present commitments or arrangements assuring us of any future equity or debt financing, and additional equity or debt financing may not be available to us on
favorable terms, if at all.

We
expect to experience a seasonal reduction in sales in Europe during the summer months. In addition, many of our customers delay purchases of our products until the end of each
quarter.

Risks And Uncertainties That You Should Consider Before Investing In Tumbleweed.

Because we are in an early stage of development and have a history of losses, it is difficult to evaluate our business and we may face expenses, delays and difficulties.

We have only a limited operating history upon which an evaluation can be based. Accordingly, our prospects must be considered in light of the risks, expenses,
delays and difficulties frequently encountered by companies in a similarly early stage of development, particularly companies engaged in new and rapidly evolving markets like secure online
communication services. We incurred net losses of $69.8 million, $24.2 million and $11.7 million in the years ended December 31, 2000, 1999 and 1998, respectively. As of
March 31, 2001, we had incurred cumulative net losses as a C-corporation of

12

---

$217 million. See "Consolidated Statements of Operations" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."

We anticipate continued losses.

Our success may depend in large part upon our ability to generate sufficient revenue to achieve profitability and to effectively maintain existing
relationships and develop new relationships with customers and strategic partners. If we do not succeed, our revenue may not increase, and we may not achieve or maintain profitability on a timely
basis or at all. In particular, we intend to expend significant financial and management resources on product development, sales and marketing, strategic relationships, technology and operating
infrastructure. As a result, we expect to incur additional losses and continued negative cash flow from operations for the foreseeable future.

Our quarterly financial results are subject to significant fluctuations.

As a result of our transition from solely using a traditional software licensing model to using a subscription-based pricing model as well as the traditional
model, our limited operating history and the emerging nature of the markets in which we compete, we may not be able to accurately forecast our revenue or expenses. Our success is dependent upon our
ability to enter into and maintain strategic relationships with customers and to develop and maintain volume usage of our products by our customers and their end-users.

Our
revenue has fluctuated and our quarterly operating results will continue to fluctuate based on the timing of the execution and termination of customer agreements in a given
quarter. Under the licensing model, our license revenue was comprised of initial license and distribution fees. As a result, we typically recognized initial license fees as revenue in the same quarter
an agreement was signed. To the extent that customers purchase our product under the subscription-based pricing model, however, we will account for and report our contracted revenue over the life of
the agreement. During the initial adoption of subscription-based pricing, we expect a significant decrease in recognized revenue when compared to the prior year. The decrease may vary significantly
based on the number of subscription-based contracts signed.

Our
services revenue historically has been comprised largely of implementation, customization and consulting fees. Our ability to receive revenue from services is subject to multiple
risks, including the risk that we may not be able to meet increasing customer demand because of a lack of adequately trained personnel, and the risk that customers may not timely accept the services
provided and delay payment for such services.

Our
transaction revenue historically has been comprised of contractual transaction minimums. Our ability to increase our transaction revenue through increased transaction volume
depends on increased usage of our products by our customers and their end users. Unless and until we have developed a significant and recurring revenue stream our revenue will continue to fluctuate
significantly.

In
addition, we have experienced, and expect to continue to experience, fluctuations in revenue and operating results from quarter to quarter for other reasons, including, but not
limited to:



13

---



As
a result of these factors, particularly our transition to a subscription-based pricing model, we believe that quarter-to-quarter comparisons of our revenue
and operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. Quarterly financials for 2001 under the new subscription-based
pricing model will not be comparable with historical quarters under the our previous licensing model. Because our staffing and operating expenses are based on anticipated revenue levels, and because a
high percentage of our costs are fixed, small variations in the timing of the recognition of specific revenue could cause significant variations in operating results from quarter to quarter. In
addition, many of our customers delay purchases of our products until the end of each quarter. If we are unable to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall, any significant revenue shortfall would likely have an immediate negative effect on our operating results. Moreover, we believe the difficulties outlined above with respect to financial
forecasts also apply to securities analysts that may publish estimates of our financial results. Our operating results in one or more future quarters may fail to meet the expectations of securities
analysts or investors due to any of a wide variety of factors, including fluctuations in financial ratios or
other metrics used to measure our performance. If this occurs, we would expect to experience an immediate and significant decline in the trading price of our stock.

Our restructuring of operations may not achieve the results we intend and may harm our business.

