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                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

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                                    FORM 10-K

[X]      ANNUAL  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
         EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1998

                                       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 0-27886

                      WORLDTALK COMMUNICATIONS CORPORATION
             (Exact name of Registrant as specified in its charter)

             Delaware                                        77-0303581
 (State or other jurisdiction of                            (IRS Employer
  incorporation or organization)                         Identification Number)

                            5155 Old Ironsides Drive
                          Santa Clara, California 95054
                    (Address of principal executive offices)

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                                 (408) 567-1500
              (Registrant's telephone number, including area code)

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           Securities registered pursuant to Section 12(b) of the Act:
                                      None

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           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.01 Par Value
                                (Title of Class)

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     Indicate  by check mark  whether the  Registrant  (1) has filed all reports
required to be filed by Sections 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 if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best  of  the  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [ ]

     The aggregate  market value of the voting stock held by  non-affiliates  of
the Registrant, based upon the closing price of such stock on March 19, 1999, as
reported by the Nasdaq National Market was approximately $26,000,000.

     The number of  outstanding  shares of the  Registrant's  Common Stock,  par
value $0.01 per share, on March 19, 1999 was 10,791,418 shares.

     Portions of the Proxy  Statement for  Registrant's  1998 Annual  Meeting of
Stockholders to be held on June 11, 1999, are  incorporated by reference in Part
III of this Annual Report on Form 10-K.

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                                     PART I

Item 1. Business

     The  discussion  in this  report  on  Form  10-K  contains  forward-looking
statements that involve risks and  uncertainties.  The Company's  actual results
may  differ  materially  from  the  results  discussed  in  the  forward-looking
statements.  Readers  should  pay  particular  attention  to  the  risk  factors
described in the  "Management's  Discussion and Analysis of Financial  Condition
and Results of  Operations,"  and  particularly  under the  heading  "Additional
Factors That May Effect Future  Results".  Readers should also carefully  review
the risk factors described in the other documents the Company files from time to
time with the Securities  and Exchange  Commission,  specifically  the Quarterly
Reports on Form 10-Q filed by the Company in 1998,  any current  Reports on Form
8-K filed by the Company and the Company's Registration Statement on Form S-1 as
declared  effective by the Securities and Exchange  Commission on April 11, 1996
(File No. 333-1482).

Introduction

     Worldtalk  Communications  Corporation,  and its  subsidiary  (collectively
"Worldtalk" or the "Company") is a leading provider of Internet content security
and policy management solutions. The Company's WorldSecure(TM) policy management
platform  enables  organizations  to define and manage  Internet  e-mail and Web
security  and  usage  policies,  reducing  the  risks,  costs,  and  liabilities
associated with Internet  communications.  The Company  delivered the industry's
first solution for managing and enforcing e-mail security  policies in September
1997. Since then,  organizations have deployed  WorldSecure  solutions to ensure
confidentiality   of  their  external  e-mail   communications,   protect  their
intellectual   property,  and  prevent  SPAMs  and  viruses  from  entering  the
organizations.

     The  Company's   products  include   WorldSecure   Server  (also  known  as
WorldSecure/Mail),  a Windows  NT-based  e-mail  firewall and policy  management
solution,   WorldSecure/ESP,   a  surveillance   program  for  Internet  E-mail,
WorldSecure Client, a desktop e-mail encryption product,  NetTalk(TM), a Windows
NT-based e-mail and directory solution, and NetJunction,  a UNIX-based directory
and messaging switch.

     The Company has experienced and managed a significant  shift in product mix
from almost 100% of software license revenue coming from UNIX-based  NetJunction
e-mail  productivity  products in 1996 to approximately  84% of software license
revenue  coming  from  Windows  NT-based  Internet  content   security,   policy
management and e-mail  directory  products in 1998. By the last quarter of 1998,
the Company  derived  approximately  94% of its  software  license  revenue from
Window NT-based  products and  approximately 89% of its software license revenue
from the WorldSecure  Server product line. In 1998 and continuing into 1999, the
Company's  marketing  efforts  will be almost  entirely  focused on the  Windows
NT-based Internet content security and policy management products.

     During 1998 and beyond,  the  Company's  products  are and will be sold and
marketed worldwide by Worldtalk's direct field and telephone sales forces, value
added resellers (VARs) and distributors.

E-mail Security

     Today's  widespread  use of e-mail  coupled with the growth of the Internet
has opened new avenues for business-level communication and electronic commerce.
E-mail has become an efficient mechanism for the transfer of critical files such
as contracts,  purchase orders and financial  information between  organizations
over the Internet. Industry analysts estimate that e-mail accounts for about 70%
of Internet network traffic.

     In today's competitive marketplace,  sensitive information such as business
plans, contracts, and earnings reports are e-mailed over the Internet.  However,
e-mail is not secure and presents severe risks to an organization's  information
assets as well as  increases  the  liability  exposure.  In  addition,  this has
resulted in financial risks and privacy and compliance  issues for organizations
across a broad  number  of  industries.  Over the past few  years,  the  network
firewall has served as the primary  solution to protect  networks  from external
attacks. But it has

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failed to protect the number one  Internet  application:  e-mail.  A solution is
needed to protect an  organization's  e-mail system and enforce e-mail  security
policies.

