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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2004



Commission File Number: 000-26223



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TUMBLEWEED COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 94-3336053                          
|(State of other jurisdiction of incorporation or organization) |  | (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(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).    Yes   x    No ̈



The number of shares of common stock outstanding as of April 30, 2004 was
47,676,595.



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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. 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, you can
identify forward-looking statements by terminology such as may, will, should, could, predicts, projects, potential, continue, expects,
anticipates, future, intends, plans, believes, estimates, or the negative of these terms and other comparable terminology, including, but not limited to, the following:



| |  | any projections of revenues, earnings, cash balances or cash flow, synergies or other financial items;
| | - | ------------------------------------------------------------------------------------------------------



| |  | any statements of the plans, strategies and objectives of management for future operations;
| | - | -------------------------------------------------------------------------------------------



| |  | any statements regarding future economic conditions or performance;
| | - | -------------------------------------------------------------------



| |  | implementing our business strategy;
| | - | -----------------------------------



| |  | attracting and retaining customers;
| | - | -----------------------------------



| |  | obtaining and expanding market acceptance of the products and services we offer;
| | - | --------------------------------------------------------------------------------



| |  | competition in our market;
| | - | --------------------------



| |  | any statements relating to integration or restructuring plans; and
| | - | ------------------------------------------------------------------



| |  | any statements of assumptions underlying any of the foregoing.
| | - | --------------------------------------------------------------



These forward-looking statements are only predictions, not historical facts. These forward-looking statements involve certain risks and uncertainties, as
well as assumptions. Actual results, levels of activity, performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences
include those discussed under the caption Risks And Uncertainties That You Should Consider Before Investing In Tumbleweed in section entitled Managements Discussion and Analysis of Financial Condition and Results of
Operations contained herein, as well as those discussed in our Form 10-K and other filings with the Securities and Exchange Commission. You should consider the risks factors and uncertainties under the caption Risks and Uncertainties
That You Should Consider Before Investing in Tumbleweed, among other things, in evaluating Tumbleweeds prospects and future financial performance. The occurrence of the events described in the risk factors could harm the business,
results of operations and financial condition of Tumbleweed. These forward-looking statements are made as of the date of this Quarterly Report on Form 10-Q. Tumbleweed disclaims any obligation to update or alter these forward-looking statements,
whether as a result of new information, future events or otherwise, or any obligation to explain the reasons why actual results may differ.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES



INDEX



|               |  |                                                                                                              |  |     
|-------------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|               |  |                                                                                                              |  | Page
|               |  | Part I                                                                                                       |  |     
|Item 1         |  | Financial Statements (unaudited)                                                                             |  | 3   
|               |  | Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003                             |  | 3   
|               |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and March 31, 2003 |  | 4   
|               |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and March 31, 2003 |  | 5   
|               |  | Notes to Condensed Consolidated Financial Statements                                                         |  | 6   
|Item 2         |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 12  
|Item 3         |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 23  
|Item 4         |  | Controls and Procedures                                                                                      |  | 24  
|               |  |                                                                                                             
|               |  | Part II                                                                                                      |  |     
|Item 1         |  | Legal Proceedings                                                                                            |  | 24  
|Item 6         |  | Exhibits and Reports on Form 8-K                                                                             |  | 26  
|Signatures     |  | 27                                                                                                          
|Certifications |  |                                                                                                             



TRADEMARKS



Our registered trademarks include Tumbleweed®, Tumbleweed Communications®, Secure Envelope®, Secure Inbox®, Tumbleweed IME Integrated Messaging Exchange®, WorldSecure® and Worldtalk®. Additional trademarks belonging to us include Tumbleweed Secure Guardian, Tumbleweed Secure Policy Gateway, Tumbleweed Secure Staging Server, Tumbleweed Staging Server, Tumbleweed Secure Mail, Tumbleweed Secure Redirect, Tumbleweed Secure Public Network, Tumbleweed SPN, Tumbleweed Secure Archive, Tumbleweed Secure Web, Tumbleweed Secure CRM, Tumbleweed Secure Messenger, Tumbleweed Secure Statements, Tumbleweed My Copy, Tumbleweed L2i, Tumbleweed IME Developer, Tumbleweed IME Personalize, WorldSecure/Mail and Tumbleweed IME Alert.



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##### Table of Contents

PART IFINANCIAL INFORMATION



ITEM 1FINANCIAL STATEMENTS



TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES



Condensed Consolidated Balance Sheets

(in thousands)

(unaudited)



|                                                                  |  |               |          |   |                  |   |          |  
|----------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                  |  | March 31,2004 |          |   | December 31,2003 |  
|Assets                                                            |  |               |          |   |                  |   |          |  
|Current assets:                                                   |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                         |  | $             | 23,361   |   |                  | $ | 25,351   |  
|Accounts receivable, net                                          |  |               | 8,300    |   |                  |   | 10,039   |  
|Other current assets                                              |  |               | 1,332    |   |                  |   | 1,068    |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total current assets                                              |  |               | 32,993   |   |                  |   | 36,458   |  
|Goodwill                                                          |  |               | 49,363   |   |                  |   | 13,308   |  
|Intangible assets, net                                            |  |               | 10,008   |   |                  |   | 4,392    |  
|Property and equipment, net                                       |  |               | 1,746    |   |                  |   | 1,648    |  
|Other assets                                                      |  |               | 772      |   |                  |   | 540      |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total assets                                                      |  | $             | 94,882   |   |                  | $ | 56,346   |  
|                                                                  |  |               |          |   |                  |   |          |  
|Liabilities and Stockholders Equity                              |  |               |          |   |                  |   |          |  
|Current liabilities:                                              |  |               |          |   |                  |   |          |  
|Accounts payable                                                  |  | $             | 886      |   |                  | $ | 250      |  
|Current installments of long-term debt                            |  |               | 267      |   |                  |   | 267      |  
|Accrued liabilities                                               |  |               | 6,346    |   |                  |   | 6,791    |  
|Accrued merger-related and other expenses                         |  |               | 1,114    |   |                  |   | 485      |  
|Deferred revenue                                                  |  |               | 12,976   |   |                  |   | 11,808   |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total current liabilities                                         |  |               | 21,589   |   |                  |   | 19,601   |  
|Long-term debt, excluding current installments                    |  |               | 400      |   |                  |   | 467      |  
|Accrued merger-related and other costs, excluding current portion |  |               | 465      |   |                  |   | 540      |  
|Deferred revenue, excluding current portion                       |  |               | 2,721    |   |                  |   | 2,984    |  
|Other long-term liabilities                                       |  |               | 159      |   |                  |   | 159      |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total long-term liabilities                                       |  |               | 3,745    |   |                  |   | 4,150    |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total liabilities                                                 |  |               | 25,334   |   |                  |   | 23,751   |  
|Stockholders equity:                                             |  |               |          |   |                  |   |          |  
|Common stock                                                      |  |               | 48       |   |                  |   | 43       |  
|Additional paid-in capital                                        |  |               | 352,344  |   |                  |   | 313,532  |  
|Treasury stock                                                    |  |               | (796     | ) |                  |   | (796     | )
|Deferred stock-based compensation expense                         |  |               | (1,616   | ) |                  |   | (302     | )
|Accumulated other comprehensive loss                              |  |               | (604     | ) |                  |   | (585     | )
|Accumulated deficit                                               |  |               | (279,828 | ) |                  |   | (279,297 | )
|                                                                  |  |               |          |   |                  |   |          |  
|Total stockholders equity                                        |  |               | 69,548   |   |                  |   | 32,595   |  
|                                                                  |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders equity                        |  | $             | 94,882   |   |                  | $ | 56,346   |  
|                                                                  |  |               |          |   |                  |   |          |  



See accompanying Notes
to Condensed Consolidated Financial Statements



3



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##### Table of Contents

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES



Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)



|                                                               |  |                             |        |   |      |   |        |  
|-------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                               |  | Three Months EndedMarch 31, |       
|                                                               |  | 2004                        |        |   | 2003 |  
|Revenue:                                                       |  |                             |        |   |      |   |        |  
|Product revenue                                                |  | $                           | 3,973  |   |      | $ | 2,629  |  
|Service revenue                                                |  |                             | 5,582  |   |      |   | 2,871  |  
|Intellectual property and other revenue                        |  |                             | 570    |   |      |   | 281    |  
|                                                               |  |                             |        |   |      |   |        |  
|Total revenue                                                  |  |                             | 10,125 |   |      |   | 5,781  |  
|Cost of revenue:                                               |  |                             |        |   |      |   |        |  
|Cost of product revenue                                        |  |                             | 244    |   |      |   | 232    |  
|Cost of service revenue                                        |  |                             | 980    |   |      |   | 1,181  |  
|Amortization of intangible assets                              |  |                             | 244    |   |      |   |       |  
|                                                               |  |                             |        |   |      |   |        |  
|Total cost of revenue                                          |  |                             | 1,468  |   |      |   | 1,413  |  
|Gross profit                                                   |  |                             | 8,657  |   |      |   | 4,368  |  
|Operating expenses:                                            |  |                             |        |   |      |   |        |  
|Research and development                                       |  |                             | 2,913  |   |      |   | 1,963  |  
|Sales and marketing                                            |  |                             | 4,708  |   |      |   | 3,441  |  
|General and administrative                                     |  |                             | 1,322  |   |      |   | 1,422  |  
|Stock-based compensation (1)                                   |  |                             | 82     |   |      |   | 34     |  
|Amortization of intangible assets                              |  |                             | 339    |   |      |   |       |  
|                                                               |  |                             |        |   |      |   |        |  
|Total operating expenses                                       |  |                             | 9,364  |   |      |   | 6,860  |  
|Operating loss                                                 |  |                             | (707   | ) |      |   | (2,492 | )
|Other income, net                                              |  |                             | 171    |   |      |   | 14     |  
|                                                               |  |                             |        |   |      |   |        |  
|Net loss before provision (benefit) for income taxes           |  |                             | (536   | ) |      |   | (2,478 | )
|Provision (benefit) for income taxes                           |  |                             | (5     | ) |      |   | 4      |  
|                                                               |  |                             |        |   |      |   |        |  
|Net loss                                                       |  | $                           | (531   | ) |      | $ | (2,482 | )
|                                                               |  |                             |        |   |      |   |        |  
|Net loss per sharebasic and diluted                           |  | $                           | (0.01  | ) |      | $ | (0.08  | )
|                                                               |  |                             |        |   |      |   |        |  
|Weighted average sharesbasic and diluted                      |  |                             | 43,254 |   |      |   | 30,494 |  
|                                                               |  |                            
|(1) Stock-based compensation is further classified as follows: |  |                             |        |   |      |   |        |  
|Cost of service revenue                                        |  | $                           | 7      |   |      | $ | 8      |  
|Research and development                                       |  |                             | 28     |   |      |   | 5      |  
|Sales and marketing                                            |  |                             | 44     |   |      |   | 11     |  
|General and administrative                                     |  |                             | 3      |   |      |   | 10     |  
|                                                               |  |                             |        |   |      |   |        |  
|Total stock-based compensation                                 |  | $                           | 82     |   |      | $ | 34     |  
|                                                               |  |                             |        |   |      |   |        |  