In January 2001, we announced a restructuring of our business, which included a reduction in force and the closure of four international locations, as
well as other steps we took to reduce expenses. The planning and implementation of our restructuring has placed, and may continue to place, a significant strain on our managerial, operational,
financial and other resources. Additionally, the restructuring may negatively affect our employee turnover, recruiting and retention of important employees. If we are unable to implement our
restructuring effectively or if we experience difficulties in effecting the restructuring, our expenses could increase more quickly than we expect. If we find that our restructuring announced in
January did not sufficiently decrease the growth of our expenses, we may find it necessary to implement further streamlining of our expenses, to perform another reduction in our headcount or to
undertake a restructuring of our business.

A limited number of customers account for a high percentage of our revenue and the failure to maintain or expand these relationships could harm our business.

The loss of one or more of our major customers, the failure to attract new customers on a timely basis, or a reduction in usage and revenue associated with the
existing or proposed customers would harm our business and prospects. Five customers comprised approximately 21% of our revenue for the three months ended March 31, 2001, and approximately 30%
of our revenue for the three months ended March 31, 2000. We expect that a small number of customers will continue to account for a majority of our revenue for the foreseeable future.

Our service provider customers may compete with us or fail to promote our product.

To date, we have generated a significant amount of Tumbleweed IME revenue from contracts with a limited number of service provider customers, which use or
intend to use our products for the communication of third-party documents and data. If these customers do not effectively promote the use of Tumbleweed IME to their end-users, the adoption
of our services and the recognition of associated revenue could be limited. Because our contracts with our service provider customers are non-exclusive, these customers could elect to
offer competing secure online communication services to their customers through our existing or future competitors. The service provider customers also may compete with our secure online communication
services through their traditional physical delivery channels.

14

---

If we do not secure key relationships with enterprise customers, our access to broader markets will be limited.

Our enterprise customers, which use or intend to use our products to intelligently manage the incoming and outgoing online communications of their enterprises,
are a significant source of our revenue. A key aspect of our strategy is to access target markets prior to adoption of alternative online distribution solutions by the larger participants in these
markets. The failure to secure key relationships with new enterprise customers in targeted markets could limit or effectively preclude our entry into these target markets, which would harm our
business and prospects.

Customers in a preliminary phase of implementing our product may not proceed on a timely basis or at all.

Some of our customers are currently in a pre-production or pre-launch stage of implementing our products and may encounter delays or
other problems in introducing them. A customer's decision not to do so or a delay in implementation could result in a delay or loss in related revenue or otherwise harm our businesses and prospects.
We cannot predict when any customer that is currently in a pilot or preliminary phase will implement broader use of our services.

The markets for enhanced online communication services generally, and for our products specifically, are new and may not develop.

The market for our products and services is new and evolving rapidly. If the market for our products and services fails to develop and grow, or if our products
and services do not gain broad market acceptance, our business and prospects will be harmed. In particular, our success will depend upon the adoption and use by current and potential customers and
their end-users of secure online communication services. Our success will also depend upon acceptance of our technology as the standard for providing these services. The adoption and use
of our products and services will involve changes in the manner in which businesses have traditionally exchanged information. In addition, sales and marketing of our products and services is to a
large extent under the control of our customers. In some cases, our customers have little experience with products, services and technology like those offered by us. Our ability to influence usage of
our products and services by customers and end-users is limited. For example, the usage of Tumbleweed IME by the end-users of our service provider customers has been limited to
date. We have spent, and intend to continue to spend, considerable resources educating potential customers and their end-users about the value of our products and services. It is difficult
to assess, or to predict with any assurance, the present and future size of the potential market for our products and services, or our growth rate, if any. Moreover, we cannot predict whether our
products and services will achieve any market acceptance. Our ability to achieve our goals also depends upon rapid market acceptance of future enhancements of our products and our ability to identify
new markets as they emerge. Any enhancement that is not favorably received by customers and end-users
may not be profitable and, furthermore, could damage our reputation or brand name. Any failure to identify and address new market opportunities could harm our business and prospects.

The markets we address are highly competitive and rapidly changing, and we may not be able to compete successfully.

We may not be able to compete successfully against current and future competitors, and the multiple competitive pressures we face could harm our business and
prospects. The markets in which we compete are intensely competitive and rapidly changing.

