---

---

SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

---

Form 10-Q

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

For the quarterly period ended September 30, 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 October 31, 2001 was 30,337,598.

---

---

---



SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

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 our business strategy and new pricing models; attracting and retaining customers; obtaining and expanding
market acceptance of the products and services we offer; forecasts of Internet usage and the size and growth of relevant markets; rapid technological changes in our industry and relevant markets; and
competition in our 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. We disclaim any obligation to update these statements for subsequent events, or to explain why actual results differ. We reserve 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 our prospects and
future financial performance.

2

---



TUMBLEWEED COMMUNICATIONS CORP.

INDEX

|           |  |                                                                                                                                           |  | Page
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|Part I    
|Item 1     |  | Financial Statements                                                                                                                      |  | 4   
|           |  | Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000                                          |  | 4   
|           |  | Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2001 and September 30, 2000 (unaudited) |  | 5   
|           |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 (unaudited)                         |  | 6   
|           |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                          |  | 7   
|Item 2     |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                                                     |  | 11  
|Item 3     |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                |  | 26  
|Part II   
|Item 1     |  | Legal Proceedings                                                                                                                         |  | 28  
|Item 2     |  | Changes in Securities and Use of Proceeds                                                                                                 |  | 28  
|Signatures |  | 29                                                                                                                                       

TRADEMARKS

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.

3

---



PART IFINANCIAL INFORMATION

ITEM 1.FINANCIAL STATEMENTS

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

|                                     |                                                | September 30, 2001                         |       | December 31, 2000 |       
|------------------------------------ | ---------------------------------------------- | ------------------------------------------ | ----- | ----------------- | ------
|
|Assets                               |                                               
|Current Assets:                      |                                                |                                            |       |                   |       
|                                     | Cash and cash equivialents                     |                                            | $     | 42,853            |       
|                                     | Accounts receivable, net                       |                                            |       | 8,757             |       
|                                     | Prepaid expenses and other current assets      |                                            |       | 2,995             |       
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total current assets                       |       |                   | 54,605
|Property and equipment, net          |                                                |                                            | 9,798 |                   |       
|Goodwill and intangible assets, net  |                                                |                                            | 7,835 |                   |       
|Other assets                         |                                                |                                            | 4,917 |                   |       
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total assets                               |       | $                 | 77,155
|                                     |                                                |                                            |       |                   |       
|Liabilities and Stockholders' Equity |                                               
|Current liabilities:                 |                                                |                                            |       |                   |       
|                                     | Accounts payable                               |                                            | $     | 3,658             |       
|                                     | Current installments of long-term debt         |                                            |       | 391               |       
|                                     | Accrued liabilities                            |                                            |       | 9,820             |       
|                                     | Accrued restructuring                          |                                            |       | 5,491             |       
|                                     | Deferred revenue                               |                                            |       | 7,430             |       
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total current liabilities                  |       |                   | 26,790
|                                     | Long-term debt, excluding current installments |                                            |       | 96                |       
|                                     | Other long-term liabilities                    |                                            |       | 844               |       
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total liabilities                          |       |                   | 27,730
|Stockholders' equity:                |                                                |                                            |       |                   |       
|                                     | Common stock                                   |                                            |       | 30                |       
|                                     | Additional paid-in capital                     |                                            |       | 294,371           |       
|                                     | Deferred compensation expense                  |                                            |       | (2,355            | )     
|                                     | Accumulated other comprehensive loss           |                                            |       | (393              | )     
|                                     | Accumulated deficit                            |                                            |       | (242,228          | )     
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total stockholders' equity                 |       |                   | 49,425
|                                     |                                                |                                            |       |                   |       
|                                     |                                                | Total liabilities and stockholders' equity |       | $                 | 77,155
|                                     |                                                |                                            |       |                   |       