See accompanying Notes
to Condensed Consolidated Financial Statements



4



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##### Table of Contents

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES



Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                                                                   |  |                             |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------ |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                   |  | Three months endedMarch 31, |       
|                                                                                                                   |  | 2004                        |        |   | 2003 |  
|Cash flows from operating activities:                                                                              |  |                             |        |   |      |   |        |  
|Net loss                                                                                                           |  | $                           | (531   | ) |      | $ | (2,482 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities:                          |  |                             |        |   |      |   |        |  
|Stock-based compensation                                                                                           |  |                             | 82     |   |      |   | 34     |  
|Depreciation and amortization                                                                                      |  |                             | 970    |   |      |   | 359    |  
|Bad debt expense                                                                                                   |  |                             |       |   |      |   | 31     |  
|Loss (gain) on disposal of property and equipment                                                                  |  |                             | (6     | ) |      |   | 30     |  
|Changes in operating assets and liabilities, net of effects of acquisitions of Incubator Limited and Corvigo, Inc. |  |                             |        |   |      |   |        |  
|Accounts receivable                                                                                                |  |                             | 2,243  |   |      |   | 716    |  
|Other current assets and other assets                                                                              |  |                             | 102    |   |      |   | (588   | )
|Accounts payable, accrued liabilities, and other long-term liabilities                                             |  |                             | (1,366 | ) |      |   | 39     |  
|Accrued merger-related and other expenses                                                                          |  |                             | (10    | ) |      |   |       |  
|Deferred revenue                                                                                                   |  |                             | 15     |   |      |   | (406   | )
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                                                |  |                             | 1,499  |   |      |   | (2,267 | )
|Cash flows from investing activities:                                                                              |  |                             |        |   |      |   |        |  
|Purchase of property and equipment                                                                                 |  |                             | (325   | ) |      |   | (64    | )
|Acquisitions of Incubator Limited and Corvigo, Inc., net of cash acquired                                          |  |                             | (3,379 | ) |      |   |       |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Net cash used in investing activities                                                                              |  |                             | (3,704 | ) |      |   | (64    | )
|Cash flows from financing activities:                                                                              |  |                             |        |   |      |   |        |  
|Repayments of borrowings and other long-term liabilities                                                           |  |                             | (67    | ) |      |   | (50    | )
|Proceeds from issuance of common stock                                                                             |  |                             | 301    |   |      |   | 15     |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                                                                |  |                             | 234    |   |      |   | (35    | )
|Effect of exchange rate fluctuation on cash and cash equivalents                                                   |  |                             | (19    | ) |      |   | 157    |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                                                          |  |                             | (1,990 | ) |      |   | (2,209 | )
|Cash and cash equivalents, beginning of period                                                                     |  |                             | 25,351 |   |      |   | 29,210 |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                                           |  | $                           | 23,361 |   |      | $ | 27,001 |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Supplemental disclosures of cash flow information:                                                                 |  |                             |        |   |      |   |        |  
|Cash paid during the period for interest                                                                           |  | $                           | 9      |   |      |   |       |  
|                                                                                                                   |  |                             |        |   |      |   |        |  
|Cash paid during the period for taxes                                                                              |  | $                           | 20     |   |      |   |       |  
|                                                                                                                   |  |                             |        |   |      |   |        |  



See accompanying Notes
to Condensed Consolidated Financial Statements



5



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##### Table of Contents

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES



Notes to Condensed Consolidated Financial Statements



(1) Organization



The condensed
consolidated financial statements included herein have been prepared by Tumbleweed Communications Corp. (Tumbleweed) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed
consolidated financial statements should be read in conjunction with Tumbleweeds audited financial statements and notes thereto included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed with the SEC on March
15, 2004.



The unaudited condensed consolidated financial
statements included herein reflect all adjustments (which include normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the financial position of Tumbleweed and its subsidiaries as of March 31, 2004, and
the results of operations and cash flows for the three months ended March 31, 2004 and 2003. The results for the three months ended March 31, 2004 and 2003 are not necessarily indicative of the results expected for the full fiscal year.



The accompanying consolidated condensed financial statements include the
accounts of Tumbleweed and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations of Tumbleweeds wholly-owned subsidiaries, Valicert, Inc.
(Valicert), Incubator, Limited (Incubator), and Corvigo, Inc. (Corvigo), have been included commencing June 23, 2003, March 15, 2004, and March 18, 2004, the effective dates of those acquisitions, respectively.



(2) Stock-Based Compensation



Tumbleweed accounts for its stock-based compensation arrangements for
employees using the intrinsic value method pursuant to Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees. As such, deferred stock-based compensation expense is recorded for fixed plan stock options when the fair
value of the underlying common stock on the date of grant exceeds the stock option exercise price or the purchase price for issuance or sales of common stock. Deferred stock-based compensation expense is being amortized on an accelerated basis over
the vesting period of the individual award consistent with the method described in Financial Accounting Standards Board (FASB) Interpretation 28.



In the three months ended March 31, 2004, Tumbleweed recorded deferred stock-based compensation expense of $1,397,000 for the difference at the effective
date of acquisition of Corvigo between the exercise price and the fair value of the common stock underlying the unvested options assumed upon the acquisition, multiplied by the ratio representing the remaining vesting period of the options assumed.
Tumbleweed recognized stock-based compensation expense of approximately $82,000 and $34,000, in the three months ended March 31, 2004 and 2003, respectively.



Had stock-based compensation expense for its stock-based compensation plan been determined consistent with the fair value approach set forth in Statement
of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation, Tumbleweeds net losses for the three months ended March 31, 2004 and 2003, respectively, would have been as follows (in thousands, except
per share amounts):



|                                                                                                     |  |                              |        |   |      |   |        |  
|---------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                     |  | Three Months Ended March 31, |       
|                                                                                                     |  | 2004                         |        |   | 2003 |  
|Net loss as reported                                                                                 |  | $                            | (531   | ) |      | $ | (2,482 | )
|Add: Stock-based compensation expense included in net loss                                           |  |                              | 82     |   |      |   | 34     |  
|Less: Total stock-based compensation expense determined under fair value based method for all awards |  | $                            | (1,406 | ) |      | $ | (1,686 | )
|                                                                                                     |  |                              |        |   |      |   |        |  
|Net loss pro forma                                                                                   |  | $                            | (1,855 | ) |      | $ | (4,134 | )
|Basic and diluted net loss per share as reported                                                     |  | $                            | (0.01  | ) |      | $ | (0.08  | )
|Basic and diluted net loss per share pro forma                                                       |  | $                            | (0.04  | ) |      | $ | (0.14  | )
|                                                                                                     |  |                              |        |   |      |   |        |  



6



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##### Table of Contents

For purposes of computing pro forma net loss, the fair value of each option grant was estimated on the
date of grant using a Black-Scholes option pricing model. The assumptions used to value the option grants are stated as follows:



|                        |  |                             |   |  |           |  
|----------------------- |  | --------------------------- | - |  | --------- | -
|                        |  | Three Months EndedMarch 31, |  
|                        |  | 2004                        |   |  | 2003      |  
|Expected life           |  | 4.0 years                   |   |  | 4.0 years |  
|Volatility              |  | 133                         | % |  | 143       | %
|Risk-free interest rate |  | 2.58                        | % |  | 4.16      | %
|Dividend yield          |  | 0                           | % |  | 0         | %



(3) Net Loss Per Share



Tumbleweed excludes potentially dilutive securities from
its diluted net loss per share computation when their effect would be antidilutive to net loss per share amounts. The following potential common shares were excluded from the net loss per share computation (in thousands):



|                                                                                                                                                                                                  |  |                              |  |      
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- |  | -----
|                                                                                                                                                                                                  |  | Three Months Ended March 31,
|                                                                                                                                                                                                  |  | 2004                         |  | 2003 
|Warrants and options for which the exercise price was less than the average fair market value of our common stock during the period (excluded
as inclusion would decrease our net loss per share) |  | 6,581                        |  | 1,004
|Warrants and options excluded due to the exercise price exceeding the average fair market value of our common stock during the
period                                                             |  | 1,828                        |  | 6,287
|                                                                                                                                                                                                  |  |                              |  |      
|Total potential common shares excluded from diluted net loss per share                                                                                                                            |  | 8,409                        |  | 7,291
|                                                                                                                                                                                                  |  |                              |  |      



(4) Business Combinations



On March 18, 2004, Tumbleweed completed the acquisition
of Corvigo, an anti-spam appliance vendor. The acquisition was entered into to strengthen Tumbleweeds position in the anti-spam and e-mail security markets and to accelerate Tumbleweeds distribution plans through the addition of
resellers already selling the Corvigo appliance. Since March 18, 2004, Corvigos results of operations have been included in Tumbleweeds consolidated condensed financial statements. The acquisition was accounted for using the purchase
method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. The purchase price of $42.3 million consisted of an exchange of
4,732,284 shares of Tumbleweeds common stock with a fair value of $32.8 million based on the fair value of Tumbleweeds stock on the date of the acquisition, cash paid of $6.0 million, an exchange of 386,000 options to purchase
Tumbleweeds common stock with a fair value of $2.7 million, including the intrinsic value of unvested options of $1.4 million, severances for former Corvigo employees of $97,000, and other acquisition-related costs of $633,000, consisting
primarily of legal fees, banking fees, and accounting fees.



The following is a summary of the allocation of the purchase price in the acquisition of Corvigo (in thousands):



|                                      |  |   |       
|------------------------------------- |  | - | ------
|Net tangible assets                   |  | $ | 2,191 
|Core/developed technology             |  |   | 3,250 
|Maintenance agreements                |  |   | 150   
|Customer base and reseller agreements |  |   | 1,850 
|Trademarks and tradenames             |  |   | 150   
|Goodwill                              |  |   | 34,660
|                                      |  |   |       
|Total                                 |  | $ | 42,251
|                                      |  |   |       



On March 15, 2004,
Tumbleweed completed the acquisition of Incubator, a reseller of Tumbleweeds products. The acquisition was entered into to expand Tumbleweeds sales in Europe. Since March 15, 2004, Incubators results of operations have been
included in Tumbleweeds consolidated condensed financial statements. The acquisition was accounted for using the purchase method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed
based on their estimated fair values on the acquisition date. The purchase price of $1.7 million consisted of an exchange of 224,278 shares of Tumbleweeds common stock with a fair value of $1.6 million based on the fair value of
Tumbleweeds stock on the date of the acquisition and other acquisition-related costs of $104,000 consisting of legal fees.