Our
principal competition in the areas of messaging management and secure communications are companies that offer of various Internet content security, web security, messaging policy
management, and enterprise relationship management products. Companies that sell products that compete with

15

---

some of the features within our products include: Baltimore Technologies plc, Critical Path, Inc., Kana Communications, Inc., Symantec Corp., Tivoli Systems, Inc., an IBM company,
Trend Micro Incorporated, ValiCert Inc., and Zixit Corporation.

Our
principal competition in the statement presentment market area comes from other online communication or information security service providers, some of which have services or
products that are intended to compete directly with our products or that could be used as alternatives to our products. Examples of some of these providers are Automatic Data Processing, Inc.,
Critical Path, Inc., New River Systems, PostX Corporation and Vestcom Corporation. Our solution statement presentment and secure delivery solutions can be an alternative to traditional mail and
courier delivery services such as those offered by Federal Express Corporation, UPS, or the U.S. Postal Service, and to general purpose e-mail applications and services. In addition,
companies with which we do not presently directly compete may become competitors in the future, either through the expansion of our products or through their product development in the area of secure
online communication services. These companies include International Business Machines Corporation/Lotus Development Corporation, Microsoft Corporation and VeriSign, Inc.

The
principal competitive factors in our industry include price, product functionality, product integration, platform coverage and ability to scale, worldwide sales infrastructure and
global technical support. Some of our competitors have greater financial, technical, sales, marketing and other resources than we do, as well as greater name recognition and a larger installed
customer base. Additionally, some of these competitors have research and development capabilities that may allow them to develop new or improved products that may compete with product lines we market
and distribute. We expect that the market for mission-critical messaging software, which has been fragmented historically, will become more consolidated with larger companies being better positioned
to compete in such an
environment in the long term. As this market continues to develop, a number of companies with greater resources than ours could attempt to increase their presence in this market by acquiring or
forming strategic alliances with our competitors or business partners. Our success will depend on our ability to adapt to these competing forces, to develop more advanced products more rapidly and
less expensively than our competitors, and to educate potential customers as to the benefits of licensing our products rather than developing their own products. Competitors could introduce products
with superior features, scalability and functionality at lower prices than our products and could also bundle existing or new products with other more established products in order to compete with us.
In addition, because there are relatively low barriers to entry for the software market, we expect additional competition from other established and emerging companies. Increased competition is likely
to result in price reductions, reduced gross margins and loss of market share, any of which could harm our business.

We face technical, operational and strategic challenges that may prevent us from successfully integrating companies we may acquire.

The integration of the Worldtalk Communications Corporation business and the Interface Systems, Inc. business, including the technology, operations and
personnel of each of them, has been and will continue to be a complex, time consuming and expensive process that may disrupt our business if not completed in a timely and efficient manner.
Additionally, the integration of any other company or business we may acquire in the future will be a complex, time consuming and expensive process that may disrupt our business if not completed in a
timely and efficient manner. Whenever an acquisition is completed, we must operate as a combined organization utilizing common information and communication systems, operating procedures, financial
controls and human resources practices. We may encounter substantial difficulties, costs and delays involved in integrating the operations of any company we acquire, including:



16

---



As
a result, we may not be successful in integrating any business or technologies we acquire and may not achieve anticipated revenue and cost benefits. We also cannot guarantee that
acquisitions will result in sufficient revenues or earnings to justify our investment in, or expenses related to, such acquisitions. Nor can we guarantee that any anticipated synergies will develop.
If we fail to execute our acquisition strategy successfully for any reason, our business will suffer significantly.

Our product development efforts may be hindered by a variety of factors.

Our new product releases may not be timely, scalable, or successful enough to meet customers' requirements. In addition, we also face certain risks associated
with the ongoing integration of the Worldtalk technology and Interface technology with our other technology. For example, because Worldtalk has historically based its products on an NT platform and we
have created a platform-independent architecture for the Tumbleweed IME products, the integration of products from Worldtalk may result in unanticipated architectural incompatibilities that would
require additional time and engineering resources to resolve. The loss of key engineering personnel from Worldtalk, Interface or any other entities we may acquire may increase the time and resources
needed to resolve these and other technical integration issues. Our headquarters and the offices of the companies we have acquired are in different locations, which may create coordination issues and
could increase employee turnover. In addition, the installation of integrated or complementary software products at customer sites may result in difficulties associated with customer-specific
installation processes.

