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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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

For the quarterly period ended June 30, 2007

or



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

For the transition period from  to

Commission File Number: 000-26223



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TUMBLEWEED
COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3336053                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|700 Saginaw Drive Redwood City, CA       |  | 94063     
|(Address of principal executive offices) |  | (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 to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated
filer ̈Accelerated filer  x    Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x

The number of shares of common stock outstanding as of July 31, 2007 was 51,126,446.



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##### Table of Contents

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, forward-looking statements can be identified 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 revenue expected to be realized from backlog;
| | - |  | -------------------------------------------------



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



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



| |  |  | any statements regarding implementing our business strategy;
| | - |  | ------------------------------------------------------------



| |  |  | any statements regarding attracting and retaining customers;
| | - |  | ------------------------------------------------------------



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



| |  |  | any statements regarding competition in, or size of, our market; 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
Factors in Part II, Item 1A contained herein, as well as those discussed in our Form 10-K and other filings with the Securities and Exchange Commission. These risks should be considered carefully, among other things, in evaluating our
prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this Quarterly
Report on Form 10-Q. We disclaim 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)                                                                                   |  | 4   
|               |  | Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006                                    |  | 4   
|               |  | Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and June 30, 2006 |  | 5   
|               |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and June 30, 2006           |  | 6   
|               |  | Notes to Condensed Consolidated Financial Statements                                                               |  | 7   
|Item 2         |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                              |  | 12  
|Item 3         |  | Quantitative and Qualitative Disclosures About Market Risk                                                         |  | 19  
|Item 4         |  | Controls and Procedures                                                                                            |  | 20  
|               |  |                                                                                                                   
|               |  | Part II                                                                                                            |  |     
|               |  |                                                                                                                   
|Item 1         |  | Legal Proceedings                                                                                                  |  | 21  
|Item 1A        |  | Risk Factors                                                                                                       |  | 22  
|Item 2         |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                        |  | 27  
|Item 3         |  | Defaults Upon Senior Securities                                                                                    |  | 27  
|Item 4         |  | Submission of Matters to a Vote of Security Holders                                                                |  | 27  
|Item 5         |  | Other Information                                                                                                  |  | 27  
|Item 6         |  | Exhibits                                                                                                           |  | 28  
|Signatures     |  | 29                                                                                                                
|Certifications |  |                                                                                                                   

TRADEMARKS

The following are registered trademarks of Tumbleweed Communications Corp. or its subsidiaries in
the United States and/or other countries: Tumbleweed®, Tumbleweed Communications®, the Arrows logo, MailGate®, Secure Envelope®, Secure Inbox®, Tumbleweed Email Firewall®, Tumbleweed IME Integrated Messaging Exchange®, Messaging Management System (MMS)®, Valicert®, and Corvigo®. The following are other trademarks and service marks of Tumbleweed
Communications Corp. or its subsidiaries in the United States and/or other countries: MailGate Appliance, Secure Messenger, Tumbleweed Secure Messenger, Desktop Messenger, Tumbleweed Desktop Messenger, Dark
Traffic, Dynamic Anti-Spam Service (DAS), Edge Defense, Tumbleweed Edge Defense, Intelligent Edge Defense, SecureTransport, Tumbleweed SecureTransport, Validation Authority, Tumbleweed Validation
Authority, Server Validator, Desktop Validator, Tumbleweed FTP Analyzer, WorldSecure, and WorldSecure/Mail. All other trademarks and service marks are the property of their respective owners.



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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)



|                                                                                                                   |  |              |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------ |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                   |  | June 30,2007 |          |   | December 31,2006 |  
|Assets                                                                                                             |  |              |          |   |                  |   |          |  
|Current Assets:                                                                                                    |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                          |  | $            | 30,003   |   |                  | $ | 30,511   |  
|Accounts receivable, net of allowance for doubtful accounts of $375 at June 30, 2007 and $431 at December 31, 2006 |  |              | 10,461   |   |                  |   | 12,506   |  
|Other current assets                                                                                               |  |              | 2,215    |   |                  |   | 1,938    |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total current assets                                                                                               |  |              | 42,679   |   |                  |   | 44,955   |  
|Goodwill                                                                                                           |  |              | 48,074   |   |                  |   | 48,074   |  
|Intangible assets, net                                                                                             |  |              | 776      |   |                  |   | 1,470    |  
|Property and equipment, net                                                                                        |  |              | 2,116    |   |                  |   | 1,820    |  
|Other assets                                                                                                       |  |              | 352      |   |                  |   | 612      |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total assets                                                                                                       |  | $            | 93,997   |   |                  | $ | 96,931   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Liabilities and Stockholders Equity                                                                               |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                               |  |              |          |   |                  |   |          |  
|Accounts payable                                                                                                   |  | $            | 1,276    |   |                  | $ | 1,808    |  
|Accrued liabilities                                                                                                |  |              | 6,227    |   |                  |   | 7,522    |  
|Accrued merger-related and other costs                                                                             |  |              |         |   |                  |   | 97       |  
|Deferred revenue                                                                                                   |  |              | 20,517   |   |                  |   | 20,003   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                          |  |              | 28,020   |   |                  |   | 29,430   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Deferred revenue, excluding current portion                                                                        |  |              | 4,311    |   |                  |   | 4,728    |  
|Other long-term liabilities                                                                                        |  |              | 42       |   |                  |   | 63       |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total long-term liabilities                                                                                        |  |              | 4,353    |   |                  |   | 4,791    |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                  |  |              | 32,373   |   |                  |   | 34,221   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Stockholders equity:                                                                                              |  |              |          |   |                  |   |          |  
|Common stock                                                                                                       |  |              | 52       |   |                  |   | 51       |  
|Additional paid-in capital                                                                                         |  |              | 362,862  |   |                  |   | 359,238  |  
|Treasury stock                                                                                                     |  |              | (796     | ) |                  |   | (796     | )
|Accumulated other comprehensive income                                                                             |  |              | 40       |   |                  |   | 29       |  
|Accumulated deficit                                                                                                |  |              | (300,534 | ) |                  |   | (295,812 | )
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                         |  |              | 61,624   |   |                  |   | 62,710   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                         |  | $            | 93,997   |   |                  | $ | 96,931   |  
|                                                                                                                   |  |              |          |   |                  |   |          |  

See accompanying Notes to Condensed Consolidated Financial Statements



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Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)



|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                          |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                          |  | 2007                        |        |   | 2006                      |   |        | 2007 |  |   | 2006   |  
|Revenue:                                  |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Product revenue                           |  | $                           | 5,121  |   |                           | $ | 5,254  |      |  | $ | 11,018 |   |  | $ | 12,679 |  
|Service revenue                           |  |                             | 7,973  |   |                           |   | 7,343  |      |  |   | 16,995 |   |  |   | 14,598 |  
|Intellectual property                     |  |                             | 1,036  |   |                           |   | 2,549  |      |  |   | 1,132  |   |  |   | 2,924  |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                             |  |                             | 14,130 |   |                           |   | 15,146 |      |  |   | 29,145 |   |  |   | 30,201 |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Cost of revenue:                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Cost of product revenue                   |  |                             | 1,307  |   |                           |   | 970    |      |  |   | 3,063  |   |  |   | 1,693  |  
|Provision for excess inventory            |  |                             |       |   |                           |   |       |      |  |   | 164    |   |  |   |       |  
|Cost of service revenue                   |  |                             | 1,929  |   |                           |   | 1,606  |      |  |   | 3,828  |   |  |   | 3,145  |  
|Amortization of intangible assets         |  |                             | 234    |   |                           |   | 489    |      |  |   | 468    |   |  |   | 999    |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total cost of revenue                     |  |                             | 3,470  |   |                           |   | 3,065  |      |  |   | 7,523  |   |  |   | 5,837  |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                              |  |                             | 10,660 |   |                           |   | 12,081 |      |  |   | 21,622 |   |  |   | 24,364 |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                       |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Research and development                  |  |                             | 3,859  |   |                           |   | 3,800  |      |  |   | 7,755  |   |  |   | 7,220  |  
|Sales and marketing                       |  |                             | 7,311  |   |                           |   | 6,596  |      |  |   | 13,928 |   |  |   | 13,049 |  
|General and administrative                |  |                             | 2,516  |   |                           |   | 2,593  |      |  |   | 5,003  |   |  |   | 5,949  |  
|Amortization of intangible assets         |  |                             | 44     |   |                           |   | 312    |      |  |   | 227    |   |  |   | 633    |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                  |  |                             | 13,730 |   |                           |   | 13,301 |      |  |   | 26,913 |   |  |   | 26,851 |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Operating loss                            |  |                             | (3,070 | ) |                           |   | (1,220 | )    |  |   | (5,291 | ) |  |   | (2,487 | )
|Other income, net                         |  |                             | 381    |   |                           |   | 301    |      |  |   | 720    |   |  |   | 565    |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss before income taxes              |  |                             | (2,689 | ) |                           |   | (919   | )    |  |   | (4,571 | ) |  |   | (1,922 | )
|Income taxes                              |  |                             | 21     |   |                           |   | 31     |      |  |   | 34     |   |  |   | 66     |  
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                  |  | $                           | (2,710 | ) |                           | $ | (950   | )    |  | $ | (4,605 | ) |  | $ | (1,988 | )
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Net loss per sharebasic and diluted      |  | $                           | (0.05  | ) |                           | $ | (0.02  | )    |  | $ | (0.09  | ) |  | $ | (0.04  | )
|                                          |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Weighted average sharesbasic and diluted |  |                             | 51,052 |   |                           |   | 49,937 |      |  |   | 50,947 |   |  |   | 49,803 |  