The following is a summary of the allocation of the purchase price in the acquisition of Incubator (in thousands):



|                                      |  |   |       |  
|------------------------------------- |  | - | ----- | -
|Net tangible liabilities              |  | $ | (493  | )
|Maintenance agreements                |  |   | 350   |  
|Customer base and reseller agreements |  |   | 450   |  
|Goodwill                              |  |   | 1,395 |  
|                                      |  |   |       |  
|Total                                 |  | $ | 1,702 |  
|                                      |  |   |       |  





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In the event that a certain sales goal is met in Tumbleweeds European sales region in the year
ending December 31, 2004, Tumbleweeds purchase price for Incubator would increase by the exchange of additional shares of Tumbleweeds common stock worth $770,000 plus 10% of the amount of Tumbleweeds European sales in excess of the
sales goal for the year ending December 31, 2004. In addition, in the event that certain sales goals are met in Tumbleweeds European sales region for both the year and the two year period, respectively, ending December 31, 2005,
Tumbleweeds purchase price for Incubator would increase by the exchange of additional shares of Tumbleweeds common stock worth $1,000,000 plus 10% of the amount of Tumbleweeds European sales in excess of the sales goal for the year
ending December 31, 2005.



On June 23, 2003, Tumbleweed
acquired Valicert, which develops and licenses secure Internet communications and identity validation software for file transfer, financial messaging, and business process integration. The acquisition was entered into to combine the two companies
into a single, more competitive industry participant. Since June 23, 2003, Valicerts results of operations have been included in Tumbleweeds consolidated condensed financial statements. The acquisition was accounted for using the
purchase method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. The purchase price of $17.0 million consisted of an exchange
of 9,713,634 shares of Tumbleweeds common stock with a fair value of $13.0 million based on the average fair value of Tumbleweeds stock two days before and two days after the announcement date of February 18, 2003, assumed stock options
with a fair value of $1.7 million, severances for former Valicert employees of $276,000, and other acquisition-related costs of $2.0 million, consisting primarily of legal fees, investment banking fees, financial printing fees, accounting fees, and
proxy mailing fees.



The following is a summary of the
allocation of the purchase price in the acquisition of Valicert (in thousands):



|                                      |  |   |        |  
|------------------------------------- |  | - | ------ | -
|Net tangible liabilities              |  | $ | (1,647 | )
|Core/developed technology             |  |   | 2,600  |  
|Maintenance agreements                |  |   | 700    |  
|Customer base and reseller agreements |  |   | 1,400  |  
|Trademarks and tradenames             |  |   | 200    |  
|In-process research and development   |  |   | 100    |  
|Purchases orders (license)            |  |   | 300    |  
|Goodwill                              |  |   | 13,308 |  
|                                      |  |   |        |  
|Total                                 |  | $ | 16,961 |  
|                                      |  |   |        |  



A summary of
intangible assets as of March 31, 2004 follows (in thousands):



|                                      |  |                               |  |                     |        |                         |   |        |     |  |   |       
|------------------------------------- |  | ----------------------------- |  | ------------------- | ------ | ----------------------- | - | ------ | --- |  | - | ------
|                                      |  | Amortizationperiod (in years) |  | Grosscarryingamount |        | Accumulatedamortization |   |        | Net
|Core/ developed technology            |  | 3 to 4                        |  | $                   | 5,850  |                         | $ | (695   | )   |  | $ | 5,155 
|Customer base and reseller agreements |  | 3                             |  |                     | 3,700  |                         |   | (385   | )   |  |   | 3,315 
|Maintenance agreements                |  | 3 to 4                        |  |                     | 1,200  |                         |   | (184   | )   |  |   | 1,016 
|Acquired workforce                    |  | 1                             |  |                     | 476    |                         |   | (258   | )   |  |   | 218   
|Trademarks and trade names            |  | 4                             |  |                     | 350    |                         |   | (46    | )   |  |   | 304   
|                                      |  |                               |  |                     |        |                         |   |        |     |  |   |       
|                                      |  |                               |  | $                   | 11,576 |                         | $ | (1,568 | )   |  | $ | 10,008
|                                      |  |                               |  |                     |        |                         |   |        |     |  |   |       



The amounts above
exclude intangible assets related to the acquisition of Valicert for Purchase orders (license) and In-process research and development in the amount of $300,000 and $100,000, respectively, as these amounts were written off in full in 2003.



The estimated amortization for each of the fiscal years
subsequent to March 31, 2004, is as follows (in thousands):



|                         |  |   |       
|------------------------ |  | - | ------
|Year Ending December 31, |  |  
|2004                     |  | $ | 2,709 
|2005                     |  |   | 3,321 
|2006                     |  |   | 2,508 
|2007                     |  |   | 1,238 
|2008                     |  |   | 232   
|                         |  |   |       
|                         |  | $ | 10,008
|                         |  |   |       



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Goodwill represents the excess of the purchase price over the fair value of acquired net tangible and
identified intangible assets. In accordance with the provisions of SFAS 142, Goodwill and Other Intangible Assets, the goodwill acquired in the Valicert, Incubator, and Corvigo acquisitions will not be amortized, but instead, the goodwill
balances will be tested for impairment at least annually and more frequently if certain impairment conditions exist. Any future impairment loss related to the goodwill recorded in connection with the acquisitions of Valicert, Incubator, and Corvigo
will not be deductible by Tumbleweed for federal income tax purposes. During the last two quarters of 2003, Tumbleweed reduced its goodwill balance by $50,000 due to actual expenditures for severances for former Valicert employees and other
acquisition-related costs being less than previously estimated.



Pro Forma Results



The following pro
forma summary presents Tumbleweeds consolidated results of operations for the three months ended March 31, 2004 and 2003 as if the acquisitions of Valicert, Incubator, and Corvigo had been consummated at the beginning of the earliest period.
The pro forma consolidated results of operations include certain pro forma adjustments, including amortization of intangible assets, amortization of deferred compensation and the elimination of certain merger-related charges incurred by Valicert,
prior to the merger with Tumbleweed, in the three months ended March 31, 2003. The pro forma results do not give effect to the deferred revenue adjustments on revenue as the adjustments are directly related to the mergers and the effects are
non-recurring. Under the purchase method of accounting, the deferred revenue balances of Valicert, Incubator, and Corvigo were reduced by $1.0 million, $390, 000, and $793,000, respectively, to the fair value of the related obligations as of the
acquisition dates of June 23, 2003; March 15, 2003; and March 18, 2003, respectively. These adjustments have had the effect of reducing the amount of revenue the combined company recognized in the three months ended March 31, 2004 and will also
affect the amount of revenue the combined company will recognize in future periods compared to the amount of revenue Valicert, Incubator, and Corvigo would have recognized in the same periods absent the mergers.



Pro forma results for the three months ended March 31, 2004 and 2003 are as
follows (in thousands, except per share amounts):



|                                     |  |                             |        |   |      |   |        |  
|------------------------------------ |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                     |  | Three Months EndedMarch 31, |       
|                                     |  | 2004                        |        |   | 2003 |  
|Revenues                             |  | $                           | 10,708 |   |      | $ | 9,122  |  
|Net loss                             |  | $                           | (3,579 | ) |      | $ | (4,751 | )
|Net loss per sharebasic and diluted |  | $                           | (0.08  | ) |      | $ | (0.11  | )
|                                     |  |                             |        |   |      |   |        |  



The pro forma results
are not necessarily indicative of those that would have actually occurred had the acquisitions taken place at the beginning of the periods presented.



Merger-related and Other Costs



During the last three quarters of 2003, Tumbleweed recorded merger-related and other costs of $2.9 million consisting of $1.1 million of severance costs
for Tumbleweed employees terminated in connection with the Valicert acquisition, $596,000 of merger-related marketing programs, $174,000 of other merger-related costs, and a $996,000 charge related to anticipated losses on an operating lease. The
operating lease was assumed during the acquisition of Interface, Inc. in 2000 and covers approximately 13,000 square feet of office space in Slough, United Kingdom. The lease is for a term ending in 2020 with quarterly rent payments of approximately
$65,000. This office space had been subleased to a tenant who was providing Tumbleweed with quarterly rent payments of approximately $65,000 until the sublease was terminated effective July 2003. Anticipated future sublease rental income is not
expected to cover the rent expense due to a weak office rental market in and around Slough. The following table describes merger-related and other expenses recorded in 2003 (in thousands):



|                                   |  |                       |       |                    |   |        |                                  |  |   |    
|---------------------------------- |  | --------------------- | ----- | ------------------ | - | ------ | -------------------------------- |  | - | ---
|                                   |  | Total chargesfor 2003 |       | CumulativePayments |   |        | Accrued balance atMarch 31, 2004
|Severance costs                    |  | $                     | 1,143 |                    | $ | (1,046 | )                                |  | $ | 97 
|Anticipated operating lease losses |  |                       | 996   |                    |   | (279   | )                                |  |   | 717
|Merger-related marketing programs  |  |                       | 596   |                    |   | (596   | )                                |  |   |   
|Other merger-related costs         |  |                       | 174   |                    |   | (174   | )                                |  |   |   
|                                   |  |                       |       |                    |   |        |                                  |  |   |    
|Total                              |  | $                     | 2,909 |                    | $ | (2,095 | )                                |  | $ | 814
|                                   |  |                       |       |                    |   |        |                                  |  |   |    



Accrued merger-related
and other costs at March 31, 2004 also includes liabilities of $97,000 for severance costs for former Corvigo employees and $669,000 for other merger-related costs arising from the Incubator and Corvigo acquisitions consisting primarily of legal
fees, banking fees, and accounting fees. The severance costs for former Corvigo employees and other merger-related costs arising from the Incubator and Corvigo acquisitions were recorded as goodwill in the purchase price allocations for those
acquisitions. Severance costs and payments for other merger-related costs will be paid in 2004. Payments for anticipated remaining losses on the operating lease are expected to occur over the life of the lease, which ends in 2020.



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(5) Acquired Workforce



In September 2003, Tumbleweed issued 86,538 shares of stock to a company to convert certain former contract engineers to employees in its research and
development center in Bulgaria. Tumbleweed recorded an acquired workforce intangible asset of $476,000 to recognize the fair value of the stock issued. Tumbleweed is amortizing this intangible asset over its estimated useful life of one year. During
the three months ended March 31, 2004, Tumbleweed recognized amortization expense of approximately $119,000 relating to the acquired workforce intangible asset.



(6) Comprehensive Loss



Comprehensive loss includes Tumbleweeds net loss as well as foreign currency translation adjustments, recorded net of tax. Comprehensive loss for
the three months ending March 31, 2004 and 2003, respectively, is as follows (in thousands):



|                                                          |  |                             |      |   |      |   |        |  
|--------------------------------------------------------- |  | --------------------------- | ---- | - | ---- | - | ------ | -
|                                                          |  | Three Months EndedMarch 31, |     
|                                                          |  | 2004                        |      |   | 2003 |  
|Net loss                                                  |  | $                           | (531 | ) |      | $ | (2,482 | )
|Other comprehensive income (loss)translation adjustments |  |                             | (19  | ) |      |   | 157    |  
|                                                          |  |                             |      |   |      |   |        |  
|Comprehensive loss                                        |  | $                           | (550 | ) |      | $ | (2,325 | )
|                                                          |  |                             |      |   |      |   |        |  



(7) Segment Information



As defined by SFAS 131, Disclosure About Segments of
an Enterprise and Related Information, Tumbleweeds chief operating decision-makers are its Chief Executive Officer and its Chief Operating Officer. These officers 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 is the information presented in the accompanying
consolidated statement of operations. Tumbleweed operates in a single reporting segment as its three operating segments, based on geographic regions, have similar economic characteristics.