The expansion of our business has placed a strain on resources.

Our business has expanded considerably during 2000, which has placed, and continues to place, a significant strain on managerial, informational, administrative
and operational resources. Our current systems, procedures and controls may not be adequate to achieve the rapid execution necessary to effectively operate within the market for our products and
services. We need to enhance and improve our managerial capacity, and improve or replace our existing operational, customer service and financial systems, procedures and controls. Any failure to
properly manage these systems and procedural transitions could impair our ability to attract and service customers, and could cause us to incur higher operating costs and delays in the execution of
our business plan. We will also need to continue the expansion of our employee base. Our management may not be able to hire, train, retain, motivate and manage required personnel. In addition, our
management may not be able to successfully identify, manage and exploit existing and potential market opportunities. If we cannot manage growth effectively, our business and operating results could
suffer.

We have a lengthy sales and implementation cycle which could harm our business.

If we are unable to license our services to new customers on a timely basis or if our existing and proposed customers and their end-users suffer
delays in the implementation and adoption of our services, our revenue may be limited and business and prospects may be harmed. Our customers must evaluate our technology and integrate our products
and services into the products and services they provide. In addition, our customers may need to adopt a comprehensive sales, marketing and training program in order to effectively implement
Tumbleweed IME. Finally, we must coordinate with our

17

---

customers using our product for third-party communications in order to assist end-users in the adoption of our products. For these and other reasons, the cycle associated with establishing
licenses and implementing our products can be lengthy. This cycle is also subject to a number of significant delays over which we have little or no control. Forecasts about license revenue may be
inaccurate as a result of any or all of these factors, and inaccurate forecasts may cause our business, or market valuation, to suffer.

A failure to protect our intellectual property may significantly harm the business.

We currently rely on a combination of patents, trade secrets, copyrights, trademarks and licenses, together with non-disclosure and confidentiality
agreements to establish and protect our proprietary rights in our products. We hold certain patent rights with respect to some of our products and currently have a lawsuit pending against The docSpace
Company, Inc. alleging infringement of one of our patents by docSpace. We have filed, and expect in the future to file, additional patent applications. Our existing patents or trademarks, as
well as any future patents or trademarks obtained by us, may be challenged, invalidated or circumvented, or our competitors may independently develop or patent technologies that are substantially
equivalent or superior to our technology. Further patent or trademark protection may not be obtained, in the United States or elsewhere, for our existing or new products, applications or services. In
addition, further protection, if obtained, may not be effective. In some countries, meaningful patent or trademark protection is not available.

To
date, we have not received any claims of infringement upon the proprietary rights of third parties. However, third parties could assert infringement claims against us in the
future, and the cost of responding to such assertions, regardless of their validity, could be significant. In addition, such claims may be found to be valid and could result in awards against us,
which could harm our business.

We
also rely, to some extent, on unpatented trade secrets and other unpatented proprietary information. Our policy is to have employees sign confidentiality agreements, to have
selected parties sign non-competition agreements and to have third parties sign non-disclosure agreements. Although we
take precautionary measures to maintain our unpatented proprietary information, others may acquire equivalent information or otherwise gain access to or disclose our proprietary information and we may
be unable to meaningfully protect our rights to our proprietary information.

Profitable expansion in international markets may be difficult.

We invested significant financial and managerial resources to expand our sales and marketing operations in international markets and have opened sales offices
in Germany, the United Kingdom, Japan and the Netherlands. For the three months ended March 31, 2001 and March 31, 2000, we derived 37% and 34%, respectively, of our revenue from
international operations. However, to date, we have limited experience in international operations and may not be able to compete effectively in international markets. A key component of our
long-term strategy is to further expand into international markets, and we must continue to devote substantial resources to our international operations in order to succeed in these
markets. In this regard, we may encounter difficulties such as:



18

---



In
addition, our expansion into international markets will increasingly subject us to fluctuations in currency exchange rates. In the future, an increasing number of our contracts may
be denominated in currencies other than U.S. dollars. We do not presently engage in hedging or similar transactions to protect us from currency fluctuations. Any of the foregoing difficulties of
conducting business internationally could harm our international operations and, consequently, our business and prospects.

If we do not provide adequate support services to our customers to implement our products, our business may suffer.