The Worldtalk Solution

     Worldtalk's  products provide solutions that allow  organizations to expand
the reach of their  messaging  systems  and  provide  the  security  and  policy
management needed to safely use e-mail across the Internet.  Organizations  rely
on   Worldtalk   solutions  to  protect   their   e-mail   networks  and  secure
communications  with  trading  partners   complementing  their  existing  e-mail
environment.  Worldtalk  solutions  protect  e-mail  communication  by enhancing
privacy,  integrity and  non-repudiation.  Worldtalk  solutions also provide the
needed   directory  and  messaging   connectivity  to  establish  secure  e-mail
backbones.

     
     Worldtalk's   products  are  complemented  by  its  Professional   Services
Organization  (PSO) that offers  consulting,  custom  engineering,  training and
educational  services to meet  customer  needs from initial  planning,  security
assessment, and network design to system testing and production implementation.

     Worldtalk's current product offerings include:

     WorldSecure Server (also known as  WorldSecure/Mail)  -- WorldSecure Server
is a content firewall that incorporates  content analysis,  a policy enforcement
menu, and e-mail security countermeasures including content control, encryption,
archival,  and  virus  scanning  into a single  integrated  solution.  Worldtalk
customers  are  using  the  WorldSecure  product  line to  reduce  the risks and
liabilities  associated  with Internet  e-mail.  Customers can enforce  policies
regarding which data can leave or enter the  organization;  enforce corporate or
industry  regulations  overseeing  the use of  e-mail;  and  enforce  the use of
encryption to secure Internet e-mail communications with partners,  clients, and
remote  offices.  WorldSecure  is also  used by  customers  around  the world to
prevent spams and unsolicited Internet mail from becoming a nuisance, as well as
block  virus-infected  messages  from  entering  or leaving  the  organization's
network. The WorldSecure Server provides a graphical, wizard-based configuration
interface that simplifies the definition and enforcement of e-mail policies.

     The  dynamic  content  policy menu allows an  authorized  administrator  to
define actions based on the company's  security policy.  The WorldSecure  Server
automatically scans the content of e-mail and attachments,  implementing actions
that include:  sending,  stopping,  adding  recipients  to or returning  e-mail;
quarantining  e-mail for subsequent review;  archiving,  encrypting,  annotating
e-mail; and sending an automatic policy notification message to the sender.

     The  directory-based  content policy director adds enhanced  granularity to
the automatic  application of security policies by its ability to apply specific
policies by sender or recipient;  site; data type; keywords and/or subject.  All
of the content security policies, or any combination of them, can be implemented
and modified via the graphical user interface.

     The comprehensive set of e-mail security countermeasures includes:

         o     Content     Filtering    --    WorldSecure     Server    provides
               context-sensitive  filtering  tools  that can be used to  enforce
               electronic  communications  policies and flag suspicious messages
               for review.  WorldSecure  Server also scans embedded HTML and can
               scan attachments by type or name.

         o     Encryption and Digital  Signature -- WorldSecure  Server provides
               server-based  encryption and digital  signatures using the S/MIME
               (Secure MIME) protocol. Two servers can provide  standards-based,
               secure  e-mail over the Internet with  complete  transparency  to
               end-users.  WorldSecure supports several encryption and signature
               algorithms,  with  support  for  export  to  military  grade  key
               lengths.

         o     Virus Detection and  Disinfection -- WorldSecure  Server provides
               an optional virus scanning engine which is fully  integrated with
               the product. The WorldSecure Server detects and optionally cleans
               or  strips  viruses  from the  incoming  and  outgoing  messages.
               Scheduled  virus  pattern  updates  provide  protection  from the
               latest viral threats.

         o     Archiving -- WorldSecure Server provides content-based  archiving
               of e-mail  messages  providing  a  complete  record of  exchanged
               messages.  This feature,  combined with an audit trail of message
               exchange, offers comprehensive non-repudiation mechanisms.

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         o     Access  Controls -- WorldSecure  Server provides tools to monitor
               or restrict  e-mail usage based on source,  destination and other
               criteria.  These  filters  can be easily  combined  with  content
               filters for fine-tuned control.

         o     Anti-Spam -- WorldSecure  Server provides tools for anti-spam and
               anti-relay connection management.

     WorldSecure  Client --  WorldSecure  Client  is the  desktop  component  of
Worldtalk's  WorldSecure family of products.  Using the industry standard S/MIME
protocol, WorldSecure Client ensures the confidentiality and integrity of e-mail
messages and authenticates the sender's identity.

     WorldSecure/ESP  -- WorldSecure/ESP  allows  organizations to inspect their
e-mail  network and  determine the nature of e-mail  exchanged  with the outside
world over the  Internet.  Organizations  can assess their  overall  exposure to
e-mail  and   content   security   risks  and   resulting   liability.   Through
WorldSecure/ESP,  organizations  can  determine  the  nature of e-mail  messages
exchanged over the Internet (jokes,  spams,  non-compliant  e-mail,  e-mail with
multi-media  attachments  and video  trailers,  etc.),  and take the appropriate
policy actions regarding their e-mail networks.

     NetTalk -- NetTalk is a comprehensive  and easy-to-use  directory  solution
for company Intranets.  It allows companies to deploy standards-based  directory
connectivity services, integrate client/server-based  applications such as Lotus
Notes and Microsoft Exchange, and maintain full connectivity to LAN-based e-mail
systems.  The NetTalk  Directory also acts as the X.509 certificate store for an
organization's security applications.  This allows organizations to tie security
infrastructure to existing directory infrastructure.

     NetJunction -- NetJunction  is a UNIX-based  enterprise  level backbone and
directory  solution.   NetJunction  allows   organizations  to  integrate  their
proprietary e-mail and directory applications and provide consolidated access to
the Internet and X.400 VANs.