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



|              |  |                              |        |      |   |      
|------------- |  | ---------------------------- | ------ | ---- | - | -----
|              |  | Three Months Ended March 31,
|              |  | 2003                         |        | 2003
|North America |  | $                            | 8,905  |      | $ | 5,199
|Europe        |  |                              | 843    |      |   | 82   
|Asia          |  |                              | 377    |      |   | 500  
|              |  |                              |        |      |   |      
|Total         |  | $                            | 10,125 |      | $ | 5,781
|              |  |                              |        |      |   |      



Substantially all of
Tumbleweeds long-lived assets are located in the United States.



(8)
Contingencies



In July 2000, three complaints were filed
by David H. Zimmer, Congressional Securities, Inc. and others against Interface Systems, Inc. (a company Tumbleweed acquired in 2000) and various additional defendants, including Interfaces prior president and chief executive officer, Robert
A. Nero. Plaintiffs most recent complaint sought compensatory damages for losses resulting from not selling their Interface stock from March 14, 2000 to the end of March 2000 and for losses from purchases of Interface stock from March 14, 2000
through April 12, 2000. In March 2003, the court dismissed all claims against Interface and dismissed all claims against Mr. Nero, except a breach of fiduciary duty claim to the extent that claim arises from Michigan common law. In April 2003, Mr.
Nero filed an answer and a counterclaim against Mr. Zimmer and Congressional Securities, Inc. seeking contribution and indemnity. The parties remaining in this case agreed to settle the matter, and the Court dismissed the case with prejudice in
February 2004.



In December 2001, certain plaintiffs filed a
class action lawsuit in the United States District Court for the Southern District of New York on behalf of purchasers of the common stock of Valicert, alleging violations of federal securities laws. In re Valicert, Inc. Initial Public Offering
Securities Litigation, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS). The operative amended complaint is brought on purported behalf of all persons who purchased Valicert common
stock from the date of its July 27, 2000 initial public offering through December 6, 2000. It names as defendants



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Valicert, its former chief executive officer, its chief financial officer (the Valicert Defendants), as well
as an investment banking firm that served as an underwriter for the IPO. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, on the grounds that
the registration statement for the IPO did not disclose that: (1) the underwriter agreed to allow certain customers to purchase shares in the IPO in exchange for excess commissions to the paid to the underwriter; and (2) the underwriter arranged for
certain customers to purchase additional shares in the aftermarket at predetermined prices. The complaint also appears to allege that false or misleading analyst reports were issued. The complaint does not claim any specific amount of damages.
Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial purposes. In February 2003, the Court issued a ruling on all
defendants motions to dismiss, denying Valicerts motion to dismiss the claims under the Securities Act of 1933, but granting Valicerts motion to dismiss the claims under the Securities Exchange Act of 1934.



In June 2003, Valicert accepted a settlement proposal presented to all issuer
defendants in this case. Under the proposed settlement, the plaintiffs will dismiss and release all claims against the Valicert Defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring
the issuers in all the consolidated cases, and the assignment or surrender of control to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount,
if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all of the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, Valicert
would be responsible to pay its pro rata portion of the shortfall, up to the amount of the deductible retention under its insurance policy, which is $500,000. The timing and amount of payments that Valicert could be required to make under the
proposed settlement will depend on several factors, principally the timing and amount of any payment required by the insurers pursuant to the $1 billion guaranty. The proposed settlement is subject to approval of the Court, which cannot be assured.
The accompanying consolidated financial statements do not include a reserve for any potential loss, as Tumbleweed does not consider a loss to be probable at this time.



In September 2002, Tumbleweed received a letter from Entrust, Inc. indicating that it may be interested in licensing the
technology covered by U.S. Patent No. 6,393,568, Encryption and Decryption System and Method with Content Analysis Provision, issued to Entrust. In October 2002, Tumbleweed sent a letter to Entrust indicating that Entrust may be interested in
licensing the technology covered by four patents issued to Tumbleweed. In February 2003, Tumbleweed received a letter from Entrust indicating that Tumbleweed may have an interest in three additional patents issued to Entrust. In April 2003,
Tumbleweed filed with the U.S. Patent and Trademark Office a request for interference with Entrusts Patent No. 6,393,568. In January 2004, Entrust and Tumbleweed entered into a cross license agreement covering the aforementioned patents and
selected others, as well as patents issuing from certain patent applications that have been filed or that may be filed by either company over the next three years. As part of the agreement, the companies resolved the patent interference proceeding,
and Entrust assigned to Tumbleweed U.S. Patent No. 6,393,568 in return for a financial consideration.



In June 2003, Tumbleweed was served with a summons and first amended complaint, captioned Liu v. Credit Suisse First Boston, et alia, alleging the
violation of federal and state securities laws, purportedly on behalf of persons who acquired the common stock of Tumbleweed (other than purchasers of Tumbleweeds initial public offering) from August 6, 1999 to October 18, 2000. The case is
now pending in the United States District Court for the Southern District of New York, where the Court held a status conference in September 2003. At the status conference, Tumbleweed pointed out, and plaintiffs counsel conceded, that the
named plaintiffs lacked standing to pursue the action because they had not purchased any shares of any of the issuer defendants then in the case. In October 2003, plaintiffs filed a motion for leave to file a second amended complaint, which
Tumbleweed has opposed. An adverse outcome could harm Tumbleweeds business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not
include a reserve for any potential loss, as Tumbleweed does not consider a loss to be probable at this time.



All costs incurred as a result of these legal proceedings and claims are charged to expense as incurred.



Tumbleweed indemnifies its customers from third party claims of intellectual
property infringement relating to the use of its products. Historically, costs related to these guarantees have not been significant and Tumbleweed is unable to estimate the potential impact of these guarantees on its future results of operations.



(9) Recent Accounting Pronouncements



In November 2002, the Emerging Issues Task Force (EITF) reached
a consensus on Issue 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple
revenue-generating activities. Tumbleweed is required to adopt the provisions of EITF 00-21 as of January 1, 2004. The adoption of EITF 00-21 did not have a material impact on its financial position or results of operations.



In March 2004, the EITF reached consensus on Issue 03-01 (EITF
03-01), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure
requirements for investments that are deemed to be temporarily impaired. The accounting guidance of EITF 03-01 is effective for fiscal years beginning after June 15, 2004, while the disclosure requirements are effective for fiscal years ending after
June 15, 2004. Tumbleweed does not believe that the adoption of EITF 03-01 will have a material impact on its financial position or results of operations.



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ITEM 2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The following discussion should be read in conjunction with the consolidated condensed financial statements and the accompanying notes to this
Quarterly Report on Form 10-Q and Tumbleweeds Annual Report on Form 10-K for 2003 filed with the SEC, including any amendments to our Annual Report filed with the SEC, as well as Managements Discussion and Analysis of Financial Condition
and Results of Operations included therein. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking
statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and those listed under Risks and Uncertainties That You Should Consider Before Investing In Tumbleweed.



Overview



Tumbleweed Communications Corp. (Tumbleweed or we)
is a leading provider of secure Internet messaging software products for enterprises and government. Our solutions are used by companies when e-mail, file transfer or Web communications are mission-critical. By making Internet communications secure,
reliable and automated, our products help customers significantly reduce their cost of doing business.



We have more than 900 enterprise customers who use our products to connect with over ten thousand corporations and millions of end-users.
Tumbleweeds market focus is in the financial services, healthcare and insurance, government and enterprise markets. Our customers include ABN Amro Bank, Catholic Healthcare West, Bank of America Securities, JP Morgan Chase & Co., The
Regence Group (Blue Cross/Blue Shield), Society for Worldwide Interbank Financial Telecommunication (SWIFT), St. Lukes Episcopal Healthcare System, the US Food and Drug Administration, and the US Navy and Marine Corps.



Our software solutions are:



| |  | Email Firewall and Dynamic Anti-Spam Service to protect companies from spam junk email, viruses, and to implement content filtering for regulatory compliance;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Secure File Transfer for automating the transfer of payments files, Electronic Data Interchange (EDI) files, check images and other business-critical information
between corporations, banks and processors;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Secure Email and Document Delivery for protecting confidential information such as patient records and financial statements;
| | - | ----------------------------------------------------------------------------------------------------------------------------



| |  | Identity Validation to authorize users to access secure computing systems and to digitally sign files and transactions; and
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | MailGate Appliance for protection from spam and other email threats at the gateway.
| | - | -------------------------------------------------------------------------------------



Overview of the Three Month Period Ended March 31, 2004



Our operating results during the three months ended March 31, 2004 showed improvement relative to the same three months in
2003 in revenue, net loss, and cash flow. Our growth in revenue was driven by a number of factors including increased customer adoption of our email firewall products, revenues from the secure file transfer and identity validation products we
acquired in the Valicert acquisition, and growth in our targeted customer sectors in the financial services, health care, and government industries. Our net loss was reduced due to our growth in revenues and our continuing focus on generating cost
efficiencies including our development centers in Bulgaria and India which have allowed us to augment our research and development and services offerings at a relatively lower cost structure. We had positive cash flow from operations during the
three months ended March 31, 2004 due to our reduction in net loss and lower accounts receivable balance due to an increase in collections from our customers.



Key Performance Indicators



Our key performance indicators are our bookings and sales pipeline. We measure bookings as the dollar value of contractual agreements entered into with
customers in the period that result in either revenue in the period, deferred revenue at the end of the period, or future installments to be billed and received from the customer that are not due and payable at the end of the period or for which the
software has not yet been shipped to the customer at the end of the period. In addition to measuring the level of bookings in total in each period, we track bookings for each of our software solutions, bookings by customer industry, bookings by
geographical region, and bookings by distribution channel. Generally, an increase in our bookings will result in an increase in our revenues. We measure sales pipeline as the size of the forecasted dollar value of the sales opportunities we are
addressing in current and future fiscal



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quarters. In addition to measuring the size of our sales pipeline in total, we track the sales pipeline for each of our
software solutions and the sales pipeline for each geographic region. We also track how our individual sales opportunities advance through the sales pipeline towards a contract with a customer. Generally an increase in our sales pipeline will result
in an increase in our future bookings and future revenues.



Outlook



We believe that our success in 2004 will depend
particularly on our ability to increase customer adoption of our email firewall, secure file transfer, anti-spam appliance, and identity validation products, our ability to successfully integrate the Valicert, Incubator, and Corvigo acquisitions,
and our ability to maintain tight control over expenses and cash. We believe that key risks include overall economic conditions and the overall level of information technology spending; economic and business conditions within our target customer
sectors in the financial services, health care, and government industries; growing our sales channels in Europe and Japan; and competitive factors in our rapidly changing industry. Our prospects must be considered in light of the risks, expenses and
difficulties encountered by companies at an early stage of development, particularly given that we operate in new and rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful
in addressing such risks and difficulties. Please refer to the Risks and Uncertainties section for additional information.