See
Notes to Condensed Consolidated Financial Statements

4

---



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

|                                                |                                                          | Three Months
Ended September 30, |         | Nine Months
Ended September 30, |        
|----------------------------------------------- | -------------------------------------------------------- | -------------------------------- | ------- | ------------------------------- | -------
|
|Revenue                                         |                                                          |                                  |         |                                 |        
|                                                | Product                                                  |                                  | $       | 4,958                           |        
|                                                | Service                                                  |                                  |         | 3,197                           |        
|                                                |                                                          |                                  |         |                                 |        
|                                                |                                                          | Total revenue                    |         |                                 | 8,155  
|Cost of revenue(1)                              |                                                          |                                  | 3,013   |                                 |        
|                                                |                                                          |                                  |         |                                 |        
|Gross profit                                    |                                                          |                                  | 5,142   |                                 |        
|Operating expenses:                             |                                                          |                                  |         |                                 |        
|                                                | Research and development(2)                              |                                  |         | 3,615                           |        
|                                                | Sales and marketing(3)                                   |                                  |         | 8,472                           |        
|                                                | General and administrative(4)                            |                                  |         | 2,286                           |        
|                                                | Stock-based compensation                                 |                                  |         | 618                             |        
|                                                | Amortization of goodwill and intangible assets           |                                  |         | 1,485                           |        
|                                                | Merger related, restructuring, and impairment charges(5) |                                  |         |                                |        
|                                                |                                                          |                                  |         |                                 |        
|                                                |                                                          | Total operating expenses         |         |                                 | 16,476 
|                                                |                                                          | Operating loss                   |         |                                 | (11,334
|Other income, net                               |                                                          |                                  | 439     |                                 |        
|                                                |                                                          |                                  |         |                                 |        
|Net loss before provision for taxes             |                                                          |                                  | (10,895 | )                               |        
|                                                | Provision for taxes                                      |                                  |         | (4                              | )      
|                                                | Net loss                                                 |                                  |         | (10,891                         | )      
|Other comprehensive losstranslation adjustment |                                                          |                                  | 133     |                                 |        
|                                                |                                                          |                                  |         |                                 |        
|                                                | Comprehensive loss                                       |                                  | $       | (10,758                         | )      
|                                                |                                                          |                                  |         |                                 |        
|Net loss per sharebasic and diluted            |                                                          | $                                | (0.36   | )                               | $      
|                                                |                                                          |                                  |         |                                 |        
|Weighted average sharesbasic and diluted       |                                                          |                                  | 30,296  |                                 |        
|                                                |                                                          |                                  |         |                                 |        

---

See Notes to Condensed Consolidated Financial Statements

5

---



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

|                                                     |                                                     | Nine months ended
September 30,                           |                                          
|---------------------------------------------------- | --------------------------------------------------- | --------------------------------------------------------- | -----------------------------------------
|
|Cash flows from operating activities:                |                                                     |                                                           |                                          
|                                                     | Net loss                                            |                                                           | $                                        
|                                                     |                                                     | Stock-based compensation expense                          |                                          
|                                                     |                                                     | Depreciation and amortization                             |                                          
|                                                     |                                                     | Impairment of goodwill and intangible assets              |                                          
|                                                     |                                                     | Loss on disposal of property and equipment                |                                          
|                                                     | Changes in operating assets and liabilities         |                                                           |                                          
|                                                     |                                                     | Current and other assets                                  |                                          
|                                                     |                                                     | Accounts payable, accrued and other long term liabilities |                                          
|                                                     |                                                     | Accrued restructuring                                     |                                          
|                                                     |                                                     | Deferred revenue                                          |                                          
|                                                     |                                                     |                                                           |                                          
|                                                     |                                                     |                                                           | Net cash used in operating activities    
|Cash flows from investing activities:                |                                                     |                                                           |                                          
|                                                     | Purchase of property and equipment                  |                                                           |                                          
|                                                     | Acquisitions, net of cash acquired                  |                                                           |                                          
|                                                     | Proceeds from sale of Interface product lines       |                                                           |                                          
|                                                     |                                                     |                                                           |                                          
|                                                     |                                                     |                                                           | Net cash used in investing activities    
|Cash flows from financing activities:                |                                                     |                                                           |                                          
|                                                     | Repayments of borrowings                            |                                                           |                                          
|                                                     | Proceeds from issuance of common stock and warrants |                                                           |                                          
|                                                     |                                                     |                                                           |                                          
|                                                     |                                                     |                                                           | Net cash provided by financing activities
|Effect of exchange rate fluctuation                  |                                                     |                                                           | (332                                     
|Net increase (decrease) in cash and cash equivalents |                                                     |                                                           | (32,644                                  
|Cash and cash equivalents, beginning of period       |                                                     |                                                           | 75,497                                   
|Cash and cash equivalents, end of period             |                                                     | $                                                         | 42,853                                   
|                                                     |                                                     |                                                           |                                          
|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       |                                                           |                                          
|                                                     |                                                     |                                                           |                                          