     Worldtalk's product offerings announced on November 2, 1998 for anticipated
third quarter 1999 availability include:

     WorldSecure/Web  --  WorldSecure/Web is a Web content security product that
provides  an  easy-to-use  policy  management   interface  that  simplifies  the
definition and  enforcement  of Web policies.  It integrates  multiple  security
countermeasures including content filtering (on browsed and submitted data), URL
filtering,  detection of  malicious  mobile code (Java and  Active/X)  and virus
detection  and cleaning.  Using  WorldSecure/Web  organizations  can prevent end
users  from  surfing  inappropriate  sites or  downloading  offending  material.
Organizations can reduce legal liability associated with Internet  connectivity.
WorldSecure/Web is also a solution to offer organizations the necessary tools to
control posting of confidential  information,  through web browser,  on Internet
chat  rooms  and  message  boards.  The  comprehensive  set  of  countermeasures
includes:

         o     Content    Filtering    --    WorldSecure/Web     will    provide
               context-sensitive filtering tools that can be used to enforce Web
               communications  policies  regarding  data  that can be  posted or
               retrieved reducing corporate liability.

         o     URL Filtering -- WorldSecure/Web will include built-in categories
               that  can  be  updated  daily,  along  with  the  flexibility  of
               custom-defined  approved and denied  lists.  These filters can be
               combined with content filers to fine-tune control.

         o     Mobile Code --  WorldSecure/Web  will provide a fully  integrated
               mobile  code  scanning  engine  that allows IT managers to define
               policies to control the type of applets  entering  the  corporate
               network based on applet behavior.

         o     Virus Detection and Disinfection -- WorldSecure/Web  will provide
               a fully integrated virus scanning engine. WorldSecure/Web detects
               and  optionally  cleans or strips  viruses from files  downloaded
               from the web.

Sales Channels

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     The Company has developed  multiple channels of distribution  worldwide for
its products.  The Company's distribution strategy addresses the requirements of
small  companies  to large  enterprises  and matches the  appropriate  sales and
distribution  channels to the Company's  software  product  offerings.  In North
America,  the Company has relied  primarily on direct  field  sales,  telesales,
value added resellers and its service organization for the license,  support and
installation   of  its   products.   Internationally,   sales  are  directed  by
non-exclusive  distributors  and value added  resellers  acting in concert  with
Worldtalk  salespeople.  In 1997, the Company entered into reseller arrangements
with Security Dynamics  Technologies,  Inc. (SDTI) worldwide and ASCII Something
Good  Corporation  (ASG) in Japan.  In the third  fiscal  quarter  of 1998,  the
Company  terminated  the  distribution  agreement  with ASG as a result of ASG's
failure to make contractually obligated payments.

     The  Company's  direct  field  sales  force  primarily  targets  medium  to
large-sized  organizations with enterprise-wide  implementations.  The Company's
telesales  group  typically  targets  smaller  organizations  with less  complex
implementations.  Leads  for the  direct  sales  force are  generated  through a
combination  of industry  trade show  participation,  seminars,  direct mail and
telemarketing  programs,  Internet  download  evaluation  copies,  requests  for
proposals  from  prospects and customer and channel  referrals.  The field sales
force  conducts  multiple  presentations  and  demonstrations  of the  Company's
products to  management  at the  customer's  site.  In addition,  the  potential
customers may evaluate the software on-site for a period of time without charge.
The  direct  sales  force also  works  with VARs to sell the  Company's  Windows
NT-based  WorldSecure and NetTalk  products.  The typical sales cycles can range
from  several  weeks to six months,  but may be  significantly  longer for large
sales.  The  Company  also  sells  software  upgrades  and  annual   maintenance
agreements directly to customers,  as well as through its VARs and international
distributors.

     The  Company  utilizes  the  Internet  to market its Windows NT NetTalk and
WorldSecure products.  Potential customers can download 30-day evaluation copies
of these products from the Company's web site.

Vertical Markets

     The Company  believes that its products serve the needs of organizations in
a  variety  of  industries  and  sells  its  products  into a  diverse  group of
industries.  However, as e-mail communication becomes more prevalent,  new risks
and liabilities are incurred by  organizations  in key industry  segments.  Some
organizations  are  bound  by  government  compliance  regulations.  Others  are
required to abide by a code of professional  conduct and regulations.  Worldtalk
is addressing the security needs of these  organizations by providing  solutions
that  extend  compliance  and  regulations  policies  to e-mail  communications.
Worldtalk  solutions allow these  organizations to comply with federal and other
governing  regulations and to offer a higher level of service to their customers
and partners.  Three key and targeted  vertical market  segments  identified and
marketed to by the Company during 1998 were:

     Legal -- As more and more lawyers utilize Internet e-mail,  their law firms
must  define  and  enforce  security  policies  in an effort to  protect  client
documents,  shield privileged legal advice, and safeguard intellectual property.
Worldtalk  solutions  give  legal  firms the  ability to  protect  their  e-mail
networks while ensuring the privacy and integrity of e-mail between  lawyers and
their clients via the encryption of e-mail.  By the end of 1998, more than 25 of
the leading law firms worldwide had chosen WorldSecure solutions to secure their
Internet e-mail, including 16 law firms on the AmLaw 100 list.