Other Recent Events



On March 18, 2004, we completed the acquisition of Corvigo. The purchase price of $42.3 million consisted of an exchange of 4,732,284 shares of
Tumbleweeds common stock with a fair value of $32.8 million based on the fair value of Tumbleweeds stock on the date of the acquisition, cash paid of $6.0 million, an exchange of 386,000 options to purchase Tumbleweeds common stock
with a fair value of $2.7 million, including the intrinsic value of unvested options of $1.4 million, severances for former Corvigo employees of $97,000, and other acquisition-related costs of $633,000, consisting primarily of legal fees, banking
fees, and accounting fees.



On March 15, 2004, we completed the
acquisition of Incubator. The purchase price of $1.7 million consisted of an exchange of 224,278 shares of our common stock with a fair value of $1.6 million and other acquisition-related costs of $104,000 consisting of payments for legal fees.



On June 23, 2003, we completed the acquisition of Valicert.
The purchase price of $17.0 million consisted of an exchange of 9,713,634 shares of our common stock with a fair value of $13.0 million, assumed stock options with a fair value of $1.7 million, severances for former Valicert employees of $276,000,
and other acquisition-related costs of $2.0 million consisting primarily of payments for legal fees, investment banking fees, financial printing fees, accounting fees, and proxy mailing fees.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates
and judgments in determining the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We regularly evaluate our estimates, including those related to revenue recognition,
customer arrangements, collectibility of accounts receivable, valuation of assets, and contingencies and litigation. When making estimates, we consider our historical experience, our knowledge of economic and market factors and various other
assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.



We believe that the following critical accounting policies represent areas where significant judgments and estimates have been used in the preparation
of our consolidated financial statements.



Revenue Recognition



We derive our revenue from three sources: (i) product
revenue, which includes license fees, subscription-based license fees, transaction-based license fees, and hosting arrangements; (ii) service revenue, which includes support and maintenance fees, consulting fees, and training fees; and (iii)
intellectual property and other revenue which includes patent license agreement fees and the sale of distribution rights. As described below, significant management judgments and estimates must be made and used in connection with the revenue
recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates.



We recognize revenue in accordance with Statement of Position
(SOP) 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions(SOP 98-9).



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We make significant judgments related to revenue recognition. Specifically, in connection with each transaction
involving our products, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) our fee is fixed or determinable, and (iv) collectibility is probable. We apply these criteria as discussed below.



| |  | Persuasive evidence of an arrangement exists. We require a written contract, signed by both the customer and us, or a purchase order from those customers that have previously
negotiated a standard end-user license arrangement or volume purchase agreement with us prior to recognizing revenue on an arrangement.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Delivery has occurred. We deliver software to our customers physically or electronically. For physical deliveries, our standard transfer terms are typically FOB shipping
point. For electronic deliveries, delivery occurs when we provide the customer access codes or keys that allow the customer to take immediate possession of the software on its hardware.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The fee is fixed or determinable. Our determination that an arrangement fee is fixed or determinable depends principally on the arrangements payment terms. Our standard
payment terms require the arrangement fee to be paid within 90 days. Where these terms apply, we regard the fee as fixed or determinable, and we recognize revenue upon delivery (assuming other revenue recognition criteria are met). If the payment
terms do not meet this standard, which we refer to as extended payment terms, we do not consider the fee to be fixed or determinable and generally recognize revenue when customer installments are due and payable.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Collectibility is probable. To recognize revenue, we must judge collectibility of the arrangement fees, which we do on a customer-by-customer basis pursuant to our credit
review policy. We typically sell to customers with whom we have a history of successful collection. For new customers, we evaluate the customers financial position and ability to pay. If we determine at any time that collectibility is not
probable based upon our credit review process or the customers payment history, we recognize revenue when cash is collected.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We allocate revenue on software transactions (referred to as an arrangement in the accounting literature) involving multiple elements to each
undelivered element based on their respective fair values. The residual is allocated to the product license. Our determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (VSOE). We
limit our assessment of VSOE for each element to the price charged when the same element is sold separately.



Valuation of Allowance for Doubtful Accounts



We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. A considerable amount of judgment is required when we assess the realization
of receivables, including assessing the probability of collection and the current credit-worthiness of each customer. We must make estimates of the collectibility of our accounts receivables. We specifically analyze accounts receivable, including
review of historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, aging of the balance and estimated collectibility percentages for different aging ranges, geographic and industry mix, and changes in our
customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be
required which would result in an additional general and administrative expense in the period such determination is made.



Valuation of Long-Lived Assets and Goodwill



We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors we consider important, which could trigger an impairment review, include the following:



| |  | significant underperformance relative to expected historical or projected future operating results;
| | - | ---------------------------------------------------------------------------------------------------



| |  | significant changes in the manner or our use of the acquired assets or the strategy for our overall business;
| | - | -------------------------------------------------------------------------------------------------------------



| |  | significant negative industry or economic trends;
| | - | -------------------------------------------------



| |  | significant decline in our stock price for a sustained period; and
| | - | ------------------------------------------------------------------



| |  | our market capitalization relative to net book value.
| | - | -----------------------------------------------------



When we determine that the carrying value of long-lived assets, and goodwill prior to the adoption of SFAS 142, may not be recoverable upon the existence
of one or more of the above indicators of impairment, and such carrying value is less than projected undiscounted cash flows attributed to the asset, we measure any impairment based on the amount by which the carrying amount of the assets exceeds
the fair value of the assets.



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We evaluate goodwill on an annual basis for indications of impairment based on our fair value as
determined by our market capitalization in accordance with SFAS 142, Goodwill and Other Intangible Assets.If this evaluation indicates that the value of the goodwill may be impaired, we make an assessment of the impairment of the goodwill
using the two-step method prescribed by SFAS 142. Any such impairment charge could be significant and have a material adverse effect on our reported financial statements. We did not record any impairment charges on our goodwill during the three
months ended March 31, 2004 or 2003, respectively. As of March 31, 2004, we had goodwill of $50.6 million.



Accrual for Anticipated Operating Lease Losses



In the second quarter of 2003 we recognized a charge of $996,000 related to potential losses on an operating lease in Slough, United Kingdom that was included in our consolidated statement of operations as
Merger-related and other costs. The charge was estimated to include required dilapidations, remaining lease liabilities, and brokerage fees, offset by estimated sublease income. Estimates related to sublease costs and income are based on assumptions
regarding the period required to locate and contract with a sublessee and sublease rates. Each reporting period we review these estimates, and to the extent that our assumptions change, the ultimate charge for the loss on this operating lease could
vary from our current estimates.



RESULTS OF OPERATIONS



Three Month Periods Ended March 31, 2004 and 2003



Revenue. Revenue, which consists of product revenue, service revenue and intellectual
property and other revenue, results from new contracts and backlog. We define backlog as deferred revenue, contractual commitments that are not due and payable as of the balance sheet date, or for which collectibility is in doubt, and/or for which
the product or service has not yet been delivered. Product revenue consists of license fees, subscription-based license fees, and transaction-based license fees. Service revenue includes support and maintenance fees, consulting fees, and training
fees. Intellectual property and other revenue consists of patent license agreement fees and the sale of distribution rights. Total revenue for the three months ended March 31, 2004 increased to $10.1 million from $5.8 million for the same three
months in 2003. The increase in total revenue was primarily due to a $2.3 million increase in support and maintenance revenue, a $1.4 million increase in license revenue, and a $457,000 increase in consulting revenue.



Product revenue increased to $4.0 million for the three months ended March
31, 2004 from $2.6 million for the same three months in 2003. The increase in product revenue was primarily due to a $1.4 million increase in license revenue driven by sales of the secure file transfer and identity validation products that we
acquired in the Valicert acquisition with no comparable revenue in 2003.



Service revenue increased to $5.6 million for the three months ended March 31, 2004 from $2.9 million for the same three months in 2003. The increase in service revenue was primarily due to a $2.3 million increase in
support and maintenance revenue and a $457,000 increase in consulting revenue. Support and maintenance revenue increased due to revenue growth in our installed customer base, an expansion of our customer base due to the Valicert acquisition, and the
successful customer acceptance of our dynamic anti-spam service which was released during the three months ended June 30, 2003 and is sold on a subscription service fee basis. Consulting revenue increased due to the recognition of $672,000 of
revenue as a result of a prepaid consulting contract that had an expiration clause occurring in the three months ended March 31, 2004. As a result, the portion of that consulting contract that was in deferred revenue at December 31, 2003, was
recognized in the three months ended March 31, 2004.



Intellectual property and other revenue increased to $570,000 for the three months ended March 31, 2004 from $281,000 for the same three months in 2003. The increase in intellectual property and other revenue was due to revenues from patent
license agreements in the three months ended March 31, 2004 with no comparable revenue for the same three months in 2003. This increase was offset by revenue from the sale of distribution rights recognized during the three months ended March 31,
2003 of $281,000 with no comparable revenue for the same three months in 2004.



Cost of Revenue. Cost of revenue is comprised of product costs and service costs and the amortization of core/developed technology relating to the Valicert and Corvigo acquisitions. Product cost is primarily comprised of royalties
paid to third parties for software licensed by us for inclusion in our products and the cost of hardware included in our software appliances. Service costs are comprised primarily of employee and employee-related costs for customer support and
consulting and contract development projects with third parties. Total cost of revenue increased to $1.5 million for the three months ended March 31, 2004 from $1.4 million for the same three months in 2003. Total cost of revenue increased due to
the inclusion of $244,000 of amortization of core/developed technology relating to the Valicert and Corvigo acquisitions in the three months ended March 31, 2004 with no comparable costs for the same three months in 2003, partially offset by a
$202,000 decrease in service costs.



The decrease in service
costs was primarily due to decreases in employee and employee-related costs and allocated overhead charges. Employee and employee-related costs decreased by $133,000 due to the transfer of a portion of our customer support and consulting functions
to our employees in Bulgaria and India, resulting in a lower cost structure that has allowed us to increase our total customer support and consulting headcount to 41 employees at March 31, 2004 from 25 employees at March 31, 2003 while reducing
overall employee-related costs. Allocated overhead costs decreased by $54,000 due to a reduction in our allocable cost base caused by our reduction in information technology spending and our reduction in facility costs.



Research and Development Expenses. Research and development expenses are comprised of
employee and employee-related costs and other costs required for the development and quality assurance of our products. Research and development expenses for the



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three months ended March 31, 2004 increased to $2.9 million from $1.9 million for the same three months in 2003. The
increase in research and development expenses was primarily due to increases in employee and employee-related costs, depreciation expenses, and travel expenses. Employee and employee-related costs increased by $781,000 due to an increase in
headcount to 159 employees at March 31, 2004 from 46 employees at March 31, 2003 driven by our efforts to broaden and upgrade our products including the addition of employees from the Valicert and Corvigo acquisitions. Depreciation expenses
increased by $87,000 due to the establishment of our development centers in Bulgaria and India with no comparable costs in the three months ended March 31, 2003. Travel expenses increased by $54,000 due to due to increased geographical dispersion of
our engineering workforce.