Our professional services organization assists our customers in implementing our products through software installation, integration with existing customer
systems, contract engineering, consulting and training. If the professional services organization does not adequately assess customer requirements or address technical problems, customers may seek to
discontinue their relationships with us due to dissatisfaction with the product or our customer support. Furthermore, these customers may realize lower usage than they could have otherwise achieved
because they did not fully capitalize on the product in ways that could have been addressed by our professional services organization. Our products must be integrated with existing hardware and
complex software products of our customers or other third parties, and our customers may not have significant experience with the implementation of products similar to our own. In addition, the
provision of contract engineering and integration services is an increasingly important aspect of our strategy to strengthen customer loyalty to our product and company. Therefore, our business and
future prospects significantly depend on the strength of our professional services organization and our ability to leverage this organization by augmenting our reach through trained and qualified
systems integrators.

Product performance problems, system failures, and internet problems could severely damage our business.

The ability of our customers to use Tumbleweed-based services depends on stable product performance, and the efficient and uninterrupted operation of the
computer and communications hardware as well as the software and Internet network systems that they maintain. Although our ability to manage the effects of system failures which occur in computer
hardware, software and network systems is limited, the occurrences of these failures could harm our reputation, business and prospects. The Internet has experienced a variety of outages and other
delays as a result of damage to portions of our infrastructure, and the Internet could face similar outages and delays in the future. In addition, an increasing number of our customers require us to
provide computer and communications hardware, software and Internet networking systems to them as an outsourced data center service. All data centers, whether hosted by us, our customers or by an
independent third party to which it outsources this function, are vulnerable to damage or interruption from fire, flood, earthquake, power loss, telecommunications failure or other similar events.

19

---

If our software contains errors, we may lose customers or experience reduced market acceptance of our products.

Our software products are inherently complex and may contain defects and errors that are detected only when the products are in use. In addition, some of our
customers require or may require enhanced customization of our software for their specific needs, and these modifications may increase the likelihood of undetected defects or errors. Further, we often
render implementation, consulting and other technical services, the performance of which typically involves working with sophisticated software, computing and networking systems, and we could fail to
meet customer expectations as a result of any defects or errors. As a result, we may lose customers, customers may fail to implement our products more broadly within their organization and we may
experience reduced market acceptance of our products. Some of our products are designed to facilitate the secure transmission of sensitive business information to specified parties outside the
business over the Internet. As a result, the reputation of our software products for providing good security is vital to their acceptance by customers. Our products may be vulnerable to
break-ins, theft or other improper activity that could jeopardize the security of information for which we are responsible. Problems caused by product defects, failure to meet project
milestones for services or security breaches could result in loss of or delay in revenue, loss of market share, failure to achieve market acceptance, diversion of research and development resources,
harm to our reputation, or increased insurance, service and warranty costs. To address these problems, we may need to expend significant capital resources that may not have been budgeted.

We may be unable to recruit, retain and motivate qualified personnel, which could harm our business, including product development.

We must continue to identify, recruit, hire, train, retain and motivate highly skilled technical, managerial, sales, marketing and customer service personnel.
Competition for these personnel is intense, and we may not be able to successfully recruit, assimilate or retain sufficiently qualified personnel. In particular, we may encounter difficulties in
recruiting a sufficient number of qualified software developers and sales personnel, and we may not be able to retain these employees. The failure to recruit and retain necessary technical,
managerial, sales, merchandising, marketing and customer service personnel could harm our business and our ability to obtain new customers and develop new products. Although we have used and continue
to use stock options as a retention tool, many of our employees hold stock options that are "underwater" (i.e., the market price of our stock is below their option exercise price) and these options
may be ineffective as a retention tool. Our employee turnover may increase if outstanding stock options continue to remain underwater and we do not adjust the option exercise prices. Any adjustment of
stock option exercise prices may result in dilution to our stockholders and depress our stock price.

If we lose the services of executive officers or other key employees, our ability to develop our business and secure customer relationships will suffer.

We are substantially dependent on the continued services and performance of our executive officers and other key personnel. The loss of the services of any of
our executive officers or other key employees could significantly delay or prevent the achievement of our development and strategic objectives. We do not have long-term employment
agreements with any of our key personnel. The loss of services of any of our executive officers or other key personnel could significantly harm our business and prospects.