     Healthcare  -- Healthcare  firms use Internet  e-mail to  communicate  with
government  agencies such as the FDA, or with clients,  partners and networks of
doctors.  Healthcare companies have identified  information security breaches as
major  threats  to  their  businesses.  Worldtalk  solutions  in the  healthcare
industry are enabling a better level of service to providers  and  physicians by
allowing the safe exchange of sensitive and  confidential  information,  such as
patient files,  medical  claims,  and information on eligibility and beneficiary
status. Worldtalk is making it possible for these firms to ensure doctor-patient
confidentiality,  regulate and secure Internet e-mail usage, and protect patient
records,   hospital  records,  and  hospital  policies,  among  other  sensitive
information, via the encryption of e-mail.

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<PAGE>

     Financial  -- Firms in the  financial  industry  need to protect  financial
information,  secure  communications  with clients,  and comply with  government
regulations.  Worldtalk  solutions allow financial  institutions to leverage the
Internet for the e-mail exchange of business-critical  information.  Through the
development and enforcement of corporate security policies,  Worldtalk solutions
does extend SEC regulations and compliance to e-mail systems.

International Sales

     International  license  sales,  which  are  denominated  in  U.S.  dollars,
accounted  for 28% and 37% of the Company's  total license  revenues in 1998 and
1997,  respectively.  Included in the financial results for the third quarter of
1998, the Company announced that the distribution relationship with ASG in Japan
had been terminated by Worldtalk. The cause of the termination was ASG's failure
to make payments totaling  approximately  $1.7 million for software product fees
and maintenance for the first and second quarters of 1998. ASG accounted for 18%
and 63% of the Company's  total license sales and total  international  software
license  sales,  respectively,  in 1998.  The remaining  international  software
license  revenue was primarily  sold by  distributors  in Europe,  Singapore and
Australia. These distributors provide system installation, technical support and
systems integration  services,  as well as follow-on first-line support to local
customers.  SDTI, with 17% of total software  license sales,  was the only other
single distributor,  VAR, customer or OEM to account for greater than 10% of the
Company's license revenues in 1998.

Marketing

     The  Company  uses its direct  field  sales  force and  internal  telesales
organization,  distributors,  strategic  partners and resellers,  in combination
with a variety of  marketing  programs,  to  stimulate  demand for its  software
products.  Lead  generation  through the  internal  telesales  organization  and
various marketing programs,  such as direct mail campaigns,  are utilized by the
direct sales force, distributors and resellers as part of the sales process. The
Company seeks to educate the  marketplace and to build awareness of its products
through participation in industry trade shows and conferences,  public relations
targeted  at both the  technical  and general  business  press,  publication  of
technical  articles in the trade press and communication with its installed-base
of customers.  These programs are generally  focused on target vertical markets.
In addition,  the Company has developed domestic and international  co-marketing
programs with key  strategic  partners  such as Cisco,  IBM and Hewlett  Packard
designed to leverage their sales and marketing capabilities.  As of December 31,
1998, the Company had 20 full-time  personnel employed in sales and 13 full-time
personnel employed in marketing.

Professional Services Organization (PSO)

     The  professional   services   organization  manages  on-site  installation
services  and custom  development  programs  and offers  customer  training  and
professional  consulting services to Worldtalk's customers.  The WorldSecure/ESP
content  security  assessment  service  enables  organizations  to identify SPAM
e-mail, e-mail with sensitive or confidential information, e-mail with offensive
content, and virus-infected e-mail. In addition, WorldSecure/ESP also identifies
abuses of e-mail  networks,  such as the exchange of multimedia  attachments and
e-mail  messages  sent  to very  large  distribution  lists.  PSO  services  are
delivered  by a  combination  of full-time  Company  employees  and  third-party
consultants trained on Worldtalk applications and programs. The group's products
and  services  are also  intended to  complement  related  integration  services
performed  by  the  Company's  VARs,   distributors   and  strategic   partners.
Professional  services are performed  for an  additional  fee and are offered in
conjunction with the licensing or deployment of Worldtalk's software products.

Customer Maintenance and Support

     The  Company's   software  is  generally   deployed  in   business-critical
environments,  where a high  degree of  customer  support is  important  for the
continuing  success of product  deployment.  The Company maintains a centralized
technical support group that is responsible for first-line  telephone support as
well as  distribution  of product and  documentation  updates.  This group works
closely  with  the  Company's  professional  services  and 


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product development  organizations in order to ensure continuity in the areas of
problem resolution and priority response.

     Maintenance and support  contracts,  which are typically for twelve months,
are offered  concurrently  with the initial license of a Company product.  These
contracts may be renewed  annually and are  generally  priced at 20% of the list
price of the  licensed  software.  The Company also offers  customer  support 24
hours a day, seven days a week, for those customers  requiring  around the clock
support. Pricing for such support is negotiated separately and is in addition to
the standard fees.


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<PAGE>

Strategic Relationships

     The Company  believes that strategic  relationships  with other  technology
vendors and channels of  distribution  are important to the Company's  business.
Accordingly,  the Company has entered into strategic  relationships with various
companies such as Cisco,  Hewlett-Packard,  IBM, GTE, SDTI, Entrust,  ICL, Inc.,
RSA Data  Security,  VeriSign,  Inc. and Trend Micro,  Inc. The Company plans to
continue utilizing strategic technology licensing,  marketing,  distribution and
other business partnerships in the future.