See
Notes to Condensed Consolidated Financial Statements

6

---



TUMBLEWEED COMMUNICATIONS CORP.    NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS    (in thousands)

(1) Basis of Presentation

The condensed consolidated financial statements as of September 30, 2001 and for the three and nine months ended September 30, 2001 and 2000 are
unaudited and reflect all adjustments (consisting of normal recurring accruals except as otherwise indicated) which are, in the opinion of management, necessary for fair presentation of Tumbleweed
Communications Corp.'s ("Tumbleweed") financial position and operating results for the interim periods presented.

The
accompanying consolidated financial statements include the accounts of Tumbleweed, our wholly owned subsidiary, Worldtalk Communications Corp. ("Worldtalk"), our wholly owned
subsidiaries in Switzerland, Germany, the United Kingdom, the Netherlands, Sweden, France, Australia and Hong Kong and our majority-owned subsidiary in Japan, Tumbleweed Communications KK ("TKK"). The
results of operations for our wholly owned subsidiary, Interface Systems, Inc. ("Interface") have been included commencing September 1, 2000, the effective date of its acquisition.

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

(2) Restructuring

In January 2001, our Board of Directors approved a restructuring program. The restructuring program is intended to align our cost structures with our
company-wide focus on customer service, sales and research and development. 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 reduced headcount in most areas of our business.

Restructuring
and related charges expensed during the nine months ended September 30, 2001 was comprised of the following:

Used

Remaining

ExpenseEmployee separation

$
2,642




$
2,642Facilities charges and asset impairment


611


5,383


5,994Other


195


108


303Total restructuring charges

$
3,448

$
5,491

$
8,939


Employee
separation for approximately 100 employees includes severance pay and medical and other benefits. Approximately $5.3 million of the remaining restructuring accrual
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
our rent expense due to rapidly declining office rent rates in and around Silicon Valley. These facility lease commitments last through 2003.

(3) Goodwill Impairment

During the three months ended March 31, 2001, 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 rate, and our lower actual and projected operating
results including that of the business acquired from Interface. Our assessment is supported by the significant sustained decline in our stock price since the valuation date of the shares issued in the
Interface acquisition. As a result of the

7

---

assessment, we 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 our best estimates as of March 31, 2001. The
remaining intangible assets of approximately $847,000 were amortized in full over their remaining useful life by September 30, 2001. The impairment consists of the following charge:

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 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 incremental common 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

As defined by SFAS No. 131, our chief operating decision-makers are our Chief Executive Officer and our Chief Operating Officer. Our CEO and COO review
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 our CEO and COO is the information presented in the accompanying consolidated statement of operations. Therefore, we operate in a single
operating segment.

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

Three Months Ended
September 30,

Nine Months Ended
September 30,2001

2000

2001

2000North America

$
6,314

$
9,466

$
14,191

$
19,870Europe


722


1,901


3,603


6,182Asia


1,119


1,067


2,057


3,082Total

$
8,155

$
12,434

$
19,851

$
29,134


Substantially
all of our 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

8

---

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 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. On July 27, 2001, the Court granted our motion to transfer the
lawsuits to the Eastern District of Michigan, and left the decision of the pending motions to dismiss to the transferee court. The United States District Court for the Eastern District of Michigan
held a status conference on the cases on October 23, 2001, without resolving either of our pending motions. The accompanying financial statements do not include any costs for damages, if any,
that might result from this uncertainty. We believe these actions are without merit and intend to vigorously defend and seek their dismissal.

(7) Recent Accounting Pronouncements

In July 2001, the FASB issued Statement No. 141,Business Combinations, and Statement
No. 142,Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets
acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted
for separately. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance
with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with FAS Statement No. 121,Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of.