See accompanying Notes to Condensed Consolidated Financial Statements



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##### Table of Contents

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                                          |  |                          |        |   |      |   |        |  
|----------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                          |  | Six months endedJune 30, |       
|                                                                                          |  | 2007                     |        |   | 2006 |  
|Cash flows from operating activities:                                                     |  |                          |        |   |      |   |        |  
|Net loss                                                                                  |  | $                        | (4,605 | ) |      | $ | (1,988 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                          |        |   |      |   |        |  
|Stock-based compensation expense                                                          |  |                          | 2,300  |   |      |   | 2,657  |  
|Depreciation and amortization expenses                                                    |  |                          | 1,391  |   |      |   | 2,183  |  
|Bad debt expense (credit)                                                                 |  |                          | (47    | ) |      |   | 80     |  
|Loss on disposal of property and equipment                                                |  |                          | 40     |   |      |   | 24     |  
|Changes in operating assets and liabilities:                                              |  |                          |        |   |      |   |        |  
|Accounts receivable                                                                       |  |                          | 2,092  |   |      |   | (71    | )
|Other current assets and other assets                                                     |  |                          | (17    | ) |      |   | (341   | )
|Accounts payable, accrued liabilities, and other long-term liabilities                    |  |                          | (1,965 | ) |      |   | (435   | )
|Accrued merger-related and other costs                                                    |  |                          | (97    | ) |      |   | (52    | )
|Deferred revenue                                                                          |  |                          | 97     |   |      |   | (301   | )
|                                                                                          |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                       |  |                          | (811   | ) |      |   | 1,756  |  
|                                                                                          |  |                          |        |   |      |   |        |  
|Cash flows used in investing activitiespurchase of property and equipment                |  |                          | (1,033 | ) |      |   | (677   | )
|                                                                                          |  |                          |        |   |      |   |        |  
|Cash flows provided by financing activitiesproceeds from issuance of common stock        |  |                          | 1,325  |   |      |   | 773    |  
|                                                                                          |  |                          |        |   |      |   |        |  
|Effect of exchange rate on cash and cash equivalents                                      |  |                          | 11     |   |      |   | 7      |  
|                                                                                          |  |                          |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                          | (508   | ) |      |   | 1,859  |  
|Cash and cash equivalents, beginning of period                                            |  |                          | 30,511 |   |      |   | 26,952 |  
|                                                                                          |  |                          |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                  |  | $                        | 30,003 |   |      | $ | 28,811 |  
|                                                                                          |  |                          |        |   |      |   |        |  
|Supplemental disclosure of cash flow information:                                         |  |                          |        |   |      |   |        |  
|Cash paid during the period for taxes                                                     |  | $                        | 58     |   |      | $ | 7      |  
|                                                                                          |  |                          |        |   |      |   |        |  

See accompanying Notes to Condensed Consolidated Financial Statements



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##### Table of Contents

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 note 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, 2006, filed with the SEC on March 14, 2007.

The unaudited
condensed consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to state fairly the financial position of Tumbleweed and its subsidiaries as of June 30, 2007 and
December 31, 2006, respectively, the results of operations for the three and six months ended June 30, 2007 and 2006, respectively, and cash flows for the six months ended June 30, 2007 and 2006, respectively. Such adjustments are of
a normal recurring nature, unless otherwise indicated. The results for the three and six months ended June 30, 2007 are not necessarily indicative of the results expected for the full fiscal year ending December 31, 2007.

The accompanying condensed consolidated financial statements include the accounts of Tumbleweed and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.

(2) Stock-Based Compensation

Tumbleweeds stock-based compensation program is a broad-based, long-term retention program that is intended to attract and retain employees and
align stockholder and employee interests. The stock-based compensation program includes awards of stock options and restricted stock.

On
June 30, 2006, Tumbleweed exchanged 959,531 vested stock options held by 18 employees with exercise prices ranging from $3.86 to $118.44 for 422,472 vested stock options to those same employees at an exercise price of $2.85, which was
Tumbleweeds common stock price on the date of the exchange. Neither Tumbleweeds officers nor members of its Board of Directors participated in this exchange program. Tumbleweed did not recognize any stock-based compensation expense as a
result of the exchange since the fair values of the new awards were less than the fair values of the original awards immediately prior to the exchange.

Tumbleweed estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table. The expected life of the options is based on the
weighted average period of time that options granted are expected to be outstanding, giving consideration to vesting schedules and Tumbleweeds historical exercise patterns. Tumbleweeds expected volatility is based on the daily historical
volatility of Tumbleweeds common stock, over the expected life of the option. The risk-free rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of
the option. When the expected term of Tumbleweeds stock-based awards does not correspond with the terms for which interest rates are quoted, Tumbleweed performs a straight-line interpolation to determine the rate from the available term
maturities. Tumbleweed has not historically paid dividends, thus the expected dividend yield is zero. Tumbleweed issues new shares of common stock upon the exercise of stock options. The assumptions for the three and six months ended June 30,
2007 and 2006, respectively, are as follows:



|                                      |  |                            |           |   |                          |   |           |      |  |   |           |   |  |   |           |  
|------------------------------------- |  | -------------------------- | --------- | - | ------------------------ | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                      |  | Three Months EndedJune 30, |           |   | Six Months EndedJune 30, |  
|                                      |  | 2007                       |           |   | 2006                     |   |           | 2007 |  |   | 2006      |  
|Stock options:                        |  |                            |           |   |                          |   |           |      |  |   |           |   |  |   |           |  
|Weighted average fair value of grants |  | $                          | 1.95      |   |                          | $ | 1.95      |      |  | $ | 1.85      |   |  | $ | 1.85      |  
|Expected life                         |  |                            | 4.5 years |   |                          |   | 4.5 years |      |  |   | 4.5 years |   |  |   | 4.5 years |  
|Volatility                            |  |                            | 73        | % |                          |   | 85        | %    |  |   | 73        | % |  |   | 85        | %
|Risk-free interest rate               |  |                            | 4.76      | % |                          |   | 4.99      | %    |  |   | 4.71      | % |  |   | 4.77      | %
|Dividend yield                        |  |                            | 0         | % |                          |   | 0         | %    |  |   | 0         | % |  |   | 0         | %
|                                      |  |                            |           |   |                          |   |           |      |  |   |           |   |  |   |           |  

The cost of restricted stock awards is determined using the fair value of Tumbleweeds common
stock on the date of the grant, and compensation expense is recognized over the vesting period. Generally, restricted stock awards are subject to the employees continuing service to Tumbleweed. The weighted average grant date fair value of
restricted stock granted during the six months ended June 30, 2007 was $3.28.



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##### Table of Contents

Stock-based compensation expense is included in Tumbleweeds condensed consolidated statement of
operations as follows (in thousands):



|                                       |  |                            |       |                          |   |      |  |      |       |  |   |      
|-------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ---- |  | ---- | ----- |  | - | -----
|                                       |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                       |  | 2007                       |       | 2006                     |   | 2007 |  | 2006
|Cost of product revenue                |  | $                          |      |                          | $ | 2    |  | $    |      |  | $ | 4    
|Cost of service revenue                |  |                            | 39    |                          |   | 34   |  |      | 65    |  |   | 73   
|Research and development               |  |                            | 257   |                          |   | 268  |  |      | 560   |  |   | 527  
|Sales and marketing                    |  |                            | 319   |                          |   | 167  |  |      | 539   |  |   | 356  
|General and administrative             |  |                            | 575   |                          |   | 488  |  |      | 1,136 |  |   | 1,697
|                                       |  |                            |       |                          |   |      |  |      |       |  |   |      
|Total stock-based compensation expense |  | $                          | 1,190 |                          | $ | 959  |  | $    | 2,300 |  | $ | 2,657
|                                       |  |                            |       |                          |   |      |  |      |       |  |   |      

(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 EndedJune 30, |  | Six Months EndedJune 30,
|                                                                                                                                                                  |  | 2007                       |  | 2006                     |  | 2007  |  | 2006 
|Warrants and options excluded from diluted net loss per share due to the exercise price exceeding the average fair market value of common
stock during the period |  | 9,003                      |  | 8,002                    |  | 6,851 |  | 7,853
|                                                                                                                                                                  |  |                            |  |                          |  |       |  |      

(4) Concentrations of Credit Risk

Financial instruments, which potentially subject Tumbleweed to concentrations of credit risk, consist primarily of cash equivalents and accounts
receivable. Tumbleweeds cash equivalents generally consist of money market mutual funds with qualified financial institutions. To analyze accounts receivable, Tumbleweed performs periodic evaluations of its customers financial condition
and, when necessary, records bad debt expense. No single customer comprised 10% or more of Tumbleweeds accounts receivable balance, net of allowance for doubtful accounts, at June 30, 2007. One customer comprised 27% of Tumbleweeds
accounts receivable balance, net of allowance for doubtful accounts, at December 31, 2006. For the three and six months ended June 30, 2007 no single customer comprised 10% or more of Tumbleweeds revenue, respectively. For the three
months ended June 30, 2006, one customer comprised 16%, and another customer comprised 13%, of Tumbleweeds revenue. For the six months ended June 30, 2006 one customer comprised 13% of Tumbleweeds revenue.