Product Development

     The primary  focus of  Worldtalk's  product  development  activities  is to
leverage its technical expertise and product innovation  capabilities to provide
Internet content security and policy management solutions. The Company's product
development  organization  is grouped by key product  area and is  comprised  of
development  engineers,  quality assurance engineers and technical writers.  The
approach used in product  development is a  phase-oriented  development  process
that  includes  formal  engineering   specifications,   design  test  documents,
milestone  inspections  and  quality  control.  This  process  incorporates  the
monitoring   of   quality,   schedules,   functionality,   costs  and   customer
satisfaction. The markets addressed by the Company's products are very sensitive
to quality and, therefore, the Company focuses on continuously improving product
quality.  As of  December  31,  1998,  the Company  had 25  full-time  personnel
employed in product development.

Competition

     The market for the Company's products is intensely  competitive and subject
to rapid changes.  The enterprise  security market is  characterized  by various
products and solutions that compete with  Worldtalk's  Internet content security
and policy  management  solutions.  These  include  products  offered by Content
Security Inc. (which is partially owned by Integralis Technology, Ltd.), Network
Associates,  Inc. and Trend Micro  Incorporated.  The Company  believes that its
Windows NT  Internet  content  security  and policy  management  product  family
competes favorably with these products. The Company also anticipates competition
in the future from other  companies  in the  enterprise  security  market as the
industry continues to grow.

     The Company believes that the competitive  factors affecting the market for
the Company's products and services include: product functionality and features;
product  quality  and  documentation,  performance  and  price;  ease of product
integration with disparate e-mail and groupware  solutions;  quality of customer
support services,  customer training;  hardware platforms supported;  vendor and
product reputation;  and the strength of sales channels. The relative importance
of each of  these  factors  depends  upon  the  specific  customer  environment.
Although the Company believes that its products and services  currently  compete
favorably  with  respect to such  factors,  there can be no  assurance  that the
Company can maintain its  competitive  position  against  current and  potential
competitors.

     Many  of the  Company's  current  and  potential  competitors  have  longer
operating  histories;   significantly  greater  financial,   technical,  product
development  and marketing  resources;  and greater name  recognition and larger
customer bases than the Company. The Company's present or future competitors may
be able to develop  products  comparable  or superior to those  developed by the
Company.  They may also be able to adapt more  quickly  than the  Company to new
technologies,  evolving  industry  trends or  customer  requirements,  or devote
greater resources to the development,  promotion and licensing of their products
than the Company.

Intellectual Property and Other Proprietary Rights

     The Company's  future  success is dependent upon its  proprietary  software
technology.  In addition, the Company licenses certain key technology from other
companies.  The Company has applied for a patent in regard to certain aspects of
its technology.  In addition, the Company relies on trade secret,  copyright and
trademark laws,  nondisclosure  and other  contractual  agreements and technical
measures, to protect its technology. The Company 


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also believes that factors such as the  technological and creative skills of its
personnel as well as new product developments and enhancements, are essential to
establishing  and  maintaining  a technology  leadership  position.  The Company
generally  enters  into  confidentiality  and/or  license  agreements  with  its
employees,  distributors  and  customers.  The  Company  limits  access  to  and
distribution of its software,  documentation and other proprietary  information.
Much of the Company's  software is shipped with a software  security lock, which
initially limits software access to authorized  users. In addition,  the Company
restricts  third party  access to its source  code,  except in  connection  with
source code escrow arrangements.  There can be no assurance that the steps taken
by the  Company  will  prevent  misappropriation  of its  technology,  and  such
protections  do  not  preclude   competitors   from  developing   products  with
functionality or features similar to the Company's products.  Furthermore, there
can be no assurance that third parties will not independently  develop competing
technologies  that are  substantially  equivalent  or superior to the  Company's
technologies.  The loss of any significant  third-party license or the inability
to license  additional  technology  as required,  could have a material  adverse
effect on the Company's  results of operations  unless or until such time as the
Company could replace such  technology.  The Company has not yet agreed to terms
with Trend Micro to renew the OEM agreement for  anti-virus  technology  that is
scheduled to expire in April 1999. Both Trend Micro and alternative  sources are
being  examined.  In the event that these  sources  do not  provide  replacement
software,  the Company  will no longer  provide an  anti-virus  software  module
option.

Export License Requirements

     Export of the Company's WorldSecure product family is restricted by various
United States laws and regulations governing the export of encryption technology
administered principally by the United States Department of Commerce,  Bureau of
Export Administration. The Company currently is authorized to export WorldSecure
products  of various  encryption  key  lengths  subject to the  limitations  and
conditions  of export  licenses  or license  exceptions  pursuant  to the Export
Administration  Regulations administered by the Bureau of Export Administration.
The Company is also  responsible for monitoring  customer  compliance with these
laws and regulations. Failure to obtain necessary export authorization or future
adverse  changes in United States  government  policy  relative to the export of
encryption technology could materially decrease the Company's ability to compete
in foreign markets thereby adversely affecting revenue.

Year 2000 Compliance

     The  Company  believes  that  its  products  are  compliant  with  customer
requirements for operations through the year 2000 and beyond. The Company has an
active program to make all of its computer facilities year 2000 compliant by the
middle of 1999. The Company's Year 2000  compliance  project team will establish
an inventory of all critical hardware, software and non-electronic equipment. In
addition,  vendors will be contacted  about their  product and service Year 2000
compliance.  The Company's test plan includes  checking for Year 2000 compliance
on the hardware basic input output systems (BIOS), operating systems, and server
based software.  The Company's  desktop  productivity  (i.e.,  word  processing,
spreadsheets,  etc.)  computer  environment  is  anticipated to become year 2000
compliant  with an upgrade to the  Windows 98  operating  system and  associated
announced  Office  2000  suite of  products.  The  Company's  financial  systems
currently store data in a four-digit year format while the application itself is
not year 2000 compliant.  The Company's  financial software vendor currently has
available  a release  which is Year  2000  compliant  and which  will be used to
upgrade   the   Company's   existing    financial    systems.    The   Company's
telecommunications systems have been upgraded to become year 2000 compliant with
existing  upgrades from the Company's  current vendor.  The risks to the Company
associated with the year 2000 compliant  software include the potential  partial
loss of customer  information.  The  Company's  contingency  plan to address the
above would primarily  consist of switching to alternative  vendors for standard
office productivity and financial application software.  The anticipated cost to
become year 2000 compliant is under $100,000.