We
are required to adopt the provisions of Statement 141 immediately and Statement 142 effective January 1, 2002. Furthermore, goodwill and intangible assets determined to have
an indefinite useful life acquired in a purchase business combination completed after June 30, 2001, but before Statement 142 is adopted in full will not be amortized, but will continue to be
evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before
July 1, 2001 will continue to be amortized and tested for impairment in accordance with the appropriate pre-Statement 142 accounting requirements prior to the adoption of Statement
142.

Statement
141 will require, upon adoption of Statement 142, that we evaluate our existing intangible assets and goodwill that were acquired in a prior purchase business
combination and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, we
will be required to reassess the useful lives and residual values of all intangible assets acquired, and make any necessary amortization period adjustments by the end of the first interim period after
adoption. In addition, to the extent an
intangible asset is identified as having an indefinite useful life, we will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the
first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.

In
connection with Statement 142's transitional goodwill impairment evaluation, the Statement will require us to perform an assessment of whether there is an indication that goodwill
is impaired as of the date of adoption. To accomplish this, we must identify our reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. We will then have up to six months from the date of adoption to determine the fair value of
each reporting unit and

9

---

compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and
we must perform the second step of the transitional impairment test. In the second step, we must compare the implied fair value of the reporting unit's goodwill, determined by allocating the reporting
unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with Statement 141, to its carrying amount, both of
which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment
loss will be recognized as the cumulative effect of a change in accounting principle in our consolidated statement of operations.

As
of the date of adoption, we expect to have un-amortized goodwill in the amount of $6.7 million which will be subject to the transition provisions of
Statements 141 and 142. Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these
Statements on our financial statements at the date of this report, including whether it will be required to recognize any transitional impairment losses as the cumulative effect of a change in
accounting principle.

In
June 2001, the FASB issued Statement No. 143,Accounting for Asset Retirement Obligations, which addresses financial
accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations
associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal use of the asset.

Statement
No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The
liability is accreted at the end of each
period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, we will recognize a gain or loss on settlement.

We
are required to adopt the provisions of Statement No. 143 for the quarter ending March 31, 2003. To accomplish this, we must identify all legal obligations for asset
retirement obligations, if any, and determine the fair value of these obligations on the date of adoption. The determination of fair value is complex and will require us to gather market information
and develop cash flow models. Additionally, we will be required to develop processes to track and monitor these obligations. Because of the effort necessary to comply with the adoption of Statement
No. 143, it is not practicable to estimate the impact of adopting this Statement at the date of this report.

On
October 3, 2001, the FASB issued Statement No. 144,Accounting for the Impairment or Disposal of Long-Lived
Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While Statement No. 144 supersedes Statement
No. 121, it retains many of the fundamental provisions of that Statement. Statement No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30 for the
disposal of a segment of a business. By broadening the presentation of discontinued operations to include more disposal transactions, Statement No. 144 enhances companies' ability to provide
information that helps financial statement users to assess the effects of a disposal transaction on the ongoing operations of an entity. Statement No. 144 is effective for the quarter ending
March 31, 2002. We will review and assess the impact of Statement No. 144 on our financial position and results of operations.

10

---



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

OVERVIEW

We are a leading provider of secure content management solutions for enabling the business Internet. Tumbleweed Secure Guardian is the first
enterprise-wide policy-based security framework that offers solutions to both protect and extend enterprise networks, move business processes online and enable secure communications over
the Internet. Tumbleweed solutions empower organizations to safely share and protect critical information, increase customer loyalty and privacy and dramatically reduce costs.

Secure
Guardian provides centralized security for both incoming and outgoing communications and integrates various enterprise applications for safe delivery of all forms of enterprise
content. Secure Guardian is based on a platform consisting of the Tumbleweed Secure Policy Gateway and a series of protocol enablers that allow virtually any application to connect to it.
The Secure Policy Gateway enables the enterprise to apply security to and manage content policies for bi-directional communications traffic, web content and Internet usage. Policies
include protection from viruses, malicious mobile code or SPAM attacks, as well as protection from dangerous exposure of company, partner or customer confidential information. Tumbleweed protocol
enablers allow a wide range of protocols and enterprise systems to be centrally managed from the Secure Policy Gateway to allow organizations to safely extend communications from enterprise
applications, groupware and legacy systems.