(5) Intangible Assets and Goodwill

Intangible assets
consist of the fair value of core/developed technology, customer base and reseller agreements, maintenance agreements, and trademarks and trade names, all net of accumulated amortization, acquired during the acquisitions of Valicert, Inc.
(Valicert), Tumbleweed Communications Limited (formerly Incubator Limited), and Corvigo, Inc.

A summary of intangible assets
as of June 30, 2007 follows (in thousands):



|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |    
|------------------------------------- |  | ------------------------------ |  | --------------------- | ----- | ------------------------ | - | ------ | --- |  | - | ---
|                                      |  | Amortization period (in years) |  | Gross carrying amount |       | Accumulated amortization |   |        | Net
|Core/developed technology             |  | 3 to 4                         |  | $                     | 3,250 |                          | $ | (2,669 | )   |  | $ | 581
|Customer base and reseller agreements |  | 3                              |  |                       | 2,300 |                          |   | (2,220 | )   |  |   | 80 
|Maintenance agreements                |  | 3 to 4                         |  |                       | 500   |                          |   | (412   | )   |  |   | 88 
|Trademarks and trade names            |  | 4                              |  |                       | 150   |                          |   | (123   | )   |  |   | 27 
|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |    
|                                      |  |                                |  | $                     | 6,200 |                          | $ | (5,424 | )   |  | $ | 776
|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |    



8



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##### Table of Contents

A summary of intangible assets as of December 31, 2006 is as follows (in thousands):



|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |      
|------------------------------------- |  | ------------------------------ |  | --------------------- | ----- | ------------------------ | - | ------ | --- |  | - | -----
|                                      |  | Amortization period (in years) |  | Gross carrying amount |       | Accumulated amortization |   |        | Net
|Core/developed technology             |  | 3 to 4                         |  | $                     | 3,250 |                          | $ | (2,263 | )   |  | $ | 987  
|Customer base and reseller agreements |  | 3                              |  |                       | 2,300 |                          |   | (2,032 | )   |  |   | 268  
|Maintenance agreements                |  | 3 to 4                         |  |                       | 500   |                          |   | (349   | )   |  |   | 151  
|Trademarks and trade names            |  | 4                              |  |                       | 350   |                          |   | (286   | )   |  |   | 64   
|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |      
|                                      |  |                                |  | $                     | 6,400 |                          | $ | (4,930 | )   |  | $ | 1,470
|                                      |  |                                |  |                       |       |                          |   |        |     |  |   |      

The estimated amortization of intangible assets for each of the fiscal years subsequent to June 30, 2007, is
as follows (in thousands):



|                            |  |   |    
|--------------------------- |  | - | ---
|Year Ending December 31,    |  |  
|2007 (remaining six months) |  |   | 544
|2008                        |  |   | 232
|                            |  |   |    
|                            |  | $ | 776
|                            |  |   |    

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 Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead, is tested for impairment
at least annually and more frequently if certain impairment conditions exist. Tumbleweed completed its annual assessment of goodwill in the three months ended June 30, 2007 and no impairment of goodwill was determined as a result of this
assessment. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes.

(6) Comprehensive Loss

Comprehensive loss includes Tumbleweeds net loss as well as foreign
currency translation adjustments. Comprehensive loss for the three months ending June 30, 2007 and 2006, respectively, is as follows (in thousands):



|                                                          |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |        |  
|--------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                          |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                          |  | 2007                       |        |   | 2006                     |   |      | 2007 |  |   | 2006   |  
|Net loss                                                  |  | $                          | (2,710 | ) |                          | $ | (950 | )    |  | $ | (4,605 | ) |  | $ | (1,988 | )
|Other comprehensive income (loss)translation adjustments |  |                            | (6     | ) |                          |   | (2   | )    |  |   | 11     |   |  |   | 7      |  
|                                                          |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Comprehensive loss                                        |  | $                          | (2,716 | ) |                          | $ | (952 | )    |  | $ | (4,594 | ) |  | $ | (1,981 | )
|                                                          |  |                            |        |   |                          |   |      |      |  |   |        |   |  |   |        |  

(7) Segment Information

As defined by SFAS 131, Disclosure About Segments of an Enterprise and Related Information, Tumbleweeds chief operating decision-maker is its Chief Executive Officer. This officer reviews financial
information presented on a consolidated basis accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed
is the information presented in the accompanying condensed consolidated statement of operations. Tumbleweed operates in a single reporting segment providing messaging security solutions that are developed and sold in similar ways to enterprise and
government customers of all sizes.

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



|                                |  |                            |        |                          |   |        |  |      |        |  |   |       
|------------------------------- |  | -------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                |  | Three Months EndedJune 30, |        | Six Months EndedJune 30,
|                                |  | 2007                       |        | 2006                     |   | 2007   |  | 2006
|North America                   |  | $                          | 12,555 |                          | $ | 14,226 |  | $    | 25,631 |  | $ | 28,115
|Europe, Middle East, and Africa |  |                            | 1,048  |                          |   | 706    |  |      | 2,474  |  |   | 1,486 
|Asia Pacific                    |  |                            | 474    |                          |   | 182    |  |      | 951    |  |   | 470   
|Other                           |  |                            | 53     |                          |   | 32     |  |      | 89     |  |   | 130   
|                                |  |                            |        |                          |   |        |  |      |        |  |   |       
|Total                           |  | $                          | 14,130 |                          | $ | 15,146 |  | $    | 29,145 |  | $ | 30,201
|                                |  |                            |        |                          |   |        |  |      |        |  |   |       



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##### Table of Contents

Tumbleweeds property and equipment located in the different geographic regions as of June 30,
2007 and December 31, 2006 are as follows (in thousands):



|                        |  |              |       |                  |   |      
|----------------------- |  | ------------ | ----- | ---------------- | - | -----
|                        |  | June 30,2007 |       | December 31,2006
|North America           |  | $            | 1,634 |                  | $ | 1,403
|Europe                  |  |              | 477   |                  |   | 410  
|Other                   |  |              | 5     |                  |   | 7    
|                        |  |              |       |                  |   |      
|Total long-lived assets |  | $            | 2,116 |                  | $ | 1,820
|                        |  |              |       |                  |   |      

(8) Contingencies

In December 2001, certain plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York (the District Court) 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 (IPO) through December 6,
2000. It names as defendants Valicert, its former Chief Executive Officer, and 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 be 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.

In April 2006, the District Court held a hearing on the proposed
settlement but has not yet issued a ruling on the issue.Subsequently, the Court of Appeals for the Second Circuit (the Court of Appeals) vacated the class certification of plaintiffs claims against the underwriters in
six cases designated as focus or test cases. Miles v. Merrill Lynch & Co. (In re Initial Public Offering Securities Litigation, 471 F.3d 24 (2d Cir. 2006). Thereafter, the District Court ordered a stay of all proceedings in all of
the lawsuits pending the outcome of plaintiffs petition to the Court of Appeals for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Court of Appeals denied plaintiffs petition for rehearing,
but clarified that the plaintiffs may seek to certify a more limited class in the District Court.



10



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##### Table of Contents

Accordingly, the stay remains in place and the plaintiffs and issuers have stated that they are prepared
to discuss how the settlement might be amended or renegotiated to comply with the ruling of the Court of Appeals. Failure of the District Court to approve the settlement (or an amended or renegotiated settlement) followed by 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.

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 Tumbleweeds common stock of (other than purchasers
of Tumbleweeds IPO) from August 6, 1999 to October 18, 2000. The case was transferred to the United States District Court for the Southern District of New York, where, in March 2005, the Court dismissed the case with prejudice. In
June 2005 plaintiffs filed an appeal of the dismissal with the United States Court of Appeals for the Second Circuit, which in May of 2006 affirmed the dismissal by the District Court. In September 2006 plaintiffs petitioned the Supreme Court of the
United States for a writ of certiorari, which was denied in December 2006.

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. Tumbleweed is unable to estimate the potential impact of these guarantees on its future results of operations.

Tumbleweed is
engaged in other legal actions arising in the ordinary course of business. Although there can be no assurance as to the outcome of such litigation, Tumbleweed believes it has adequate legal defenses and it believes that the ultimate outcome of any
of these actions will not have a material effect on its consolidated financial positions or results of operations.

(9) Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 48, Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109,
Accounting for Income Taxes and requires a two-step approach to evaluate tax positions and determine if they should be recognized in the financial statements. The two-step approach involves recognizing any tax positions that are more
likely than not to occur and then measuring those positions to determine if they are recognizable in the financial statements. The interpretation is effective for fiscal years beginning after December 15, 2006. Tumbleweed adopted FIN 48
on January 1, 2007. The impact of FIN 48 did not have a material effect on Tumbleweeds consolidated financial position, results of operations, or cash flows.