20

---

Our efforts to establish, maintain and strengthen our brands will require significant expenditures and may not be successful.

If the marketplace does not associate our brands with high quality Internet communication services, it may be more difficult for us to attract new customers or
introduce future products and services. The market for our services is new. Therefore, our failure to establish brand recognition at this stage could harm our ability to compete in the future with
other companies that successfully establish a brand name for their services. We must succeed in our marketing efforts, provide high quality services and increase our user base in order to build our
brand awareness and differentiate our products from those of our competitors. These efforts have required significant expenditures to date. Moreover, we believe that these efforts will require
substantial commitments of resources in the future as our brands become increasingly important to our overall strategy and as the market for our services grows.

Because our products utilize the Internet, if use of the Internet does not increase, the level of use of our products will suffer.

If the Internet and other products and services necessary for the utilization of our products are not sufficiently developed, fewer customers and
end-users will use our products and our business will be harmed. In particular, the success of our products and services will depend on the development and maintenance of adequate Internet
infrastructure, such as a reliable network backbone with the necessary speed, data capacity and other features demanded by users. Moreover, our success will also depend on the timely development of
complementary products or services such as high-speed Internet connections for providing reliable access and services and this may not occur. Because the online exchange of information is
new and evolving, the Internet may not prove to be a viable platform for secure online communication services in the long term. The Internet has experienced, and is expected to continue to experience,
significant growth in the numbers of users and amount of traffic. As the Internet continues to experience increased numbers of users and frequency of use, or if its users require increasingly more
resources, the Internet infrastructure may not be able to support the
demands placed on it. As a result, the performance or reliability of the Internet may be harmed. This in turn could decrease the level of Internet usage and also the level of utilization of our
products and services.

Government regulation relating to the Internet may increase costs of doing business or require changes in our business model.

We are subject to regulations applicable to businesses generally and laws or regulations directly applicable to companies utilizing the Internet. Although
there are currently few specific laws and regulations directly applicable to the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet. These laws
could cover issues like user privacy, pricing, content, intellectual property, distribution, taxation, antitrust, legal liability and characteristics and quality of products and services. The adoption
of any additional laws or regulations could decrease the demand for our products and services and increase our cost of doing business or otherwise harm our business or prospects. Delays in the
enactment of expected regulations may result in delayed software purchasing by our customers who are subject to such regulations, which in turn may harm our business.

Moreover,
the applicability to the Internet of existing laws in various jurisdictions governing issues like property ownership, sales and other taxes, libel and personal privacy is
uncertain and may take years to resolve. For example, tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in online commerce. New state tax
regulations may subject us to additional state sales and income taxes. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply
to our business, or the

21

---

application of existing laws and regulations to the Internet and commercial online services could harm our ability to conduct business and harm operating results.

Our products are subject to export controls, and we may be unable to obtain necessary export approvals.

Exports of software products utilizing encryption technology are generally restricted by the U.S. and various foreign governments. All cryptographic products
require export licenses from certain U.S. government agencies. We have obtained approval to export products using up to 128-bit symmetric encryption and 1024-bit public key
encryption, including IME Server, IME Desktop, IME Receive Applet, IME Remote API using OmniORB with SSL, MMS WorldWide/56 and MMS Strong WorldWide/128. We are not exporting other products and
services that are subject to export control under U.S. law. However, the list of products and countries for which export approval is required, and the related regulatory policies, could be revised,
and we may not be able to obtain necessary approval for the export of future products. The inability to obtain required approvals under these regulations
could limit our ability to make international sales. Furthermore, competitors may also seek to obtain approvals to export products that could increase the amount of competition we face. Additionally,
countries outside of the U.S. could impose regulatory restrictions impairing our ability to import our products into those countries.

Costs of communicating via the Internet could increase if access fees are imposed.

Certain local telephone carriers have asserted that the increasing popularity and use of the Internet has burdened the existing telecommunications
infrastructure, and that many areas with high Internet use have begun to experience interruptions in telephone service. These carriers have petitioned the Federal Communications Commission to impose
access fees on Internet service providers and online service providers. If these access fees are imposed, the costs of communicating on the Internet could increase substantially, potentially slowing
the increasing use of the Internet. This could in turn decrease demand for our services or increase the costs of doing business.

We may have liability for Internet content.