Additionally,
Tumbleweed Secure Guardian enables a broad spectrum of network extension solutions that help companies leverage the business efficiencies and benefits of the business
Internet, including secure communications between trading partners, moving paper-based processessuch as statement presentmentonline, and delivery and storage of aggregated
enterprise communications into a single, branded secure inbox. Tumbleweed is trusted by 1,000 blue-chip customers including American Express, Banc of America Securities, Inc., JP
Morgan Chase & Co., Chevron, Datek Online, SEB Bank, ABN Amro, the Federal Drug Administration, John Deere, Merrill Lynch, Nike, Northern Trust, NTT, Salomon Smith Barney, Travelers, United
Parcel Service, and seven of the world's largest postal services. Eight of the Fortune 10 and over 100 of the Fortune 500 are included among our customer base.

Revenue,
which consists of both product and services revenue, results from new contracts and backlog. We define backlog as contractual commitments that are not due and payable as of
the balance sheet date and deferred revenue. Product revenue consists of license fees and transaction revenue. We currently offer our software products under a perpetual license. Under a perpetual
license our customers pay a one-time license fee for the right to use our software. Perpetual license revenue is typically recognized upon software shipment. Transaction revenue is based
on actual volume of transactions or contractual minimum volumes, and the related revenue is recognized based on payment schedules or transaction reports from our customers. Services revenue consists
of consulting fees and support and maintenance fees. Consulting fees related to installation or customization are recognized upon client acceptance or 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. Revenue from the reseller channel is recognized upon the execution of a distribution agreement and receipt of substantive
identification of the end-user customer.

A
substantial portion of our revenue relates to international customers or operations. Most of our contracts are denominated in U.S. dollars; however, in the future, an increasing
number of contracts may be denominated in foreign currencies. We currently do not have hedging or similar arrangements

11

---

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.

In
January 2001, our Board of Directors approved a restructuring program. This restructuring program is intended to align our cost structures with our company-wide
focus on customer service, sales and research and development. The restructuring involved closing sales offices in Paris, France; Chatsworth, Australia; Stockholm, Sweden; and Hong Kong, realigning
our professional services organization, and reducing 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 nine months ended September 30, 2001, which includes charges related to vacating leased facilities domestically and abroad.

Our
future net income and cash flow may be adversely affected by limitations on our 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 our stock.

RESULTS OF OPERATIONS

Three and Nine Month Periods Ended September 30, 2001 and 2000

Revenue.Revenue is comprised of product and services revenue. Total revenue for the three months ended
September 30, 2001 decreased to $8.2 million from $12.4 million for the same three months in 2000. Total revenue for the nine months ended September 30, 2001 decreased to
$19.9 million from $29.1 million for the same nine months in 2000. Revenues were lower in the quarter and the nine months ended September 30, 2001 due to softer global
macroeconomic conditions in 2001, the closure of offices in Australia, France, Hong Kong, and Sweden associated with our 2001 restructuring, and an abbreviated selling period in the quarter ended
September 30, 2001.

Product
revenue for the three months ended September 30, 2001 decreased to $5.0 million from $9.9 million for the same three months in 2000. The decrease in
product revenue during the quarter was due to softer macroeconomic conditions, the closure of a number of our international offices, and an abbreviated selling period in the quarter ended
September 30, 2001. Product revenue for the nine months ended September 30, 2001 decreased to $12.1 million from $23.2 million for the same nine months in 2000.

Services
revenue for the three months ended September 30, 2001 increased to $3.2 million from $2.5 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 and increases in maintenance fees from our installed customer base. Services revenue for
the nine months ended September 30, 2001 increased to $7.7 million from $6.0 million for the same nine months in 2000.

Cost of Revenue.Cost of revenue, excluding non-cash stock-based compensation, is comprised of product and
services costs. Product license cost is primarily comprised of royalties paid to third parties for software licensed by us for inclusion in our products. Product transaction costs include bandwidth
costs associated with hosting servers for those customers who use our hosting services. Services costs are comprised primarily of personnel and overhead costs related to customer support and contract
development projects. Total cost of revenue for the three months ended September 30, 2001 decreased to $3.0 million from $3.6 million for the same three months in 2000. The
decrease in total cost of revenue was due to a decrease in service costs and a reduction in product costs which were tied to our revenues, as our revenues decreased. Total cost of revenue for the nine
months ended September 30, 2001 increased to $9.2 million from $9.0 million for the same nine months in 2000. Professional services costs increased due to the growth that occurred
throughout 2000 in our professional services team in order to support our larger customer base and also as a result of the Interface acquisition that occurred

12

---

in September 2000. This cost increase was partially offset by the workforce reduction associated with our 2001 restructuring.