As of January 1, 2007, Tumbleweed did not have any federal, state, and foreign unrecognized tax benefits. Upon adoption of FIN 48, Tumbleweed adopted an accounting policy to classify interest and penalties
on unrecognized tax benefits as income tax expense. For the years prior to adoption of FIN 48, Tumbleweed did not have interest or penalties on unrecognized tax benefits and therefore, had no established accounting policy. As of January 1,
2007, Tumbleweed had no interest or penalties accrued on unrecognized tax benefits. Tumbleweed files income tax returns in the U.S. federal jurisdiction, various states, and foreign jurisdictions. Tumbleweed is subject to U.S. federal and state
income tax examinations by tax Authorities for all periods since inception due to net operating losses. As of June 30, 2007, Tumbleweed did not have and does not expect any material changes to unrecognized tax benefits within the next twelve
months.

In June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue 06-2, Accounting for
Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-2). EITF 06-2 requires that the costs associated with unrestricted sabbaticals and other similar
benefit arrangements are recognized over the service period during which the employee earns the benefit. The provisions of EITF 06-2 are effective for fiscal years beginning after December 15, 2006. The provisions of EITF 06-2 were applied by
Tumbleweed through a cumulative effect adjustment to its accumulated deficit that resulted in increases of $117,000 each to its accumulated deficit and accrued liabilities balances, respectively. The changes in accumulated deficit for the six months
ended June 30, 2007 were as follows:



|                                |  |                |          |  
|------------------------------- |  | -------------- | -------- | -
|                                |  | (In thousands) |         
|Balance as of December 31, 2006 |  | $              | (295,812 | )
|Net loss                        |  |                | (4,605   | )
|Adoption effect of EITF 06-2    |  |                | (117     | )
|                                |  |                |          |  
|Balance as of June 30, 2007     |  | $              | (300,534 | )
|                                |  |                |          |  



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes to this
Quarterly Report on Form 10-Q and Tumbleweeds Annual Report on Form 10-K for 2006 filed with the Securities and Exchange Commission (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 Tumbleweeds plans, estimates and beliefs. Tumbleweeds 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 at Part II, Item 1A, Risk Factors to this Quarterly Report.

Overview

Tumbleweed Communications Corp. (Tumbleweed or we) is a recognized expert in providing messaging security solutions for enterprise and government customers of all sizes. With our products,
organizations can block security threats, protect information, confidently conduct business online, and reduce their cost of doing business. We provide one of the most comprehensive solutions for inbound and outbound email protection,
secure file transfer and routing, and identity validation that allow organizations to safely and confidently conduct business over the Internet. We offer these solutions in three comprehensive product suites: MailGate®, SecureTransport, and Validation Authority. MailGate® provides protection against spam, viruses, and attacks, and enables policy-based message
filtering, encryption, and routing. SecureTransport enables customers to safely exchange large files and transactions without having to change their internal infrastructure. Validation Authority is a leading solution for determining the
validity of digital certificates.

We are trusted by approximately 2,900 enterprise and government customers who use our products to
connect with over ten thousand corporations and millions of end-users. While our solutions apply to many industry sectors, our traditional market focus has been in the financial services, healthcare, and government markets. Security-conscious
organizations use our products to block security threats, protect information assets, and enable the safe exchange of messages, files, and transactions.

Backlog

Our backlog consists of deferred revenue as well as contractual commitments that are not due and payable as of the
balance sheet date, or for which the product or service has not yet been delivered, and/or for which collectibility is not considered probable. Our backlog excludes all items relating to consulting and training services. Backlog was $23.0 million at
June 30, 2007. We believe that $18.5 million of the backlog at June 30, 2007 will be recognized as revenue in the next 12 months in accordance with our revenue recognition policy, with the balance to be recognized thereafter.

Outlook

We believe that our success in the
remainder of 2007 will depend on our ability to build on our core competency in enterprise messaging security and:



| |  |  | expand our reseller channel by having our sales organization and channel partners work cooperatively to expand our revenue base;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | expand the pipeline of sales opportunities and then close those opportunities in a timely manner;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | expand our customer base in email and file transfer by solving a larger number of our customers problems in messaging security;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | differentiate our products on ease of use and security effectiveness; and
| | - |  | -------------------------------------------------------------------------



| |  |  | increase our brand awareness including building greater mindshare among buyers of email, file transfer, and validation technologies.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------

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 markets; timing of the closure of customer contracts; the integration of our new members of our sales management; 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 rapidly evolving markets. We may not be
successful in addressing such risks and difficulties. Please refer to the Risk Factors section at Part II, Item 1A for additional information.



12



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##### Table of Contents

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our condensed 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 condensed consolidated financial statements.

Revenue Recognition

We derive our revenue from three sources: (i) product revenue, which includes license fees and
appliance fees (for products that are either sold as a standalone software solution or pre-loaded on an appliance platform), subscription-based license fees, and transaction-based license fees; (ii) service revenue, which consists of support
and maintenance fees, consulting fees, and training fees; and (iii) intellectual property revenue which includes patent license agreement fees. 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 based on the judgments and estimates made by our management.

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). We make significant judgments related to revenue recognition. Specifically, as set
forth in paragraph 8 of SOP 97-2 in connection with each transaction involving our products, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the 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 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 transfer terms are typically free on
board, or 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 due within a maximum of 90 days. Where these terms apply, we regard the fee as fixed or determinable, and we recognize revenue upon delivery pursuant to the terms of the arrangement
(assuming all 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 determined that collectibility is not
probable based upon our credit review process or the customers payment history, we recognize revenue when payment is received.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We allocate revenue on software transactions (referred to as arrangements in the accounting literature) involving multiple elements to each undelivered element based on their respective fair values.
Specifically, in a multi-element arrangement we allocate revenue first to undelivered elements such as support and maintenance, consulting services, and training based on each elements fair value and the residual is allocated to the product
license as product revenue. The fair value of support and maintenance fees is recognized ratably over the contractual term of the maintenance, which is typically one year. The fair value of services not considered essential to the functionality
of the product or technology delivered is initially deferred and recognized into revenue as the services are performed. Our determination of the fair value of each element in multiple element arrangements is based on vendor-specific objective
evidence (VSOE). We limit our assessment of the VSOE of fair value for each element to the price charged when that element is sold separately.



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##### Table of Contents

Arrangements that include consulting services are evaluated to determine whether those services are
essential to the functionality of the other elements of the arrangement. When services are not considered essential, the revenue allocable to the services is recognized separately from the software, provided VSOE of the fair value of these services
exists. If we provide consulting services that are considered essential to the functionality of the software products, both the product revenue and service revenue are recognized under contract accounting in accordance with the provisions of SOP
81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. Revenue from these arrangements is recognized under the percentage of completion method based on the ratio of direct labor hours incurred to date to
total projected labor hours except in limited circumstances where completion status cannot be reasonably estimated, in which case the completed contract method is used.

Our software products are typically fully functional upon delivery and do not require significant modification or alteration. For arrangements where services are not essential to the functionality of the software,
customers typically purchase consulting services to facilitate the adoption of our technology, but they may also decide to use their own resources or appoint other professional service organizations to perform these services. Software products and
related support and maintenance services may be billed separately and independently from professional services, which are typically billed on either a time-and-materials basis or a fixed fee basis. For time-and-materials contracts, we recognize
revenue as the services are performed. For fixed fee engagements with milestones or acceptance provisions, revenue is recognized upon completion of a milestone or acceptance, if applicable.

We recognize revenue from patent license agreements when (i) the patent license agreement is executed, (ii) the amounts due are fixed,
determinable, and billable, and (iii) collection of the resulting receivable is probable.

We recognize revenue from indirect channels
such as resellers using the same criteria as is used for arrangements obtained through our direct sales team.

We typically grant our
customers a warranty which guarantees that our products will substantially conform to our current specifications for 90 days from the delivery date pursuant to the terms of the arrangement. We account for the estimated cost of product and service
warranties in accordance with Statement of Financial Accounting Standards (SFAS) 5, Accounting for Contingencies, provided that it is probable that a liability exists, and provided the cost to repair or otherwise satisfy the claim
can be reasonably estimated. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims for the three months ended June 30, 2007 and 2006 were $6,000 and $25,000,
respectively. Costs related to warranty claims for the six months ended June 30, 2007 and 2006 were $121,000 and $25,000, respectively.

Stock-based Compensation Expense

Effective January 1, 2006, we adopted the fair value recognition provisions of
SFAS 123 revised (2004), Share-Based Payment (SFAS 123R), using the modified prospective transition method. Under this transition method, stock-based compensation expense includes compensation expense for all stock-based
compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, Accounting for Stock-Based Compensation
(SFAS 123). We recognize stock-based compensation expense for the unvested portion of stock-based compensation awards granted prior to, but not yet vested, as of January 1, 2006 on an accelerated basis over the vesting period
of the individual award consistent with our methodology prior to the adoption of SFAS 123R and consistent with the method described in Financial Accounting Standards Board Interpretation 28, Accounting for Stock Appreciation Rights and Other
Variable Stock Option or Award Plans. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R
and compensation cost for these awards is recognized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. In accordance with the provisions of SFAS 123R, we recognize stock-based
compensation expense net of an estimated forfeiture rate and recognize the compensation expense for only those shares expected to vest over the requisite service period of the award, which is generally the option vesting term. We estimate the
forfeiture rate based on our historical experience during the preceding term that equals the expected life of the options. The expected life of the options is based on the weighted average period of time that options granted are expected to be
outstanding giving consideration to vesting schedules and our historical exercise patterns. Our expected volatility is based on the daily historical volatility of our common stock, over the expected life of the option. The risk-free rate is based on
the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of the option. Where the expected term of our stock-based awards does not correspond with the terms for which interest
rates are quoted, we perform a straight-line interpolation to determine the rate from the available term maturities. Determining the fair value of stock based awards at the grant date requires judgment, including estimating the expected life of
stock options, the expected volatility of our stock and the amount of stock options expected to be forfeited. To the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative
adjustment in the period estimates are revised. Actual results, and future changes in estimates, may differ substantially from our current estimates and our results of operations could be materially impacted.