Employees

     As of December 31, 1998,  the Company had a total of 83 employees,  of whom
33 were engaged in sales and marketing,  25 in research and  development,  14 in
professional  services and technical support and 11 in administration,  finance,
MIS and operations. The Company's employees are not represented by labor unions,
nor 


                                       9
<PAGE>

are they generally bound by employment or non-competition  agreements or covered
by key-person life insurance policies.  The Company has not experienced any work
stoppages and considers its relations with its employees to be good.

     The Company  intends to continue to hire sales,  marketing and  engineering
personnel in the future.  Competition  for such personnel is intense,  and there
can be no assurance that the Company can hire and retain qualified  personnel in
the future.  If the  Company is unable to hire  required  personnel  on a timely
basis, the Company's  business,  operating results and financial condition could
be adversely affected.

Item 2. Properties

     The Company's  headquarters  is located in Santa Clara,  California,  which
houses  product  development,   sales,   technical  support  and  administrative
operations in approximately  30,000 square feet of space. This facility is under
lease through September 2005.

     The Company has leased  sales  offices in San Ramon,  California;  Chicago,
Illinois;  New York, New York; London, United Kingdom and McLean,  Virginia. The
Company, through its subsidiary,  Deming Software, also has a leased engineering
office in Redmond, Washington.

Item 3. Legal Proceedings

     The Company is engaged in certain  legal  actions  arising in the  ordinary
course of business. The Company believes that it has adequate legal defenses and
that ultimate  outcome of these  actions will not have a material  effect on the
Company's financial position and results of operation.

     As part of the financial results for the third quarter of 1998, the Company
announced  that  the  distribution   relationship   with  Ascii  Something  Good
Corporation (now known as I4 Corporation,  a Japanese  corporation)  ("ASG") had
been  terminated  by  Worldtalk  for ASG's  failure to make agreed  payments for
software product fees and maintenance then totaling  approximately  $1.7 million
for the first and second  quarters of 1998.  On December 11,  1998,  the Company
filed a lawsuit against ASG in the United States District Court for the Northern
District of  California,  which case was assigned  Case Number  C-98-21231.  The
Complaint alleges the breach by ASG of the Distribution Agreement by ASG through
default  of its  payment  obligations.  The  lawsuit  seeks  payment  of  unpaid
balances,  currently in excess of $2.7 million, interest thereon, and reasonable
attorneys' fees and costs. ASG has until May 12, 1999 in which to respond to the
Complaint.

Item 4. Submission of Matters to a Vote of Security Holders

     Not applicable


                                       10
<PAGE>

                                     PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

     The  Company's  Common Stock has been  included for quotation on the Nasdaq
National  Market  under the Nasdaq  symbol  "WTLK" since the  Company's  initial
public offering in April 1996. The following  table sets forth,  for the periods
indicated,  the range of high and low bid information  for the Company's  Common
Stock for 1998 and 1997.

                                                        High     Low      
                                                        ----     ---      
           1997:                                        
           First Quarter..........................     10 1/4    6
           Second Quarter.........................      7        3 1/8
           Third Quarter..........................      8 1/8    3 3/8
           Fourth Quarter.........................      8 1/8    3 1/8

           1998:
           First Quarter..........................      4 3/4    2 7/8
           Second Quarter.........................      6 3/8    2 3/4
           Third Quarter..........................      5 1/8    1 3/8
           Fourth Quarter.........................      4        1 5/8
           
     These  over-the-counter  market  quotations  reflect  inter-dealer  prices,
without retail mark-up,  mark-down,  or commissions and may not represent actual
transactions.  As of February 28, 1999, there were  approximately 101 holders of
record of the  Company's  Common  Stock.  The number of record  holders does not
include those  beneficial  owners who hold in street or nominee name.  When such
beneficial owners are included,  the Company believes the number of shareholders
exceeds 500.

Dividend Policy

     The Company has never paid cash dividends on its Common Stock.  The Company
presently  intends to retain all cash for use in the  operation and expansion of
the Company's  business and does not anticipate paying any cash dividends in the
near future.  The Company's bank line of credit agreement  prohibits the payment
of  dividends  without  the  bank's  written  consent.  See  Item  8  "Financial
Statements and  Supplemental  Data, Note (6) of Notes to Consolidated  Financial
Statements."