Research and Development Expenses.Research and development expenses, excluding non-cash stock-based
compensation, are comprised of engineering and related costs associated with the development of our applications, quality assurance and testing. Research and development expenses for the three months
ended September 30, 2001 decreased to $3.6 million from $4.2 million for the same three months in 2000. The decreased spending was driven by lower personnel costs resulting from
workforce synergies created by the Interface acquisition. Research and development expenses for the nine months ended September 30, 2001 increased to $11.7 million from
$10.2 million for the same nine months in 2000. The increase in costs over the nine month period reflects headcount growth in 2000 to enhance the core product platform and develop new products.

Sales and Marketing Expenses.Sales and marketing expenses, excluding non-cash stock-based compensation,
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
September 30, 2001 decreased to $8.5 million from $10.8 million for the same three months in 2000. The decrease in sales and marketing expenses was primarily due to decreased
personnel costs as a result of the 2001 restructuring and other cost savings from our closure of offices in Australia, France, Hong Kong, and Sweden. Sales and marketing expenses for the nine months
ended September 30, 2001 increased to $28.0 million from $27.7 million for the same nine months in 2000 reflecting investments made to increase our sales coverage and an increase
in marketing programs in the first quarter of 2001.

General and Administrative Expenses.General and administrative expenses, excluding non-cash stock-based
compensation, 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 September 30, 2001 decreased to $2.3 million from $2.9 million for the same three months in 2000. The decrease in general and administrative expenses was due to
decreased personnel costs as a result of the 2001 restructuring and lower legal costs as the prior year included expenses resulting from our patent infringement lawsuit against the docSpace
Company, Inc. General and administrative expenses for the nine months ended September 30, 2001 decreased to $6.5 million from $6.9 million for the same nine months in 2000
primarily due to a decline in legal costs in 2001.

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 that had not vested. Amortization of deferred stock
compensation expense in the three months ended September 30, 2001 decreased to $618,000 from $1.9 million for the
same three months in 2000. This decrease was the result of the termination of certain employees during the restructuring in the prior quarter of 2001 whose options had not yet vested. Amortization of
deferred stock compensation expense for the nine months ended September 30, 2001 decreased to $2.6 million from $4.8 million for the same nine months in 2000.

Merger Related, Restructuring and Impairment Charges.During the first quarter of 2001, our Board of Directors approved
a restructuring program. This restructuring program focuses our efforts on aligning our cost structures with our company-wide focus on customer service, sales and research and development.
The restructuring involved closing international sales office locations in Paris, France; Chatsworth, Australia; Stockholm, Sweden; and Hong Kong, realigning our professional services organization,
and reducing headcount in most areas of our business. The reduction in work force

13

---

involved approximately 100 employees and total charges incurred as a result of the restructuring were approximately $8.9 million during the nine months ended September 30, 2001, which
includes charges related to vacating leased facilities domestically and abroad. No restructuring charges were incurred during the three months ended September 30, 2001. Merger related and
restructuring expenses for the nine months ended September 30, 2000 were recorded in connection with the acquisition of Worldtalk, and were primarily comprised of investment banker's fees,
legal fees, severance payments and accounting and printer fees. Merger related and restructuring expenses for the nine months ended September 30, 2000 were $10.4 million.

During
the three months ended March 31, 2001, 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 our lower actual and projected operating results including that
of the business acquired from Interface. Our assessment is supported by the significant sustained decline in our stock price since the valuation date of the shares issued in the Interface acquisition,
which resulted in the net book value of our assets prior to the impairment charge significantly exceeding our 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 estimates as of March 31, 2001. The remaining intangible assets of
approximately $847,000 were amortized in full over their remaining useful life by September 30, 2001.