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Valuation of Allowance for Doubtful Accounts

We must make estimates of the collectibility of our accounts receivable. We maintain an allowance 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 specifically analyze accounts receivable, including review of historical bad debts, customer credit-worthiness, current economic trends, aging of the balance and estimated collectibility percentages for different aging ranges, and
changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of certain of our customers were to deteriorate, resulting in an impairment of their ability to make payments, we
may record a specific allowance against amounts owed to us by those customers, and thereby reduce the value of the receivable to the amount we reasonably believe will be collected. If all collection efforts have been exhausted, we would write off
the receivable against the allowance.

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 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 our net book value.
| | - |  | ---------------------------------------------------------

We evaluate whether goodwill is impaired on at least an annual basis in accordance with SFAS 142, Goodwill and Other Intangible Assets(SFAS 142) or more frequently if certain indicators are
present. 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 June 30, 2007 and 2006, respectively.

Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by us for federal income tax purposes.
As of June 30, 2007 we had goodwill of $48.1 million.

RESULTS OF OPERATIONS

Three and Six Months Ended June 30, 2007 and 2006

Revenue for the three and six months ended
June 30, 2007 was $14.1 million and $29.1 million, respectively, as compared to $15.2 million and $30.2 million, respectively, for the same three and six months in 2006. Net loss for the three and six months ended June 30, 2007 was $2.7
million and $4.6 million, respectively, as compared to $950,000 and $2.0 million, respectively, for the same three and six months in 2006.

Net loss for both the three and six month periods increased primarily due to decreases in revenue and increases in cost of revenue. The decrease in total revenue for the three month period was primarily due to a decrease in intellectual
property revenue. The decrease in total revenue for the six month period was due to decreases in intellectual property revenue and in product revenue, partially offset by an increase in service revenue.

Total cost of revenue increased to $3.5 million for the three months ended June 30, 2007 from $3.1 million for the same three months in 2006 due to
increases in product costs and in service costs, partially offset by a decrease in the amortization of intangible assets. Total cost of revenue increased to $7.5 million for the six months ended June 30, 2007 from $5.8 million for the same six
months in 2006 due to increases in product costs, in service costs, and in provision for excess inventory, partially offset by a decrease in the amortization of intangible assets. The increases in product costs were primarily due to increases in
costs associated with appliances due to increases in the number of appliances shipped to our customers as customer adoption of our appliance products increased, and due to an increase in sales of our products that require us to make associated
royalty payments to third parties. The increases in service costs for the three and six month periods ended June 30, 2007 were



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primarily due to increases in employee and employee-related costs. The decreases in the amortization of intangible assets were due to the amortization in
full during the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired during the acquisition of Valicert.

Revenue. Revenue, which consists of product revenue, service revenue and intellectual property 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 not considered probable, and/or for which the product or service has not yet been delivered.
Product revenue consists of license fees and appliance fees (for products that are either sold as a standalone software solution or are pre-loaded on an appliance platform), subscription-based license fees, and transaction-based license fees.
Service revenue includes support and maintenance fees, consulting fees, and training fees. Intellectual property revenue consists of patent license agreement fees. Total revenue for the three months ended June 30, 2007 was $14.1 million as
compared to $15.1 million for the same three months in 2006. The decrease in total revenue was primarily due to a $1.5 million decrease in intellectual property revenue and a $133,000 decrease in product revenue, partially offset by a $630,000
increase in service revenue. Total revenue for the six months ended June 30, 2007 decreased to $29.1 million from $30.2 million for the same six months in 2006. The decrease in total revenue was due to a $1.8 million decrease in intellectual
property revenue and a $1.7 million decrease in product revenue, partially offset by a $2.4 million increase in service revenue.

Product
revenue decreased to $5.1 million for the three months ended June 30, 2007 from $5.3 million for the same three months in 2006. Product revenue decreased to $11.0 million for the six months ended June 30, 2007 from $12.7 million for the
same six months in 2006. The decreases in product revenue were due to two large transactions during the six months ended June 30, 2006 that accounted for 20% of our total revenue during that period, with no comparable transactions recorded
during the six months ended June 30, 2007. This was partially offset by increases in the volume of our license transactions, reflecting an expansion of our customer base. Service revenue increased to $8.0 million for the three months ended
June 30, 2007 from $7.3 million for the same three months in 2006. Service revenue increased to $17.0 million for the six months ended June 30, 2007 from $14.6 million for the same six months in 2006. The increases in service revenue were
primarily due to increases in support and maintenance revenue of $616,000 and $1.7 million for the three and six months ended June 30, 2007, respectively. The increase in service revenue for the six months ended June 30, 2007 was also due
to an increase in consulting revenue of $484,000. The increases in support and maintenance revenue were due to the increased number of customers covered by support agreements. The increase in consulting revenue was due to increased customer demand
for consulting services related to our Secure Transport product line.

Intellectual property revenue decreased to $1.0 million for the
three months ended June 30, 2007 from $2.5 million for the same three months in 2006. Intellectual property revenue decreased to $1.1 million for the six months ended June 30, 2007 from $2.9 million for the same six months in 2006. The
decreases in intellectual property revenue were due to a large patent license agreement during the three months ended June 30, 2006, with no comparable transactions in 2007.

Cost of revenue. Cost of revenue is comprised of product costs, service costs, provision for excess inventory, and the amortization of intangible
assets for core/developed technology and maintenance agreements relating to the acquisitions of Valicert, Inc. (Valicert), Incubator Limited (now named Tumbleweed Communications Limited), and Corvigo, Inc. (Corvigo). Product
costs are primarily comprised of royalties paid to third parties for software licensed by us for inclusion in our products, the cost of our products sold on appliances including related shipping and warranty costs, and employee and employee-related
costs, including stock-based compensation expense. Service costs are comprised primarily of employee and employee-related costs, including stock-based compensation expense, for customer support, consulting and training, and contract development
projects with third parties. Provision for excess inventory is comprised of costs associated with excess inventory resulting from our transition to a new appliance manufacturer. Total cost of revenue increased to $3.5 million, or 25% of total
revenue, for the three months ended June 30, 2007 from $3.1 million, or 20% of total revenue, for the same three months in 2006. The increase in total cost of revenue was due to a $337,000 increase in product costs and a $323,000 increase in
service costs, partially offset by a $255,000 decrease in the amortization of intangible assets. Total cost of revenue increased to $7.5 million, or 26% of total revenue, for the six months ended June 30, 2007 from $5.8 million, or 19% of total
revenue, for the same six months in 2006. The increase in total cost of revenue was due to a $1.4 million increase in product costs, a $683,000 increase in service costs, a $164,000 increase in provision for excess inventory, partially offset by a
$531,000 decrease in the amortization of intangible assets.

Cost of product revenue increased to $1.3 million, or 9% of total revenue, for
the three months ended June 30, 2007 from $970,000, or 6% of total revenue, for the same three months in 2006. Cost of product revenue increased to $3.1 million, or 11% of total revenue, for the six months ended June 30, 2007 from $1.7 million, or
6% of total revenue, for the same six months in 2006. The increases in product costs were primarily due to increases of $262,000 and $1.2 million for the three and six months ended June 30, 2007, respectively, in appliance costs due to increases in
the number of appliances shipped to our customers as customer adoption of our appliance products increased. In addition, royalty costs increased by $203,000 and $407,000 for three and six months ended June 30, 2007, respectively, due to increases in
revenues from our anti-virus and



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appliance products, both of which require third-party licenses for which we pay royalties. We expect cost of product revenue to increase on a year-over-year
basis during the remainder of 2007 due to an expected increase in the number of appliance products to be shipped.

Provision for excess
inventory of $164,000, or 1% of total revenue, for the six months ended June 30, 2007 is the estimated loss for excess inventory associated with transitioning our hardware products to a new appliance manufacturer and from a proprietary design
to a standard product offering. This $164,000 expense was recognized during the three months ended March 31, 2007. There was no comparable expense during the three months ended June 30, 2007 or during the three and six months ended
June 30, 2006.