                                       11
<PAGE>

Item 6. Selected Consolidated Financial Data
<TABLE>

     The following  selected  consolidated  financial  data for each of the last
five  fiscal  years has been  derived  from the audited  consolidated  financial
statements of the Company.  The selected  consolidated  financial data set forth
below should be read in conjunction with  "Management's  Discussion and Analysis
of Financial  Condition and Results of Operations" and the financial  statements
and notes thereto included elsewhere in this report.
<CAPTION>
                                                               Years Ended December 31,
                                          ---------------------------------------------------------------
                                             1998          1997         1996          1995         1994
                                          ----------    -----------  ----------    ----------    --------
                                               (All amounts in thousands, except per share data)
<S>                                        <C>            <C>         <C>            <C>         <C>     
Statement of Operations Data:
Total revenue ..........................   $ 13,448       $ 11,327    $ 14,205       $  6,705    $  4,392
Total cost of revenue ..................      3,306          3,991       3,438          1,828       1,552
Gross profit ...........................     10,142          7,336      10,767          4,877       2,840
Total operating expense ................     15,600         14,361      16,547          8,548       6,674
Net loss ...............................   $ (5,084)(3)   $ (6,700)   $ (5,240)(1)   $ (3,640)   $ (3,903)
Basic and diluted net loss per share ...   $  (0.48)      $  (0.65)   $  (0.68)(2)   $  (3.59)   $  (1.92)
Shares  used  in  computing basic and
     diluted net loss per share ........     10,584         10,355       7,669          1,014       2,038
</TABLE>
<TABLE>
<CAPTION>

                                                          As of December 31,
                                       -------------------------------------------------------
                                           1998       1997      1996        1995        1994
                                         --------   --------  ---------   ---------   --------
<S>                                      <C>        <C>        <C>        <C>         <C>      
Balance Sheet:
Working capital (deficit) ............   $  2,552   $  6,574   $ 12,581   $    801    $ (1,192)
Total assets .........................     11,146     17,265     21,719      5,727       2,170
Redeemable convertible preferred stock       --         --         --       12,816       2,342

Stockholders' equity (deficit) .......   $  4,088   $  8,656   $ 14,396   $(11,405)   $ (3,058)
<FN>
----------

(1)      Includes  in-process  research  and  development  of $4.5  million  and
         Deming-related integration expenses of $279,000.

(2)      Exclusive  of the expenses  noted in footnote  (1) above,  net loss per
         share would have been ($.06).

(3)      Includes an  allowance  for  doubtful  accounts  for the full amount of
         approximately  $1,700,000  owed by ASG as result of the termination and
         associated non-payments.
</FN>
</TABLE>


                                       12
<PAGE>


Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

Overview

     This  discussion  and  analysis  of  financial  condition  and  results  of
operations contains descriptions of the Company's  expectations regarding future
trends  affecting  its  business.  These  forward-looking  statements  and other
forward-looking  statements made elsewhere in this document are made in reliance
upon the safe harbor provisions of the Securities Litigation Reform Act of 1995.
The discussion in this report contains  forward-looking  statements that involve
risks and uncertainties. The Company's actual results may differ materially from
the results  discussed  in the  forward-looking  statements.  Factors that could
cause or contribute to such differences  include,  but are not limited to, those
discussed below and in "Additional Factors That May Affect Future Results".

     The Company is a leading  provider of Internet  content security and policy
management solutions.  The Company's  WorldSecure(TM) policy management platform
enables  organizations to define and manage Internet e-mail and Web security and
usage  policies,  reducing the risks and  liabilities  associated  with Internet
communications. The Company delivered the industry's first solution for managing
and enforcing e-mail security policies in September 1997. The Company's products
include WorldSecure Server (also known as WorldSecure/Mail),  a Windows NT-based
content firewall and policy management solution, WorldSecure/ESP, a surveillance
program for Internet E-mail,  WorldSecure  Client,  a desktop e-mail  encryption
product,  NetTalk(TM),  a Windows  NT-based e-mail and directory  solution,  and
NetJunction, a UNIX-based directory and messaging switch.

     The Company has  experienced a significant and planned shift in product mix
from almost 100% of software license revenue coming from UNIX-based  NetJunction
products in 1996 to  approximately  84% of software  license revenue coming from
Windows  NT-based  Internet  content  security,  policy  management  and  e-mail
directory  products in 1998.  By the last quarter of 1998,  the Company  derived
approximately  94% of its software license revenue from Window NT-based products
and  approximately  89% of its software  license  revenue  from the  WorldSecure
Server product line. However, a significant portion of the revenue reported from
these  products  during the 1998  fiscal  year came from  shipments  of products
pursuant to minimum  non-refundable  commitment  terms with two large resellers,
which do not directly reflect sales to end-users.  During the first two quarters
of 1999, the Company expects to report  additional  revenue from the recognition
of  the  balance  of a  non-refundable  prepaid  purchase  commitment  from  one
reseller. The Company believes that reaching and maintaining  profitability will
depend on increased  market  acceptance of its  WorldSecure  product line. A key
element  of the  Company's  future  revenue  growth  will be the  ability of the
Company's  resellers  and  international  distributors  to  sell  the  Company's
products in volume.  There can be no assurance  that the Company's  resellers or
international distributors will be successful in marketing these products.

     The financial  results for the third quarter,  fourth  quarter,  and fiscal
1998 were  greatly  impacted  by  Worldtalk's  termination  of the  License  and
Distribution  Agreement with Worldtalk's Japanese  distributor,  Ascii Something
Good. The termination was the result of ASG's failure to make payments  totaling
approximately  $1.7 million for software  product fees and  maintenance  for the
first and second  quarters of 1998.  As a result of the  termination,  Worldtalk
established  an  allowance  for  doubtful   accounts  for  the  full  amount  of
approximately $1.7 million owed by Ascii Something Good in the financial results
for the third fiscal quarter of 1998 affecting general and administrative costs.
In addition,  Worldtalk did not recognize any revenue from Ascii  Something Good
or the  Japanese  market in the third and fourth  fiscal  quarter of 1998.  As a
result,  the Company  experienced a sequential quarter decline in revenue in the
third quarter of 1998 and a significant  operating  loss for 1998. The Company's
results improved by the fourth quarter of 1998 as a result of increased  revenue
from the WorldSecure product line and continued cost control measures.