Sales and Marketing Expenses. Sales and
marketing expenses are comprised of salaries, commission expenses, travel expenses, other related employee costs, and costs associated with marketing programs. Sales and marketing expenses for the three months ended March 31, 2004 increased to $4.7
million from $3.4 million for the same three months in 2003. The increase in sales and marketing expenses was due to a $1.3 million increase in employee and employee-related costs, including commissions expenses, due to an increase in headcount to
91 employees at March 31, 2004 from 42 employees at March 31, 2003. The increase in sales and marketing employees was driven by our efforts to increase our marketing initiatives and expand our sales presence, including the acquisitions of Valicert,
Incubator, and Corvigo. Our increased sales also increased commission expenses.



General and Administrative Expenses. General and administrative expenses consist primarily of employee and employee-related and support costs for our administrative, finance, legal, and human resources departments as well as public
reporting costs, bad debt expense, and professional fees including intellectual property enforcement and protection costs. General and administrative expenses for the three months ended March 31, 2004 decreased to $1.3 million from $1.4 million for
the same three months in 2003. The decrease in general and administrative expenses was primarily due to a $59,000 decrease in legal expenses due to costs associated with the eBay patent matter in the three months ended March 31, 2003. The settlement
of our lawsuit and signing of a cross-license agreement with eBay in the fourth quarter of 2003 reduced costs associated with this matter in the three months ended March 31, 2004.



Stock-based Compensation Expense. Stock-based compensation expense consists of the amortization of deferred stock compensation
recorded as a result of stock option grants to non-employees, unvested options assumed in the Valicert and Corvigo acquisitions, options granted to employees at exercise prices less than the fair value of the underlying stock on the grant date, and
the vesting acceleration of certain employees stock options, net of credits related to stock options granted to employees who were later terminated. Stock-based compensation expense for the three months ended March 31, 2004 increased to
$82,000 from $34,000 for the same three months in 2003. The increase in stock-based compensation expense was due to the amortization of deferred stock compensation resulting from unvested options assumed in the Valicert and Corvigo acquisitions in
the three months ended March 31, 2004 with no comparable expense in the same three months in 2003.



Amortization of intangible assets. Amortization of intangible assets was $339,000 for the three months ended March 31, 2004. Amortization of intangible assets and write-off of in-process research and
development resulted from the acquisitions of Valicert and Corvigo and the conversion, in the third quarter of 2003, of certain former contract engineers to employees in our research and development center in Bulgaria. The remaining intangible
assets will be amortized over their estimated useful lives of one to five years. No similar intangible asset amortization charges were recorded for the same three months in 2003.



Other income, net. Other income, net, is primarily comprised of interest income earned on investment securities, interest expense
paid on outstanding debt, and the sale in the three months ended March 31, 2004 of a legacy product line to a third party. The increase in other income, net, is primarily due to income of approximately $100,000 recorded from the sale of the legacy
product line in the three months ended March 31, 2004 with no comparable income for the same three months in 2003.



LIQUIDITY AND CAPITAL RESOURCES



Since inception, we have financed our operations primarily through the issuance of equity securities. As of March 31, 2004, 2003, we had approximately
$23.4 million in cash and cash equivalents.



Net cash provided
by operating activities for the three months ended March 31, 2004 was $1.5 million. Net cash used in operating activities for the same three months in 2003 was $2.3 million. Net cash provided by operating activities for the three months ended March
31, 2004 was primarily due to a $2.2 million adjustment to our net loss of $531,000 due to a decrease in accounts receivable, net of the acquisitions of Incubator and Corvigo. Accounts receivable, net of the acquisitions of Incubator and Corvigo,
decreased due to the collection in three months ended March 31, 2004 of a $3.3 million receivable that was outstanding at December 31, 2003. Net cash used in operating activities in the three months ended March 31, 2003 was primarily the result of
our net loss of $2.5 million for that period.



Net cash used in
investing activities for three months ended March 31, 2004 increased to $3.7 million from $64,000 for the same three months in 2003. Net cash used in investing activities for three months ended March 31, 2004 was comprised of $3.4 million for



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the acquisition of Incubator and Corvigo, net of cash acquired, and $325,000 of purchases of property and equipment. The
$3.4 million outflow for the acquisitions of Incubator and Corvigo includes the impact of a $6.0 million payment as part of the purchase price for Corvigo. Net cash used in investing activities for three months ended March 31, 2003 was comprised of
purchases of property and equipment.



Net cash provided by
financing activities for the three months ended March 31, 2004 was $234,000. Net cash used in financing activities for the same three months in 2003 was $35,000. Net cash provided by financing activities for the three months ended March 31, 2004 was
comprised of an inflow of $301,000 for the proceeds from the issuance of common stock and warrants offset by an outflow $67,000 related to debt repayments on outstanding debt originally assumed in the acquisition of Valicert. Net cash used in
financing activities for the three months ended March 31, 2003 resulted primarily from the repayment of an equipment loan facility that was repaid in full in 2003.



As of March 31, 2004, our principal commitments consisted of obligations related to outstanding operating leases, a bank
loan, and unconditional purchase obligations. We do not anticipate a substantial increase in operating lease obligations in the immediate future.



In June 1999, we entered into an operating lease covering approximately 40,000 square feet of office space in Redwood City, California that was scheduled
to expire in November 2004. During the three months ended September 30, 2003 we renewed this lease in advance of the scheduled termination date at a lower monthly rent cost in exchange for an extension of the lease term. The renewed lease expires in
July 2008 with current monthly rent payments of approximately $73,000. In September 2000, we leased an additional 42,000 square feet in an adjacent building with a term of five years and subleased this space. We terminated this second lease as of
December 31, 2001 and made a lease settlement payment of $2.3 million, using lease deposits, in the first quarter of 2002 as a part of the lease termination agreement.



As a result of the Interface acquisition, we assumed an operating lease in Slough, United Kingdom. The lease is for a term
ending in 2020 with current quarterly rent payments of approximately $65,000. We subleased this office space to a tenant who was providing us with quarterly rent payments of approximately $65,000 until the sublease was terminated effective July
2003. Anticipated future sublease rental income is not expected to cover the rent expense due to a weak office rental market in and around Slough. In the second quarter of 2003 we recognized a charge of $996,000 related to potential losses on this
lease that was included in our consolidated statement of operations as Merger-related and other costs. We are currently attempting to find a new sublessee.



In the acquisition of Valicert, we assumed debt of $855,000 resulting from equipment leases with two financing companies. During the three months ended
September 30, 2003 this debt was refinanced with an $800,000 loan from the same bank from whom we previously had obtained equipment loan facilities. The new debt bears interest at prime rate plus 0.63%, is due and payable in 36 equal monthly
installments, and is secured by certain of our assets.



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 decreased our spending on capital expenditures in recent quarters and do not anticipate significant increases in capital expenditures in the immediate future. We believe that our existing capital resources should enable us to
maintain our current and planned operations for at least the next twelve months. Our current cash reserves, however, may be insufficient if we experience either lower than expected revenues or extraordinary or unexpected cash expenses, or for other
reasons. Funding, if pursued, may not be available on acceptable terms or at all. If adequate funds are not available, we may be required to curtail significantly or defer one or more of our operating goals or programs, or take other steps that
could harm our business or future operating results.



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.



We regularly evaluate acquisition candidates that have products, technologies, or customers that may complement our own, and
expect to continue this practice.



At March 31, 2004, we did
not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.



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Contractual Obligations and Commercial Commitments



Future cash payments for contractual obligations and commercial commitments as of March 31, 2004, are as follows (in
thousands):



|                                   |  |      |       |      |   |       |  |      |       |      |   |           |  |       |     |  |   |       |  |   |       
|---------------------------------- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ---- | - | --------- |  | ----- | --- |  | - | ----- |  | - | ------
|                                   |  | 2004 |       | 2005 |   | 2006  |  | 2007 |       | 2008 |   | After2008 |  | Total
|Debt obligations                   |  | $    | 220   |      | $ | 283   |  | $    | 204   |      | $ |          |  | $     |    |  | $ |      |  | $ | 707   
|Operating leases                   |  |      | 1,461 |      |   | 1,371 |  |      | 1,206 |      |   | 943       |  |       | 931 |  |   | 3,120 |  |   | 9,032 
|Unconditional purchase obligations |  |      | 278   |      |   | 359   |  |      |      |      |   |          |  |       |    |  |   |      |  |   | 637   
|                                   |  |      |       |      |   |       |  |      |       |      |   |           |  |       |     |  |   |       |  |   |       
|Total                              |  | $    | 1,959 |      | $ | 2,013 |  | $    | 1,410 |      | $ | 943       |  | $     | 931 |  | $ | 3,120 |  | $ | 10,376
|                                   |  |      |       |      |   |       |  |      |       |      |   |           |  |       |     |  |   |       |  |   |       



The amounts above will
be offset by sublease payments of $147,000 in 2004 and $34,000 in 2005.



RISKS AND UNCERTAINTIES THAT YOU SHOULD CONSIDER BEFORE INVESTING IN TUMBLEWEED.



We have a history of losses and may experience losses in the future.



Our prospects must be considered in light of the risks, expenses, delays and difficulties frequently encountered by companies engaged in new and rapidly
evolving technology markets like ours. We incurred net losses of $9.2 million, $20.9 million, and $114.2 million in 2003, 2002, and 2001, respectively. As of March 31, 2004, we had incurred cumulative net losses of $279.8 million.



Our success may depend in large part upon the adoption and utilization of our
products and technology, as well as our ability to effectively maintain existing relationships and develop new relationships with customers and strategic partners. If we do not succeed in doing so, 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 may incur
additional losses and continued negative cash flow from operations for the foreseeable future and may not achieve or maintain profitability.



We expect to continue making strategic investments and acquisitions, which may involve substantial costs, may substantially dilute our existing investors, and may fail
to yield anticipated benefits.



We are continuously
evaluating investments in complementary technologies and businesses. Acquisitions of companies, divisions of companies, or products, including our acquisitions of Valicert, Incubator, and Corvigo entail numerous risks, including:



| |  | potential inability to successfully integrate acquired operations and products or to realize cost savings or other anticipated benefits from integration;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | diversion of managements attention;
| | - | ------------------------------------



| |  | loss of key employees of acquired operations;
| | - | ---------------------------------------------



| |  | coordinating sales and pricing efforts to effectively communicate the value and capabilities of the combined company;
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | the difficulty of assimilating geographically dispersed operations and personnel of the acquired companies;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | the potential disruption of our ongoing business;
| | - | -------------------------------------------------



| |  | expenses related to such integration;
| | - | -------------------------------------



| |  | the correct assessment of the relative percentages of in-process research and development expense that can be immediately written off as compared to the amount which must be
amortized over the appropriate life of the asset;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the impairment of relationships with employees and customers of either an acquired company or our business;
| | - | -----------------------------------------------------------------------------------------------------------



| |  | the potential unknown liabilities associated with acquired business; and
| | - | ------------------------------------------------------------------------



| |  | inability to recover strategic investments in development stage entities.
| | - | -------------------------------------------------------------------------



As a result of acquisitions, we may acquire significant assets that include goodwill and other purchased intangibles. The testing of these intangibles
under established accounting guidelines for impairment requires significant use of judgment and assumptions. Changes in business conditions could require adjustments to the valuation of these assets.