Service costs increased to $1.9 million, or 14% of total revenue, for the three months ended June 30, 2007 from
$1.6 million, or 11% of total revenue, for the same three months in 2006. Service costs increased to $3.8 million, or 13% of total revenue, for the six months ended June 30, 2007 from $3.1 million, or 10% of total revenue, for the same six
months in 2006. The increases in service costs for the three and six month periods ended June 30, 2007 were due to increases in employee and employee-related costs and increases in travel expenses. Employee and employee-related costs increased
by $288,000 and $588,000, respectively, for the three and six months ended June 30, 2007 due to increases in average services headcount. Average services headcount increased to 80 and 79, respectively, for the three and six months ended
June 30, 2007, from 56 and 54, respectively, for the same three and six months in 2006 primarily due to transitioning from a partial utilization of third parties in our support function towards a full employee-based support model and due to the
need for greater personnel resources to fulfill our customer service requirements due to our increased service revenues. Travel expenses increased by $55,000 and $127,000, respectively, for the three and six months ended June 30, 2007. Travel
expenses increased due to increased travel related to customer projects. We expect cost of service revenue to increase on a year-over-year basis during the remainder of 2007 due to an anticipated increase in employee and employee-related costs
driven by increased headcount necessary to meet our customer requirements.

Amortization of intangible assets included in cost of revenue
decreased to $234,000, or 2% of total revenue, for the three months ended June 30, 2007 from $489,000, or 3% of total revenue, for the same three months in 2006. Amortization of intangible assets included in cost of revenue decreased to
$468,000, or 2% of total revenue, for the six months ended June 30, 2007 from $999,000, or 3% of total revenue, for the same six months in 2006. The decreases in the amortization of intangible assets were due to the amortization in full during
the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired during the acquisition of Valicert.

Research and development expenses. Research and development expenses are primarily comprised of employee and employee-related costs, including stock-based compensation expense, and other costs required for the
development and quality assurance of our products. Research and development expenses for the three months ended June 30, 2007 increased slightly to $3.9 million, or 27% of total revenue, from $3.8 million, or 25% of total revenue, for the same
three months in 2006. The increase in research and development expenses was primarily due to an $81,000 increase in consulting costs as a result of greater utilization of third-parties to assist in our research and development processes. Research
and development expenses for the six months ended June 30, 2007 increased to $7.8 million, or 27% of total revenue, from $7.2 million, or 24% of total revenue, for the same six months in 2006. The increase in research and development expenses
was primarily due to an increase in employee and employee-related costs and in consulting costs. Employee and employee-related costs increased by $343,000 primarily due to salary increases and growth in average engineering headcount. Average
engineering headcount increased to 158 for the six months ended June 30, 2007 from 153 for the same six months in 2006. The increase in average engineering headcount was primarily driven by our efforts to broaden and upgrade our products.
Consulting costs increased by $240,000 due to a greater utilization of third-parties to assist in our research and development processes. We expect research and development expenses to increase on a year-over-year basis during the remainder of 2007
due to our continuous efforts to broaden and upgrade our products.

Sales and marketing expenses. Sales and marketing expenses are
primarily comprised of employee and employee-related costs, including stock-based compensation expense, travel expenses, and costs associated with marketing programs. Sales and marketing expenses increased to $7.3 million, or 52% of total revenue,
for the three months ended June 30, 2007 from $6.6 million, or 44% of total revenue, for the same three months in 2006. Sales and marketing expenses for the six months ended June 30, 2007 increased to $13.9 million, or 48% of total
revenue, from $13.0 million, or 43% of total revenue, for the same six months in 2006.

The increases in sales and marketing expenses were
primarily due to increases in employee and employee-related costs. Employee and employee-related costs increased by $511,000 and $757,000 for three and six months ended June 30, 2007, respectively, primarily due to salary increases, growth in
average sales and marketing headcount, and increases in stock-based compensation expense. Average sales and marketing headcount increased to 97 and 100, respectively, for the three and six months ended June 30, 2007, from 87 and 86, respectively,
for the same three and six months in 2006. Stock-based



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compensation expense increased by $152,000 and $183,000, respectively, for the three and six months ended June 30, 2007. The increases in average sales
and marketing headcount were primarily due to our efforts to expand the capabilities of our sales force. Stock-based compensation expense increased due to a greater number of stock options vesting over the three and six month periods ended
June 30, 2007 as compared to the same periods in 2006. We expect sales and marketing expenses to increase on a year-over-year basis during the remainder of 2007 due to an anticipated increase in headcount relative to 2006 and an anticipated
increase in marketing programs, which are designed to increase awareness of, and interest in, our products.

General and administrative
expenses. General and administrative expenses consist primarily of employee and employee-related costs, including stock-based compensation expense, for our administrative, finance, legal, and human resources departments as well as public
reporting costs, and professional fees including intellectual property enforcement and protection costs. General and administrative expenses for the three months ended June 30, 2007 decreased to $2.5 million, or 18% of total revenue, from $2.6
million, or 17% of total revenue, for the same three months in 2006. The decrease in general and administrative expenses was primarily due to a $271,000 decrease in incentive compensation expense, partially offset by an $87,000 increase in
stock-based compensation expense. Incentive compensation expense decreased due to a decrease in intellectual property revenue for the three month period ended June 30, 2007 as compared to the same period in 2006. Stock-based compensation
expense increased due to a greater number of stock options vesting over the three month period ended June 30, 2007 as compared to the same period in 2006. General and administrative expenses for the six months ended June 30, 2007 decreased
to $5.0 million, or 17% of total revenue, from $5.9 million, or 20% of total revenue, for the same six months in 2006. The decrease in general and administrative expenses was primarily due to a decrease of $561,000 in stock-based compensation
expense due to the acceleration of vesting, during the three months ended March 31, 2006, of certain stock options granted to our Chief Executive Officer with no comparable activity during 2007. In addition, intellectual property incentive
compensation expense decreased by $294,000 as a result of decreased intellectual property revenue.

Amortization of
intangible assets. Amortization of intangible assets included in operating expenses consists of the amortization of intangible assets for customer base and reseller agreements and trademarks and trade names recorded as a result of the Valicert,
Incubator Limited, and Corvigo acquisitions. Amortization of intangible assets included in operating expenses decreased to $44,000, or approximately 0% of total revenue, for the three months ended June 30, 2007 from $312,000, or 2% of total
revenue, for the same three months in 2006. Amortization of intangible assets included in operating expenses for the six months ended June 30, 2007 decreased to $227,000, or 1% of total revenue, from $633,000, or 2% of total revenue, for the
same six months in 2006. The decreases in the amortization of intangible assets included in operating expenses were due to completing the amortization of the customer base and reseller agreements acquired during the Valicert acquisition during the
three months ended June 30, 2006.

Other income, net. Other income, net, is generally comprised of interest income earned on
investment securities. Other income, net, increased to $381,000 for the three months ended June 30, 2007 from $301,000 for the same three months in 2006. Other income, net for the six months ended June 30, 2007 increased to $720,000 from
$565,000 for the same six months in 2006. The increases in other income, net were primarily due to increases in interest income driven by an increase in interest rates and a larger average cash balance.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we
have financed our operations primarily through the issuance of equity securities. As of June 30, 2007, we had approximately $30.0 million in cash and cash equivalents.

Net cash used in operating activities for the six months ended June 30, 2007 was $811,000, which was primarily the result of our net loss of $4.6
million and a decrease in our accounts payable, accrued liabilities, and other liabilities of $2.0 million, the impact of which was partially offset by a decrease in our accounts receivable balance of $2.1 million and by our non-cash charges of $2.3
million for stock-based compensation expense and $1.4 million for depreciation and amortization expenses. Our accounts receivable balance decreased due to an increase in cash collections from our customers. Our accounts payable, accrued liabilities,
and other long-term liabilities balances decreased due to an increase in payments to our vendors as well as payments to employees, during the six months ended June 30, 2007, for bonuses and commissions earned during 2006.

Net cash used in operating activities for the six months ended June 30, 2007 was $811,000 compared to net cash provided by operating activities for
the six months ended June 30, 2006 of $1.8 million. This was primarily the result of a $2.6 million increase in our net loss for the six months ended June 30, 2007 compared to the same six months in 2006.

Net cash used in investing activities for the six months ended June 30, 2007 increased to $1.0 million from $677,000 for the same six months in 2006. Net
cash used in investing activities for both the six months ended June 30, 2007 and June 30, 2006 was comprised of purchases of property and equipment. Purchases of property and equipment for the six months



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ended June 30, 2007 increased as compared to the six months ended June 30, 2006 due to investments made to strengthen our information technology
infrastructure as well as additional computer equipment driven by an increase in number of employees.

Net cash provided by financing
activities for the six months ended June 30, 2007 increased to $1.3 million from $773,000 for the same six months in 2006. Net cash provided by financing activities for both the six months ended June 30, 2007 and June 30, 2006 was due
to the proceeds from the issuance of common stock as a result of the exercises of stock options. The increase in net cash provided by financing activities was due to an increase in the number of stock option exercises.

As of June 30, 2007, our principal commitments consisted of obligations related to outstanding operating leases 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 and renewed that lease in 2003. The renewed lease expires in July 2008 with current monthly rent payments of approximately $77,000.

Our capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and
services, and the resources devoted to the development of our products and services and to sales and marketing and other operating activities. 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 may consider future financing alternatives, which may include the incurrence of debt, 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.

OFF-BALANCE SHEET ARRANGEMENTS

At June 30, 2007, 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.