Other Income, Net.Other income, net, is primarily comprised of interest income earned on investment securities. Other
income, net, for the three months ended September 30, 2001 decreased to $439,000 from $1.0 million for the same three months in 2000. The decrease in other income, net, is due to the
decline in interest rates and a reduction in our cash balances relative to the year-earlier period when we received proceeds from the issuance of securities in August 2000. Other
income, net for the nine months ended September 30, 2001 was flat at $2.1 million for the same nine months in 2000. This resulted from the decline in interest rates being offset by
increased cash balances in the first two quarters of 2001.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations primarily through the issuance of equity securities. On September 30, 2001, we had approximately
$42.9 million in cash and cash equivalents.

Net
cash used in operating activities decreased to $5.3 million in the three months ended September 30, 2001 from $8.6 million in the three months ended
June 30, 2001 and from $15.6 million (which includes $3.3 million related to restructuring) in the three months ended March 31, 2001. We anticipate that cash used in
operations may decline in the next quarter. Cash used in operating activities was primarily the result of net operating losses and a decrease in accrued liabilities, offset by certain
non-cash charges including depreciation and amortization, the non-cash portion of the restructuring accrual and the expense recognized for goodwill impairment. Cash used in
operating activities for the nine months ended September 30, 2001 decreased to $29.5 million from $34.6 million for the same nine months in 2000 due to improved management of
working capital.

Net
cash used in investing activities for the nine months ended September 30, 2001 decreased to $2.9 million from $18.8 million for the same nine months in 2000
as the year-earlier period included the impact of acquisitions. Net cash used in investing activities for the nine months ended September 30, 2001 was comprised of purchases of
property and equipment.

Net
cash provided by financing activities for the nine months ended September 30, 2001 was approximately $90,000. Cash provided by financing activities was attributable to the
net proceeds from

14

---

the issuance of common stock upon exercise of stock options and our employee stock purchase plan, partially offset by the repayment of credit facilities and capital lease obligations. Net cash
provided by financing activities for the nine months ended September 30, 2000 was $82.7 million reflecting the issuance of equity securities in August 2000.

As
of September 30, 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. 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. We also do not anticipate an increase in operating lease obligations.

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 continued increases in capital expenditures in 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. Additionally, equity or debt financing may not be available to us on
favorable terms, if at all.

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
September 30, 2001, we had incurred cumulative net losses as a C-corporation of $242.2 million.

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.

15

---



Our quarterly financial results are subject to significant fluctuations.

As a result of 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 profitable relationships with customers and to develop and maintain profitable 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 traditional software licensing model, license revenue is comprised of initial license and distribution fees. As a result, we typically recognize 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 account for and report our contracted revenue over
the life of the agreement.

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.

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:



As
a result of these factors 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 that include revenue accounted for under the both the subscription-based pricing model and the
traditional software pricing model will not be comparable with historical quarters that used 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.

In
addition, the terrorist acts of September 11, 2001 in New York City, Washington D.C. and Pennsylvania, and the United States' military response, have created an uncertain
economic environment and we cannot predict the impact of these events, any subsequent terrorist acts or of any related military action, on our customers or business. We believe that, in light of these
events, some

16

---

businesses may curtail spending on information technology, which could also affect our quarterly results or financial condition in the future.

Restructuring of operations and other cost reducing measures we have implemented may not achieve the results we intend and even 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.
Since that time we have continuously engaged in other measures to reduce expenses and establish an enterprise that is appropriate for our expected revenue levels. The planning and implementation of
this effort has placed, and may continue to place, a significant strain on our managerial, operational, financial and other resources. Additionally, the actions undertaken to restructure the business
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 carrying out the restructuring, our expenses could increase more
quickly than we expect. If we find that the actions taken to date did not sufficiently decrease the growth of our expenses, we may find it necessary to implement further streamlining of our expenses,
to perform additional reductions in our headcount or to undertake additional restructurings of our business.

We may have insufficient cash reserves to see us through to profitability

We have put in place a variety of mechanisms and cost cutting measures designed to assure that we have sufficient cash reserves to carry us through to
profitability. Nonetheless, our current cash reserves may be insufficient in the face of either lower than expected revenues or extraordinary or unexpected cash expenses. As a result, we may need to
seek cash from other sources.