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If we do not successfully optimize our marketing and distribution capacity, our business could be harmed.



If we do not optimize our methods of marketing and
selling our products, it could significantly limit our ability to compete successfully against current and future competitors. The markets in which we compete are intensely competitive and rapidly changing, in part because third parties (such as
hackers and spammers) whose timing and methods are somewhat unpredictable can have a significant impact on customer demand. Vendors in our markets use different methods of marketing and distribution in order to meet expected customer demand. For
example, our competitors in the anti-spam market include multiple software-only vendors, appliance-only vendors, and service providers, as well as vendors that offer a combination of some or all of the foregoing. Moreover, vendors offerings
range from single-function point products and services to more sophisticated and scalable multi-functional offerings. In addition, pricing and other terms and conditions of sales contracts also vary considerably among our competition. Because it is
difficult to predict demand in our rapidly changing markets, we may not be able to manage our marketing and sales efforts in an optimal way, which may disadvantage our business in comparison to competitors.



Additional competitive factors in our industry include product performance
and integration, platform coverage, 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 secure Internet messaging software products
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 effective 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 success depends on our ability to grow and develop our indirect distribution channels
and the inability to do so could adversely affect future operating results.



Our failure to increase the number of our indirect distribution channels could have a material adverse effect on our business, operating results, and financial condition. We must increase the number of strategic and
other third-party relationships with vendors of Internet-related systems and application software, resellers and systems integrators. Our existing or future channel partners may choose to devote greater resources to marketing and supporting the
products of other companies.



The volume of spam may not continue to grow
rapidly, which may adversely affect the market for anti-spam solutions.



Although the volume of spam has grown rapidly during the last several years, it may not continue to do so because of recently enacted anti-spam legislation, enforcement efforts under that legislation, and
collaborative efforts by leaders of the email provider industry, as well as the potential development of new and successful anti-spam technologies. Accordingly, the market for anti-spam solutions may not continue to grow rapidly and may in fact
decline, which may adversely affect our business.



Contractual issues may
arise during the negotiation of license agreements that may delay the anticipated closure of a transaction and our ability to recognize revenue as anticipated.



Because we focus on selling enterprise-wide software products to enterprises and government entities, the process of
contractual negotiation is critical and may be lengthy. Additionally, several factors may require us to defer recognition of license revenue for a significant period of time after entering into a license agreement, including instances where we are
required to deliver either unspecified additional products or specified upgrades for which we do not have vendor-specific objective evidence of fair value. Although we have a standard software license agreement that provides for revenue recognition
to the extent that (i) delivery has taken place, (ii) collectibility from the customer is reasonably assured, and (iii) no significant future obligations or customer acceptance rights exist, customer negotiations and revisions to these terms could
impact our ability to recognize revenues at the time of delivery.



Many enterprise customers negotiate software licenses near the end of each quarter. In part, this is because enterprise customers are able, or believe that they are able, to negotiate lower prices and more favorable terms at that time. Our
reliance on a large portion



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of software license revenue occurring at the end of the quarter and the increase in the dollar value of transactions that
occur at the end of a quarter can result in increased uncertainty relating to quarterly revenues. Due to end-of-period variances, forecasts may not be achieved, either because expected sales do not occur or because they occur at lower prices or on
terms that are less favorable to us.



A limited number of customers account
for a high percentage of our revenue, and the failure to maintain or expand these relationships could adversely affect our future revenue.



The loss of one or more of our major customers, the failure to attract new customers on a timely basis or a reduction in revenue associated with existing
or proposed customers would harm our future revenue and prospects. During the three months ended March 31, 2004 and 2003, five customers comprised approximately 18% and 28% of our revenue, respectively.



Fluctuations in our quarterly operating results may not be predictable and may result in
significant volatility in our stock price.



Our product
revenue has fluctuated and our quarterly operating results will continue to fluctuate based on, among other things, the timing of the execution and termination of customer agreements in a given quarter. 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:



| |  | target customers electing to adopt and implement our technology;
| | - | ----------------------------------------------------------------



| |  | the substantial decrease in information technology spending in general, and among our target customers in particular;
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | customers choosing to delay their purchase commitments or purchase in smaller amounts than expected due to a general downturn in the economy;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  | our ability to continue to license our patents, the timing of such licenses, and the costs necessary to defend our patents;
| | - | ---------------------------------------------------------------------------------------------------------------------------



| |  | the amount and timing of operating costs and capital expenditures relating to our business, operations and infrastructure;
| | - | --------------------------------------------------------------------------------------------------------------------------



| |  | our ability to accurately estimate and control costs;
| | - | -----------------------------------------------------



| |  | our ability to timely collect fees owed by customers;
| | - | -----------------------------------------------------



| |  | the announcement or introduction of new or enhanced products and services in the secure content management, content security, secure online communications, or document delivery
markets; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | acquisitions that we complete or propose.
| | - | -----------------------------------------



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. We may not be able to accurately forecast our revenue or expenses. 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 challenges and difficulties that we face, as 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.



Economic conditions could adversely affect our ability to maintain and increase revenue.



Our revenue and profitability or loss depends on the overall demand for our products, our intellectual property, and our services, particularly within the
industries in which we offer specific versions of our products. Because our sales are primarily to customers in the financial services, health care, and government industries, our business depends on the overall economic conditions and the economic
and business conditions within these industries. Any weakening of the global economy, the information technology industry in particular, and the weakening of the business conditions within the above industries could cause a decrease in our license
revenues. A softening of demand for information technology spending caused by a continued weakening of the economy, domestically or internationally, may result in a decrease in revenues and continued losses.



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In addition, the financial, political, economic and other uncertainties following the terrorist attacks
upon the United States and the United States involvement in Iraq have led to a further weakening of the global economy, and have created an uncertain economic environment. We cannot predict the impact of these events, any subsequent terrorist acts
or any related military action, on our customers or business. Subsequent terrorist acts and/or the threat of future outbreak or continued escalation of hostilities involving the United States or other countries could adversely affect spending on
information technology and on our software license revenue, as well as have an adverse effect on our business, financial condition or results of operations.



The terms of any financing we may obtain could result in substantial dilution of existing stockholders.



In the future, we may be required or elect to seek additional financing to
fund our operations. Factors such as the commercial success of our existing products and services, the timing and success of any new products and services, the progress of our research and development efforts, our results of operations, the status
of competitive products and services, and the timing and success of potential strategic alliances or potential opportunities to acquire or sell technologies or assets may require us to seek additional funding sooner than we expect. In the event that
we require additional cash, we may not be able to secure additional financing on terms that are acceptable to us, especially in light of uncertainty in the current market environment, and we may not be successful in implementing or negotiating such
other arrangements to improve our cash position. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and the securities we issue might have rights,
preferences and privileges senior to those of our current stockholders. If adequate funds were not available on acceptable terms or at all, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential
expansion, take advantage of new opportunities, develop or enhance products or services, or otherwise respond to competitive pressures could be significantly limited.



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



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. 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 our common stock.



We may be unable to adequately protect our intellectual property rights or may be subject to claims of patent infringement, either of which could result in substantial costs to us.



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. 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. We also rely on unpatented trade secrets and other unpatented proprietary information. 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. As a result, our operating results could suffer.



Third parties could assert patent or other intellectual property infringement
claims against us and the cost of responding to such assertions, regardless of their validity, could be significant. We may increasingly be subject to claims of intellectual property infringement as the number of our competitors grows and the
functionality of their products and services increasingly overlap with ours. In addition, we may infringe upon patents that may be issued to third parties in the future. It may be time consuming and costly to defend ourselves against any of these
claims and we may not prevail. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief that could block our ability to further develop or commercialize some or all of our products in the United States and
abroad. In the event of a claim of infringement, we may be required to obtain one or more licenses from or pay royalties to third parties. We may be unable to obtain any such licenses at a reasonable cost, if at all. Defense of any lawsuit or
failure to obtain such license could harm our business.



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The enforcement of our intellectual property rights, especially through patent infringement lawsuits we may initiate,
could result in substantial litigation costs and ultimately may not result in additional revenue to us or a favorable judicial determination.



Since 1999 we have aggressively pursued cases of potential infringement by third parties of our patents and other intellectual property rights. The
enforcement process is costly and requires significant management attention. These costs generally are expensed during the period incurred, and the costs of pursuing the litigation may not be directly matched with the related licensing or settlement
revenue, if any. In addition, our enforcement of our rights may increase the risk of adverse claims, with or without merit, which could be time consuming to defend, result in costly litigation, divert managements attention and resources, limit
the use of our services, or require us to enter into royalty or license agreements. In addition, such counter-claims asserted by these third parties may be found to be valid and could result in an injunction or damages against us. Our ability to
prevail in this litigation is inherently uncertain, and if we were subject to an adverse judicial determination, our ability to protect our products and to secure related licensing or settlement revenue could be lost.



Failure to license necessary third party software incorporated in our products could cause
delays or reductions in our sales.



We license third party
software that we incorporates into our products. These licenses may not continue to be available on commercially reasonable terms, or at all. Some of this technology would be difficult to replace. The loss of any such license could result in delays
or reductions of our applications until we identify, license and integrate or develop equivalent software. If we are required to enter into license agreements with third parties for replacement technology, we could face higher royalty payments and
our products may lose certain attributes or features. In the future, we might need to license other software to enhance our products and meet evolving customer needs. If we are unable to do this, we could experience reduced demand for its products.



We are a defendant in two purported securities class action lawsuits that
could divert management attention and resources or eventually expose us to liability.



In June 2003, we were served with a summons and first amended complaint, captioned Liu v. Credit Suisse First Boston, et alia, alleging the violation of federal and state securities laws, purportedly on behalf
of persons who acquired our common stock (other than purchasers of our initial public offering) from August 6, 1999 to October 18, 2000. The case is now pending in the United States District Court for the Southern District of New York, where the
Court held a status conference in September 2003. At the status conference we pointed out, and plaintiffs counsel conceded, that the named plaintiffs lacked standing to pursue the action because they had not purchased any shares of any of the
issuer defendants then in the case. In October 2003 plaintiffs filed a motion for leave to file a second amended complaint, which we have opposed. An adverse outcome could harm our business and operating results. Moreover, the costs in defending
this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve for any potential loss, as we do not consider a loss to be probable at this time. An adverse outcome could harm our
business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results.



In December 2001, certain plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York on behalf of
purchasers of the common stock of Valicert, alleging violations of federal securities laws. In re Valicert, Inc. Initial Public Offering Securities Litigation, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities
Litigation, No. 21 MC 92 (SAS). In June 2003, Valicert accepted a settlement proposal presented to all issuer defendants in this case. Under the proposed settlement, the plaintiffs will dismiss and release all claims against the Valicert Defendants
in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in all the consolidated cases, and the assignment or surrender of control to the plaintiffs of certain claims the issuer
defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all
of the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, Valicert would be responsible to pay its pro rata portion of the shortfall, up to the amount of the deductible retention under its insurance
policy, which is $500,000. The timing and amount of payments that Valicert could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment required by the insurers pursuant to
the $1 billion guaranty. The proposed settlement is subject to approval of the Court, which cannot be assured. Failure of the Court to approve the settlement followed by an adverse outcome could harm our business and operating results. Moreover, the
costs in defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve for any potential loss, as we do not consider a loss to be probable at this time. An adverse outcome
could harm our business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results.