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

Future cash payments for contractual obligations and commercial commitments
as of June 30, 2007, are as follows (in thousands):



|                                   |  |                 |       |            |   |                  |  |       |   |  |   |      
|---------------------------------- |  | --------------- | ----- | ---------- | - | ---------------- |  | ----- | - |  | - | -----
|                                   |  | Less Than1 Year |       | 1  2Years |   | More Than2 Years |  | Total
|Operating leases                   |  | $               | 761   |            | $ | 614              |  | $     |  |  | $ | 1,375
|Unconditional purchase obligations |  |                 | 247   |            |   | 244              |  |       |  |  |   | 491  
|                                   |  |                 |       |            |   |                  |  |       |   |  |   |      
|Total                              |  | $               | 1,008 |            | $ | 858              |  | $     |  |  | $ | 1,866
|                                   |  |                 |       |            |   |                  |  |       |   |  |   |      



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

We currently do not use financial instruments to hedge operating expenses in Australia, Bulgaria, Japan, the Netherlands, Singapore, 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 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



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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 June 30, 2007, 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, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2007. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that, as of June 30, 2007, our disclosure controls and procedures are effective.

(b) Changes in internal controls.

No 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) occurred
during the three months ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



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PART IIOTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

In December 2001, certain
plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York (the District Court) 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 (IPO) through December 6, 2000. It names as defendants Valicert, its former Chief
Executive Officer, and 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 be 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.

In April 2006, the District Court held a hearing on the proposed settlement but has not yet issued a ruling on the
issue.Subsequently, the Court of Appeals for the Second Circuit (the Court of Appeals) vacated the class certification of plaintiffs claims against the underwriters in six cases designated as focus or test cases.
Miles v. Merrill Lynch & Co. (In re Initial Public Offering Securities Litigation, 471 F.3d 24 (2d Cir. 2006). Thereafter, the District Court ordered a stay of all proceedings in all of the lawsuits pending the outcome of
plaintiffs petition to the Court of Appeals for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Court of Appeals Circuit denied plaintiffs petition for rehearing, but clarified that the
plaintiffs may seek to certify a more limited class in the District Court.

Accordingly, the stay remains in place and the plaintiffs and
issuers have stated that they are prepared to discuss how the settlement might be amended or renegotiated to comply with the ruling of the Court of Appeals. Failure of the District Court to approve the settlement (or an amended or
renegotiated 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 condensed 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.

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 of
(other than purchasers of our IPO) from August 6, 1999 to October 18, 2000. The case was transferred to the United States District Court for the Southern District of New York, where, in March 2005, the Court dismissed the case with
prejudice. In June 2005 plaintiffs filed an appeal of the dismissal with the United States Court of Appeals for the Second Circuit, which in May of 2006 affirmed the dismissal by the District Court. In September 2006, plaintiffs petitioned the
Supreme Court of the United States for a writ of certiorari, which was denied in December 2006.

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.



21



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We are engaged in other legal actions arising in the ordinary course of business. Although there can be
no assurance as to the outcome of such litigation, we believe we have adequate legal defenses and we believe that the ultimate outcome of any of these actions will not have a material effect on our consolidated financial positions or results of
operations.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

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

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 rapidly evolving technology markets like ours. We incurred net losses of $4.9 million, $3.9 million, and $7.5 million in 2006, 2005, and 2004,
respectively. As of June 30, 2007, we had incurred cumulative net losses of $300.4 million.

Our success may depend in large part upon
the adoption and use of our products and technology, as well as our ability to effectively maintain existing relationships and develop new relationships with customers, both in new vertical markets and new segments, and via direct sales, channel
sales partners, and strategic partners. 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 for the foreseeable future and may not be able to achieve positive cash flow from operations.

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

Our revenue and our operating
results have fluctuated and may continue to fluctuate based on, among other things, the timing of the execution and termination of customer agreements in a given quarter. We have experienced, and expect to continue to experience, fluctuations in
revenue and operating results from quarter to quarter for other reasons, including the timing of our target customers election to adopt and implement our products and services, the election of our customers to delay their purchase commitments
or purchase in smaller amounts, and the timing of and our ability to continue to license our patents. Further, we have experienced and may continue to experience difficulty in managing the amount and timing of operating costs and capital
expenditures relating to our business, operations and infrastructure as well as collecting fees owed by customers. Finally, any acquisitions or divestitures we complete as well as the announcement or introduction of new or enhanced products and
services may create additional volatility in our results.

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. 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 our 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 the
past have, and in future quarters may, fail to meet our expectations or those of securities analysts or our 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.

Competitive pricing,
sales volume, mix and product costs could materially adversely affect our revenue and gross margins.

Our gross margins are impacted by
a variety of factors, including competitive pricing, product costs (including in-licensed software), and both the volume and relative mixture of our product and service revenue streams. Increased product costs, increased pricing pressures, the
relative and varying rates of increases or decreases in product costs and product prices, changes in product and services revenue mixture or decreased volume could each have a material adverse effect on our revenues, gross margins or ability to make
a profit.

The costs of third-party components comprise a significant portion of our product costs. While we generally have been able to
manage our component costs, we may have difficulty managing such costs if supplies of certain components become limited or component prices increase. Any such limitation could result in an increase in our component costs, and an increase in product
costs relative to our product prices could have a material adverse effect on our gross margins and earnings.



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We may have difficulty in executing our business operations.

Our future operating results will depend on our overall ability to manage operations, which includes, among other things:



| |  |  | retaining and hiring, as required, the appropriate number of qualified employees;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | transitioning from our historical distribution model, which emphasized direct sales, to a distribution model that emphasizes sales through channel partners such as
value added resellers and system integrators;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | building an adequate pipeline of prospective sales;
| | - |  | ---------------------------------------------------



| |  |  | accurately forecasting revenues;
| | - |  | --------------------------------



| |  |  | training our sales force to sell more products and services;
| | - |  | ------------------------------------------------------------



| |  |  | managing inventory levels, including minimizing excess and obsolete inventory, while maintaining sufficient inventory to meet customer demands;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | controlling expenses;
| | - |  | ---------------------



| |  |  | managing, protecting and enhancing, as appropriate, our infrastructure, including but not limited to, our information systems and internal controls; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | otherwise executing on our plans.
| | - |  | ---------------------------------

An unexpected
decline in revenues without a corresponding and timely reduction in expenses or a failure to manage other aspects of our operations could have a material adverse effect on our business, results of operations or financial condition.

If we lose the services of executive officers or other key employees, or our new 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 and
do not have long-term employment agreements with any of our key personnel. In this regard, during 2006 we appointed a new Chief Executive Officer, Chief Technology Officer, Chief Marketing Officer, and during the six months ended June 30, 2007
we appointed new members of our sales management, including our Executive Vice President, Worldwide Field Operations. These new appointments subject us to heightened risks as these executive officers assume their roles, work together as a team, and
make changes to our business and operations. The loss of the services of any of our executive officers or other key employees, including members of our sales force, could significantly delay or prevent the achievement of the goals of our strategic
and operating plan.

If we have elected an ineffective strategy, or do not execute our strategy well, our business could be harmed.

We have developed a strategic and operating plan with four key initiatives: expanding our reseller channel, expanding our international sales, increasing
our brand awareness, and delivering a broader product portfolio. If the company strategy we have elected to pursue turns out to be ineffective, it could significantly limit our ability to compete successfully against current and future competitors.

If on the other hand we have elected to pursue an effective strategy, but we do not execute our strategy well by optimizing our methods of
producing, marketing, and selling our products, it could significantly limit our ability to compete successfully against current and future competitors.

If we do not develop our products, marketing and distribution channels more successfully than our competitors, our business could be harmed.

Larger companies, such as Microsoft, Cisco Systems, Google, Symantec, Websense, and Secure Computing, are concentrating an increasing amount of their substantially greater financial and other resources on the markets
in which we participate, which represents a serious competitive threat to Tumbleweed.

The markets in which we compete are intensely
competitive and rapidly changing, through consolidation and otherwise. Vendors in our markets use different methods of marketing and distribution in order to meet expected customer demand. For example, our competitors 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, our competitors 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 product development, marketing, and sales efforts in an optimal way, which may disadvantage our business in comparison to competitors.

Competitors may develop new technologies or products in advance of us or establish business models or technologies disruptive to us. Our business may be materially adversely affected by the announcement or
introduction of new products, including hardware and software products and services by our competitors, and the implementation of effective marketing or sales strategies by our competitors. The material adverse effect to our business could include a
decrease in demand for our products and services and an increase in the length of our sales cycle due to customers taking longer to compare products and services and to complete their purchases.



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Competitive factors in our industry include customer-driven requirements such as high quality, additional
functionality, improved product performance, ease of use, integration capacity, platform coverage, and the quality of each vendors global technical support. Some of our competitors, particularly Microsoft, Cisco Systems, Google, Symantec,
Websense, and Secure Computing, 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 messaging security products will continue to 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 have increased their presence in this market and others 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 our strategy to these competing forces, to develop and successfully launch 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 or licensing our competitors products. In
particular our product development team is transitioning to an agile software development process, a transition that may cause delays, attrition, and near-term inefficiencies with respect to product development.

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.