As a provider of Internet communication products and services, we face potential liability for defamation, negligence, copyright, patent or trademark
infringement and other claims based on the nature and content of the materials transmitted online. Any imposition of liability, particularly liability that is not covered by insurance or is in excess
of insurance coverage, could be costly and could require us to implement measures to reduce exposure to this liability. This may require us to expend substantial resources or to discontinue selected
service or product offerings.

We
do not and cannot screen all of the content generated by users of our product but may be exposed to liability with respect to this content. Furthermore, certain foreign
governments, such as Germany, have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the U.S. Other countries, such
as China, regulate or prohibit the transport of telephonic data in their territories. Failure to comply with regulations in a particular jurisdiction could result in fines or criminal penalties or the
termination of service in one or more jurisdictions. Moreover, the increased attention focused on liability issues as a result of lawsuits and legislative proposals could impact the growth of Internet
use. Liability insurance may not cover claims of these types, or may not be adequate to indemnify against all liability that may be imposed.

22

---

Interface Systems, Inc., a Tumbleweed subsidiary, is a defendant in several purported securities class action lawsuits.

On July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface and
various additional defendants, including Interface's President and Chief Executive Officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the
Southern District of New York. The three cases contain substantially similar allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock
price. The complaints seek relief under the federal securities laws on behalf of purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of
action. On September 27, 2000, we filed (i) a motion to strike or dismiss for failure to meet the certification requirements of the Private Securities Litigation Reform Act,
(ii) a motion to dismiss for failure to state a claim, and (iii) a motion to dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern
District of Michigan. The Court has scheduled a hearing on these motions, to occur on May 25, 2001.

Although
we believe these lawsuits are without merit, no assurance can be given about their outcome, and an adverse outcome could significantly harm our business and operating
results. Moreover, the costs in defending these complaints could harm future operating results.

We may be unable to find sub-tenants to sublease currently leased and vacant space.

In September 2000, we entered into a lease covering 42,000 square feet of office space adjacent to our headquarters. This lease is for five years at a
monthly rent of approximately $286,000. Although we currently sublease this space, this sublease is scheduled to expire with respect to half of the space in September 2001 and with respect to
the other half in April 2002. We are currently searching for a new tenant to sublease this space. Potential losses from the result of this lease have been accrued for in the restructuring
accrual expensed during the quarter ended March 31, 2001. We also sublease an additional 15,000 square feet in Santa Clara, California and 10,000 in New York City to third parties. We may not
be able to find suitable sub-tenants to occupy these spaces in the future in a timely manner, if at all, or otherwise sublease these properties profitably. If we are unable to find
suitable sub-tenants, we may experience greater than anticipated operating expenses in the future.

Internet related stock prices are especially volatile and this volatility may depress our stock price.

The stock market has experienced significant price and volume fluctuations and the market prices of securities of technology companies, particularly
Internet-related companies, have been highly volatile. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been
instituted against companies. The institution of this type of litigation against us could result in substantial costs and a diversion of our management's attention and resources, which could harm our
business and prospects.

Our certificate of incorporation and bylaws contain provisions that could discourage or prevent an acquisition of Tumbleweed, which could depress our stock price.

Our certificate of incorporation and bylaws may inhibit changes of control that are not approved by our board of directors. These provisions could limit the
price that investors might be willing to pay in the future for shares of our common stock. In particular, our certificate of incorporation provides for a classified board of directors and prohibits
stockholder action by written consent. These provisions require advance notice for nomination of directors and stockholders' proposals. In addition, as a Delaware corporation, we are subject to
Section 203 of the Delaware General Corporation Law. In general, this law prevents a person who becomes the owner of 15% or more of the corporation's outstanding voting stock from engaging in
specified business combinations for three years unless

23

---

specified conditions are satisfied. In addition, our certificate of incorporation allows our board of directors to issue preferred stock without further stockholder approval. This could have the
effect of delaying, deferring or preventing a change in control. The issuance of preferred stock also could effectively limit the voting power of the holders of Tumbleweed common stock. The provisions
of our certificate of incorporation and bylaws, as well as provisions of Delaware law, may discourage or prevent an acquisition or disposition of our business.

Future sales of common stock by our stockholders could depress our stock price.

We cannot predict if future sales of our common stock, or the availability of our common stock for sale, will depress the market price for our common stock or
our ability to raise capital by offering equity securities. Sales of substantial amounts of common stock, or the perception that these sales could occur, may depress prevailing market prices for the
common stock.