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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, including recent additions to our management team as a result of
our acquisitions of Incubator and Corvigo, 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 international business exposes us to additional risks that may result in future additional costs or limit the market for product sales.



Products and services provided to Tumbleweeds international customers accounted for 12% and 10% of our revenues for
three months ended March 31, 2004 and 2003, respectively. Conducting business outside of the United States subjects us to additional risks, including:



| |  | changes in regulatory requirements;
| | - | -----------------------------------



| |  | reduced protection of intellectual property rights;
| | - | ---------------------------------------------------



| |  | evolving privacy laws;
| | - | ----------------------



| |  | tariffs and other trade barriers;
| | - | ---------------------------------



| |  | difficulties in staffing and managing foreign operations;
| | - | ---------------------------------------------------------



| |  | problems in collecting accounts receivable; and
| | - | -----------------------------------------------



| |  | difficulties in authenticating customer information.
| | - | ----------------------------------------------------



Managing these risks may subject us to additional costs that may not be justified in light of the market opportunity, and the inability to comply with or
manage foreign laws and related risks may preclude or limit sales in foreign jurisdictions. In addition, the recent outbreak of severe acute respiratory syndrome, or SARS, that began in China, Hong Kong, Singapore and Vietnam may have a negative
impact on our operations by factors such as reduced sales in international channels.



We rely on public key cryptography and other security techniques that could be breached, resulting in reduced demand for our products and services.



A requirement for the continued growth of electronic commerce is the secure transmission of confidential information over
public networks. We rely on public key cryptography, an encryption method that utilizes two keys, a public and private key, for encoding and decoding data, and on digital certificate technology, to provide the security and authentication necessary
for secure transmission of confidential information. Regulatory and export restrictions may prohibit us from using the strongest and most secure cryptographic protection available, and thereby may expose us or our customers to a risk of data
interception. A party who is able to circumvent our security measures could misappropriate proprietary information or interrupt our or our customers operations. Any compromise or elimination of our security could result in risk of loss or
litigation and possible liability and reduce demand for our products and services.



ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We currently do not use financial instruments to hedge operating expenses in Bulgaria, India, Japan, the Netherlands, Switzerland, or the United Kingdom
denominated in the respective local currency. We assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis.



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



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



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market risk. This means that a change in prevailing interest rates may cause the fair value 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, our investments are not subject to market risk because the interest paid on these funds fluctuates with the prevailing interest rate. As of March 31,
2004, none of our cash equivalents were subject to market risk.



ITEM 4CONTROLS AND PROCEDURES



(a) Evaluation of disclosure controls and procedures.



Our management, with the participation of our chief executive officer and chief financial officer, evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rule 13a-154(e) and 15(d)-14(c) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of March 31, 2004, and, based on that evaluation, our
chief executive officer and chief financial officer concluded that, as of March 31, 2004, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be
disclosed by us in the reports we file under the Exchange Act



(b) Changes in internal controls.



There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the first quarter of 2004 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.



PART IIOTHER INFORMATION



ITEM 1LEGAL PROCEEDINGS



In July 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and others against Interface Systems, Inc. (a company we acquired in 2000) and various additional defendants, including
Interfaces prior president and chief executive officer, Robert A. Nero. Plaintiffs most recent complaint sought compensatory damages for losses resulting from not selling their Interface stock from March 14, 2000 to the end of March 2000
and for losses from purchases of Interface stock from March 14, 2000 through April 12, 2000. In March 2003, the court dismissed all claims against Interface and dismissed all claims against Mr. Nero, except a breach of fiduciary duty claim to the
extent that claim arises from Michigan common law. In April 2003, Mr. Nero filed an answer and a counterclaim against Mr. Zimmer and Congressional Securities, Inc. seeking contribution and indemnity. The parties remaining in this case agreed to
settle the matter, and the Court dismissed the case with prejudice in February 2004.



In December 2001, certain plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York on behalf of purchasers of the common stock of Valicert, alleging violations
of federal securities laws. In re Valicert, Inc. Initial Public Offering Securities Litigation, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS). The operative amended complaint is
brought on purported behalf of all persons who purchased Valicert common stock from the date of its July 27, 2000 initial public offering through December 6, 2000. It names as defendants Valicert, its former chief executive officer, its chief
financial officer (the Valicert Defendants), as well as an investment banking firm that served as an underwriter for the IPO. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and
20(a) of the Securities Exchange Act of 1934, on the grounds that the registration statement for the IPO did not disclose that: (1) the underwriter agreed to allow certain customers to purchase shares in the IPO in exchange for excess commissions to
the paid to the underwriter; and (2) the underwriter arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. The complaint also appears to allege that false or misleading analyst reports were issued.
The complaint does not claim any specific amount of damages. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial
purposes. In February 2003, the Court issued a ruling on all defendants motions to dismiss, denying Valicerts motion to dismiss the claims under the Securities Act of 1933, but granting Valicerts motion to dismiss the claims under
the Securities Exchange Act of 1934.



In June 2003, Valicert
accepted a settlement proposal presented to all issuer defendants in this case. Under the proposed settlement, the plaintiffs will dismiss and release all claims against the Valicert Defendants in exchange for a contingent payment guaranty by the
insurance companies collectively responsible for insuring the issuers in all the consolidated cases, and the assignment or surrender of control to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the
guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all of the cases. If the plaintiffs fail to recover $1
billion and payment is required under



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the guaranty, Valicert would be responsible to pay its pro rata portion of the shortfall, up to the amount of the
deductible retention under its insurance policy, which is $500,000. The timing and amount of payments that Valicert could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any
payment required by the insurers pursuant to the $1 billion guaranty. The proposed settlement is subject to approval of the Court, which cannot be assured. The accompanying consolidated financial statements do not include a reserve for any potential
loss, as Tumbleweed does not consider a loss to be probable at this time.



In September 2002, we received a letter from Entrust, Inc. indicating that we may be interested in licensing the technology covered by U.S. Patent No. 6,393,568, Encryption and Decryption System and Method with
Content Analysis Provision, issued to Entrust. In October 2002, we sent a letter to Entrust indicating that Entrust may be interested in licensing the technology covered by four patents issued to us. In February 2003, we received a letter from
Entrust indicating that we may have an interest in three additional patents issued to Entrust. In April 2003, we filed with the U.S. Patent and Trademark Office a request for interference with Entrusts Patent No. 6,393,568. In January 2004, we
entered into a cross license agreement with Entrust covering the aforementioned patents and selected others, as well as patents issuing from certain patent applications that have been filed or that may be filed by either company over the next three
years. As part of the agreement, the companies resolved the patent interference proceeding, and Entrust assigned to us U.S. Patent No. 6,393,568 in return for a financial consideration.



In June 2003, we were served with a summons and first amended complaint, captioned Liu v. Credit Suisse First Boston, et
alia, alleging the violation of federal and state securities laws, purportedly on behalf of persons who acquired our common stock (other than purchasers of ours initial public offering) from August 6, 1999 to October 18, 2000. The case is now
pending in the United States District Court for the Southern District of New York, where the Court held a status conference in September 2003. At the status conference, we pointed out, and plaintiffs counsel conceded, that the named plaintiffs
lacked standing to pursue the action because they had not purchased any shares of any of the issuer defendants then in the case. In October 2003, plaintiffs filed a motion for leave to file a second amended complaint, which we have opposed. An
adverse outcome could harm our business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve for any potential loss, as
we do not consider a loss to be probable at this time.



All
costs incurred as a result of these legal proceedings and claims are charged to expense as incurred.



We indemnify our customers from third party claims of intellectual property infringement relating to the use of our products. Historically, costs related
to these guarantees have not been significant and we are unable to estimate the potential impact of these guarantees on our future results of operations.



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ITEM 6EXHIBITS AND REPORTS ON FORM 8-K



a. Exhibits are incorporated herein by reference or are filed with this report as indicated below (numbered in accordance with Item 601 of Regulation S-K):



|              |  |                                                                                                                                                                                                                 
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                     
|              | 
|2.1(1)        |  | Agreement and Plan of Merger and Reorganization by and among Tumbleweed Communications Corp., Corvigo, Inc., Greenland Acquisition Company
L.L.C., and Mark Kvamme as Stockholders Agent, dated March 18, 2004.
|              | 
|3.1(2)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                                                                 
|              | 
|3.2(2)        |  | Amended and Restated Bylaws of Registrant                                                                                                                                                                       
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                               

---

|(1) | Incorporated by reference to Exhibit 2.1 of our Current Report on Form 8-K, filed March 23, 2004.
|--- | -------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to our Registration Statement on Form S-1 (File No. 79687), filed June 29, 1999.
|--- | ----------------------------------------------------------------------------------------------------------



b. Report on Form 8-K:



On April 26, 2004, we filed a report on Form 8-K, which announced executive management changes and our financial results for
the fiscal quarter ended March 31, 2004.



On March 23, 2004, we
filed a report on Form 8-K, which announced our acquisition of Corvigo.



On February 27, 2004, we filed a report on Form 8-K, which announced our 2004 Analyst Meeting and included copies of presentation materials relating to the meeting.



On January 22, 2004, we filed a report on Form 8-K, which announced financial results for the three months and fiscal year
ended December 31, 2003.



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SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized:



|                   |  |                                 |  |                                                                                                                                           
|------------------ |  | ------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|                   |  | TUMBLEWEED COMMUNICATIONS CORP.
|                   |  |                                
|Date: May 10, 2004 |  | By:                             |  | /s/    JEFFREY C. SMITH                                                                                                                   
|                   |  |                                 |  | Jeffrey C. SmithChairman of the Board andChief Executive Officer(Principal Executive
Officer)                                             
|                   |  |                                
|Date: May 10, 2004 |  | By:                             |  | /S/    TIMOTHY G. CONLEY                                                                                                                  
|                   |  |                                 |  | Timothy G. ConleySenior Vice President of Finance and Chief Financial Officer(Principal Financial Officer andPrincipal Accounting
Officer)



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INDEX TO EXHIBITS



|              |  |                                                                                                                                                                                                                 
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                     
|              | 
|2.1(1)        |  | Agreement and Plan of Merger and Reorganization by and among Tumbleweed Communications Corp., Corvigo, Inc., Greenland Acquisition Company
L.L.C., and Mark Kvamme as Stockholders Agent, dated March 18, 2004.
|              | 
|3.1(2)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                                                                 
|              | 
|3.2(2)        |  | Amended and Restated Bylaws of Registrant                                                                                                                                                                       
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                               
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                               

---

|(1) | Incorporated by reference to Exhibit 2.1 of our current report on Form 8-K, filed March 23, 2004.
|--- | -------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to our Registration Statement on Form S-1 (File No. 79687), filed June 29, 1999.
|--- | ----------------------------------------------------------------------------------------------------------



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