In particular, our success depends on our ability to grow and develop our indirect distribution channels, both in the United States and internationally, and the inability to do so could adversely affect future
operating results. Our failure to increase revenue through our indirect distribution channels could have a material adverse effect on our business, operating results, and financial condition. We must continue to 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, which could have a negative impact on our company. In addition, our success depends in part on our ability to sell our appliance-based products through both direct and indirect distribution channels. In comparison to
several of our leading competitors, we have less experience in managing the product development, marketing, and sales of appliance-based products. Historically most of our revenue has been derived from software-based products, not appliance-based
products, and our business could be harmed if we do not successfully execute our plans with respect to our appliance-based products.

We may be unable
to keep pace with rapid industry, technological and market changes.

The markets in which we compete are characterized by rapid
technological change, frequent new product introductions, evolving industry standards and changing needs of customers. There can be no assurance that our existing products will be properly positioned in the market or that we will be able to
introduce new or enhanced products into the market on a timely basis, or at all. We spend a considerable amount of money on research and development and introduce new products from time to time. There can be no assurance that enhancements to
existing products and solutions or new products and solutions will receive customer acceptance. As competition in the information technology industry increases, it may become increasingly difficult for us to maintain a technological advantage and to
leverage that advantage toward increased revenues and profits.

Risks associated with the development and introduction of new products
include delays in development and changes in information security and operating system technologies that could require us to modify existing products.

Risks inherent in the transition to new products include:



| |  |  | the difficulty in forecasting customer preferences or demand accurately;
| | - |  | ------------------------------------------------------------------------



| |  |  | the inability to expand production capacity to meet demand for new products;
| | - |  | ----------------------------------------------------------------------------



| |  |  | the impact of customers demand for new products on the products being replaced, thereby causing a decline in sales of existing products and an excessive,
obsolete supply of inventory; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | delays in initial shipments of new products.
| | - |  | --------------------------------------------



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Further risks inherent in new product introductions include the uncertainty of price-performance relative
to products of competitors, competitors responses to the introductions and the desire by customers to evaluate new products for extended periods of time. Our failure to introduce new or enhanced products on a timely basis, keep pace with rapid
industry, technological or market changes or effectively manage the transitions to new products or new technologies could have a material adverse effect on our business, results of operations, or financial condition.

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, many factors may require us to defer recognition of license revenue for a significant period of time after entering into a license agreement.

Many customers negotiate software licenses near the end of each quarter. In part, this is because 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 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 have accounted 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. No single customer comprised 10% or more of our revenue for the three and six months ended June 30, 2007 or our
accounts receivable balance, net of allowance for doubtful accounts, at June 30, 2007. For the three months ended June 30, 2006, one customer comprised 16%, and another customer comprised 13% of our revenue. For the six months ended
June 30, 2006, one customer comprised 13% of our revenue. For the three months ended June 30, 2007 and 2006, five customers comprised approximately 16% and 33% of our revenue, respectively. For the six months ended June 30, 2007 and
2006, five customers comprised approximately 11% and 27% of our revenue, respectively.

Our appliance products may not be adopted in the market and
expose us to hardware costs and supply chain issues.

Over time, we have expanded our portfolio of products sold on appliances, which
are manufactured by a third party. The inclusion of these hardware appliances in our product portfolio subjects us to additional risks, including, but not limited to:



| |  |  | increased marginal costs relative to software-only transactions which may reduce our gross profits, particularly with respect to lower priced appliances, which may
represent a greater percentage of our sales than in the past;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the inability of the manufacturer to perform in accordance with our expectations, including our expectations regarding the hardware appliances compliance with
any applicable regulations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the inability to deliver appliance products to customers in a timely manner, harming our ability to win time-sensitive customer contracts and/or recognize revenue;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | product shortages that could result in increased product costs;
| | - |  | ---------------------------------------------------------------



| |  |  | price increases from suppliers that may not be able to be passed on to customers;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | oversupply or obsolescence of inventory, which may result in the need to reduce our prices and/or write down inventory; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | product quality issues.
| | - |  | -----------------------

The
occurrence of any of these events could adversely affect our business and operating results.

Economic conditions that result in a decrease in
information technology spending could adversely affect our business.

An important factor affecting our ability to generate revenue is
the impact of general economic conditions on our customers willingness to spend on information technology. Variability in employment, corporate profit growth, interest rates, energy prices and other factors in specific markets could impact
customers willingness to spend on information technology in the near term. In addition, country-to-country variability in economic conditions could significantly impact our business as our reliance on international sales as a percentage of our
overall revenue increases.



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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.

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 are expensed during the period incurred, and the
costs of pursuing the litigation may not be directly matched with the related patent license agreement 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 our 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 incorporate 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 our products.

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 our international customers accounted for 11% and 7% of our revenues for the three months ended June 30, 2007 and
June 30, 2006, respectively, and for 12% and 7% of our revenues for the six months ended June 30, 2007 and June 30, 2006, respectively. Conducting business outside of the United States subjects us to additional risks, including:



| |  |  | changes in regulatory requirements and any resulting costs of compliance, for example, the introduction by the European Union of its Restrictions on Hazardous
Substances;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | reduced protection of intellectual property rights; evolving privacy laws; tariffs and other trade barriers;
| | - |  | ------------------------------------------------------------------------------------------------------------



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



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| |  |  | increased income tax expenses;
| | - |  | ------------------------------



| |  |  | 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.

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 a 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.

Our stock price could be adversely
affected if we are unable to continue to favorably assess the effectiveness of our internal control over financial reporting or if our independent registered public accounting firm is unable to provide an unqualified report on our assessment.

In the future, we may encounter problems or delays in completing the implementation of any changes necessary to make a favorable
assessment of our internal controls over financial reporting. In addition, in connection with the attestation process by our independent registered public accounting firm, we may encounter future problems or delays in completing the implementation
of any requested improvements and receiving a favorable attestation. If we cannot favorably assess the effectiveness of our internal controls over financial reporting, investor confidence and our stock price could be adversely affected.



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

Not
applicable.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

Not applicable.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

On
June 12, 2007, we held our Annual Meeting of Stockholders. The stockholders voted on the following matters:

1) Election of directors:
Dr. Deborah D. Rieman, Dr. Taher A. Elgamal, and James P. Scullion were nominated and elected as Class II directors for terms expiring in 2010. Votes were counted as follows:



|                      |  |            |  |         
|--------------------- |  | ---------- |  | --------
|                      |  | For        |  | Withheld
|Dr. Deborah D. Rieman |  | 45,518,464 |  | 996,070 
|Dr. Taher A. Elgamal  |  | 45,529,327 |  | 985,207 
|James P. Scullion     |  | 46,187,609 |  | 326,925 

As of June 30, 2007, our board of directors was comprised of each of our Class II Directors listed in the
table above, our Class I Directors, Jeffrey C. Smith and Kenneth R. Klein, and our Class III Directors, Christopher H. Greendale, James A. Heisch, and Standish H. OGrady.

2) Ratification of the selection of KPMG LLP as our independent auditors for the fiscal year ending December 31, 2007. The selection of KPMG LLP was ratified by a vote of 46,349,341 for and 117,530 votes against,
with 47,661 votes abstaining.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

Not applicable.



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##### Table of Contents

|ITEM 6. | EXHIBITS
|------- | --------

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                                                                                                                                                          
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                      
|              | 
|3.2(1)        |  | Amended and Restated Bylaws of Registrant                                                                                                                            
|              | 
|10.1          |  | Amendment to the employment agreement between Bernard J. Cassidy and Tumbleweed, dated June 15, 2007                                                                 
|              | 
|10.2          |  | Amendment to the transition agreement between Jeffrey C. Smith and Tumbleweed, dated August 2, 2007                                                                  
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), 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                                                   

---

|(1) | Incorporated by reference to our Registration Statement on Form S-4 (File No. 333-92589), filed December 10, 1999.
|--- | ------------------------------------------------------------------------------------------------------------------



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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: August 7, 2007 |  | By:                             |  | /S/ JAMES P. SCULLION               
|                     |  |                                 |  | James P. Scullion                   
|                     |  |                                 |  | Chairman and Chief Executive Officer
|                     |  |                                 |  | (Principal Executive Officer)       
|                     |  |                                
|Date: August 7, 2007 |  | By:                             |  | /S/ TIMOTHY G. CONLEY               
|                     |  |                                 |  | Timothy G. Conley                   
|                     |  |                                 |  | Senior Vice President of Finance and
|                     |  |                                 |  | Chief Financial Officer             
|                     |  |                                 |  | (Principal Financial Officer and    
|                     |  |                                 |  | Principal Accounting Officer)       



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INDEX TO EXHIBITS



|              |  |                                                                                                                                                                      
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                          
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                      
|              | 
|3.2(1)        |  | Amended and Restated Bylaws of Registrant                                                                                                                            
|              | 
|10.1          |  | Amendment to the employment agreement between Bernard J. Cassidy and Tumbleweed, dated June 15, 2007                                                                 
|              | 
|10.2          |  | Amendment to the transition agreement between Jeffrey C. Smith and Tumbleweed, dated August 2, 2007                                                                  
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), 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 our Registration Statement on Form S-4 (File No. 333-92589), filed December 10, 1999.
|--- | ------------------------------------------------------------------------------------------------------------------



30