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.

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.

17

---

Our service provider customers may compete with us, fail to promote our product or cease to use our products at all.

To date, we have generated a significant amount of Secure Messenger 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 Secure Messenger to their end-users or cease to
offer Secure Messenger 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.

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 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 Secure
Messenger 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.

We may not find broad acceptance of the Tumbleweed Secure Guardian suite of products.

In October of 2001 we re-launched our existing product line under the Tumbleweed Secure Guardian suite of products including Tumbleweed Secure Mail
(formerly Tumbleweed MMS) and Tumbleweed Secure Messenger, Secure Statements (formerly IME and IME Statements) and Secure Redirect (formerly MMS Secure Redirect). If we do not obtain anticipated
acceptance and understanding of these re-branded product offerings, our ability to grow our sales may suffer. In addition, if we do not achieve the anticipated growth of the new marketing
or even suffer sales decreases as a result of a misperceptions of our products, we may be forced to expend additional resources in new or different marketing directions.

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.

18

---

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 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, and ValiCert Inc.

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.

Our recent product releases may not be accepted and our development efforts may be hindered by a variety of factors.

In August and September of 2001 we released the newest versions of our existing product lines (Secure Mail 5.0 and Secure Messenger 5.0). These releases may
not be scalable, may contain unexpected bugs or problems, may not meet customers' requirements or expectations and may not be accepted as providing added value to our existing customers. In addition,
the installation of integrated or complementary software products at customer sites may result in difficulties associated with customer-specific installation processes and may result in new issues
arising with respect to our new software releases.

19

---

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

Our business 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 continue 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. Despite our
restructuring, we expect that we may 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. Finally, as part of the expansion of our business in 2000, we may have acquired operational, customer service and financial systems that are not appropriate for our current estimated
size. Moving to more appropriate office systems may also place a strain on our current systems and require financial expenditures to end the commitments on other systems.

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 some of
our products. Finally, we must coordinate with our 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. 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 material 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.

20

---

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, Japan, the Netherlands and the United Kingdom. For the three months ended September 30, 2001, June 30, 2001 and March 31, 2001, we derived 23%, 30% and 37%,
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:



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

21

---

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, profitably providing 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. If our professional services
organization does not adequately meet these multiple challenges, our business and prospects could suffer.

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.

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.

22

---

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.

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, or the architecture of the Internet is altered, 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. Moreover, changes in the architecture of the
Internet may limit the success of our products. Because the online exchange of information is new and evolving, the Internet may not prove to be a viable platform for secure online

23

---

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 at
present there are relatively 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 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

24

---

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.

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. On July 27, 2001, the Court granted our motion to transfer the lawsuits to the Eastern District of Michigan, and left the decision on the pending motions to dismiss to the
transferee Court. The United States District Court for the Eastern District of Michigan held a status conference on the cases on October 23, 2001 without resolving either of our pending
motions.

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 ends in 2003. Although
we had previously subleased all of this space, our sublease expired with respect to half of the space in September 2001 and will expire with respect to the other half in April 2002.
Potential losses from the result of this lease have been accrued for in the restructuring accrual expensed during the quarters ended March 31, 2001 and June 30, 2001. If we are

25

---

unable to find suitable sub-tenants or fail to return the property to the landlord, 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 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, Germany, Netherlands or Japan denominated 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.

26

---

Interest Rate Sensitivity

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 September 30, 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.

27

---



PART IIOTHER INFORMATION

ITEM 1:LEGAL PROCEEDINGS

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. On July 27, 2001, the Court granted our motion to transfer the lawsuits to the Eastern District of Michigan, and left the decision on the pending motions to dismiss to the
transferee Court. The United States District Court for the Eastern District of Michigan held a status conference on the cases on October 23, 2001, without resolving either of our pending
motions. 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 did not receive any of the
proceeds from shares sold by its stockholders. We received net proceeds of $77.6 million from the offering of primary shares. For the quarter ended September 30, 2001, the net capital
was used for working capital and general corporate purposes. Remaining proceeds were predominantly held in cash and cash equivalents.

28

---



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: November 13, 2001 | By:                            
|Date: November 13, 2001 | By:                            

29

---

QuickLinks