ITEM 3:QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Tumbleweed transacts business in various foreign currencies. Accordingly, Tumbleweed is subject to exposure from adverse movements in foreign currency exchange
rates. This exposure is primarily related to revenue and operating expenses denominated in each subsidiary's respective local currency. To date, Tumbleweed has not entered into any derivative
financial instruments or hedging activities.

Tumbleweed
currently does not use financial instruments to hedge operating expenses in the United Kingdom or Japan dominated in the respective local currency. Tumbleweed assesses the
need to utilize financial instruments to hedge currency exposures on an ongoing basis.

Tumbleweed
does not use derivative financial instruments for speculative trading purposes, nor does Tumbleweed hedge its foreign currency exposure in a manner that entirely offsets
the effects of changes in foreign exchange rates. Tumbleweed regularly reviews its hedging program and may as part of this review determine at any time to change its hedging program.



The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal
amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed rate equal to the then-prevailing interest rate and the prevailing interest rate
later rises, the fair value of our investment will decline. To minimize this risk, we maintain our portfolio of cash equivalents in commercial paper and money market funds. In general, money market
funds are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. As of March 31, 2001, none of our cash equivalents were subject to
market risk by range of expected maturity and weighted-average interest rates, not including money market funds because these funds are not subject to market risk.

24

---



PART IIOTHER INFORMATION

ITEM 1:LEGAL PROCEEDINGS

On March 3, 1999, we sued The docSpace Company, Inc. in the United States District Court for the Northern District of California alleging
infringement of our U.S. Patent No. 5,790,790. In its answer, docSpace raised counterclaims alleging, among other things, antitrust violations and unfair competition. On March 9, 2000,
Critical Path, Inc. acquired docSpace. On March 9, 2001 the court issued an order that (i) granted in part and denied in part our motion for summary judgment of literal
infringement, and (ii) granted in part docSpace's motion for summary judgment of no infringement. Essentially, the court ruled that the docSpace products Express 4.0 and Express 5.0 violate our
patent at issue and that Express 5.1 and later versions, all designed after the lawsuit was initiated, do not literally infringe that patent. The order does not address U.S. Patent
No. 6,192,407 which was issued to us on February 20, 2001. We believe all versions of the docSpace Express product violate our U.S. Patent No. 6,192,407. On April 10, 2001,
the Court denied a motion filed by docSpace for reconsideration of the order dated March 9, 2001.

On
July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface and various additional defendants,
including Interface's President and Chief Executive Officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the Southern District of New York.
The three cases contain substantially similar allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock price. The complaints seek
relief under the federal securities laws on behalf of purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of action. On
September 27, 2000, we filed (i) a motion to strike or dismiss for failure to meet the certification requirements of the Private Securities Litigation Reform Act, (ii) a motion to
dismiss for failure to state a claim, and (iii) a motion to dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern District of Michigan. The
Court has scheduled a hearing on these motions, to occur on May 25, 2001. We intend vigorously to defend the Interface lawsuits and seek their dismissal. Although we believe these actions to be
without merit, no prediction of the ultimate outcome can be made at this time and the outcome may harm our business. In addition, the costs in defending these complaints could harm future operating
results.

ITEM 2:CHANGES IN SECURITIES AND USE OF PROCEEDS

On August 1, 2000, Tumbleweed completed a primary and secondary public offering of 3,000,000 shares of its common stock at a price of $56.00 per share.
Of the 3,000,000 shares of common stock, 1,500,000 primary shares were sold by Tumbleweed and 1,500,000 secondary shares were sold by stockholders of Tumbleweed. Tumbleweed will not receive any of the
proceeds from shares sold by its stockholders. The company received net proceeds of $77.6 million from the offering of primary shares. For the quarter ended March 31, 2001, the net
capital was used for working capital and general corporate purposes. Remaining proceeds were predominantly held in cash and cash equivalents.

ITEM 6.EXHIBITS

None

25

---



SIGNATURES

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,
hereunto duly authorized:

|                   |  | TUMBLEWEED COMMUNICATIONS CORP.
|------------------ |  | -------------------------------
|Date: May 15, 2001 |  | By:                            
|Date: May 15, 2001 |  | By:                            

26

---

QuickLinks