     The Company's  Internet  content  security and policy  management  products
continue to place the Company in competition with a set of vendors, many of whom
have significantly greater resources than the Company.  Accordingly, the Company
intends to invest  significantly in its business.  As a result,  there can be no
assurance  that the Company will be  profitable  on a quarterly or annual basis.
The Company's future operating  results may 


                                       13
<PAGE>

fluctuate due to factors such as the demand for the Company's products; size and
timing of customer orders;  success of the Company's resellers and international
distributors;  the introduction of new products and product  enhancements by the
Company or its competitors; the budgeting cycles of customers; acceptance by the
market of the Company's products;  changes in United States government policy on
encryption  software;  changes  in the  proportion  of revenue  attributable  to
license  and  service  fees;  changes in the level of  operating  expenses;  the
ability of the Company to develop new  distribution  channels;  and  competitive
conditions in the industry.

Results of Operations

     The  following  table  sets  forth  certain   consolidated   statements  of
operations data for the periods indicated as a percentage of total revenues:

                                                    Years Ended December 31,
                                                 -----------------------------
                                                  1998       1997        1996
                                                 -------    -------    -------
Revenue:
  Software licenses ..........................     71.6%      60.6%      68.4%
  Maintenance, installation and training .....     28.4       39.4       31.6
                                                  -----      -----      -----  
          Total revenue ......................    100.0      100.0      100.0
                                                  -----      -----      -----  
Cost of revenue:
  Software licenses ..........................      5.5        9.1        7.6
  Maintenance, installation and training .....     19.1       26.1       16.6
                                                  -----      -----      -----  
          Total cost of revenue ..............     24.6       35.2       24.2
                                                  -----      -----      -----  
Gross margin .................................     75.4       64.8       75.8
                                                  -----      -----      -----  
Operating expenses:
  Product development ........................     29.3       37.9       25.1
  Sales and marketing ........................     55.6       65.1       47.5
  General and administrative .................     31.1       23.8       12.2
  Purchased research and development .........       --         --       31.7
                                                  -----      -----      -----  
          Total operating expense ............    116.0      126.8      116.5
                                                  -----      -----      -----  
          Operating loss .....................    (40.6)     (62.0)     (40.7)
Interest income, net .........................      2.8        4.5        3.8
                                                  -----      -----      -----  
          Loss before income taxes ...........    (37.8)     (57.5)     (36.9)
Income taxes .................................       --        1.6         --
                                                  -----      -----      -----  
          Net loss ...........................    (37.8)%    (59.1)%    (36.9)%
                                                  =====      =====      =====  

Revenues

     The Company's  total  revenues are derived  primarily from license fees for
its  software and charges for  services,  including  maintenance,  customization
consulting,  installation and training.  License fees relate to both the initial
licenses of its software  products,  as well as  subsequent  purchases to expand
capacity or add functionality.  Maintenance,  installation and training revenues
relate to support contracts,  installation and training services.  Revenues from
software licenses are generally  recognized upon shipment of software.  Revenues
from  maintenance  contracts  are  recognized  over  the  contract  term,  which
generally is one year, while  installation and training  revenues are recognized
when the  services  are  performed.  The  Company  also  reported  revenue  from
shipments of products pursuant to minimum  non-refundable  commitment terms with
two large resellers.

     The  Company's  total  revenues  were $13.4  million in 1998 as compared to
$11.3 million in 1997 and $14.2 million in 1996, representing an increase of 19%
from fiscal 1997 to fiscal 1998 and a decrease of 20% from fiscal 1996 to fiscal
1997.

     Software  license and software  development  revenues  were $9.6 million in
1998 as compared to $6.9 million in 1997 and $9.7 million for 1996, representing
an  increase  of 40% from  fiscal 1997 to fiscal 1998 and a decrease of 29% from
fiscal 1996 to fiscal  1997.  The  increase in software  license  revenues  from
fiscal 1997 to 1998 was  attributable  to the  increased  sales of the Company's
WorldSecure  product line,  which was first shipped in September 1997. The level
of  software  license  revenue in 1998 was  impacted by the  termination  of the
Japanese  distributor  in the third  quarter  resulting  in no software  license
revenue from the Japanese  market in the third and fourth  quarters of 1998. The
decrease in software license and software  development revenues from fiscal 1996
to  fiscal  1997 was  primarily  due to the  decline  in  sales  of  NetJunction
enterprise backbone products which was not

                                       14
<PAGE>

offset rapidly enough by increased  sales of the Company's new Windows  NT-based
products, WorldSecure and NetTalk.

     Software license revenue for the Company's  WorldSecure Server product line
was 72% of total software license revenue for fiscal 1998 as compared to 16% for
fiscal 1997.  Also, the WorldSecure  Server license revenue in 1998 grew by 524%
as compared to 1997.  The  WorldSecure  Server  product line was  introduced  in
September 1997.  Geographically,  the Company's software license revenue in 1998
was  72%  for  the  United  States,  compared  with  63% in  1997,  and  28% for
international  business  in  1998,  compared  with 37% in 1997.  The  growth  in
software license revenue combined with the lack of license sales in Japan of the
WorldSecure  product  line  starting  in the third  quarter  contributed  to the
decreased  percentage  of  international  software  license  revenue for 1998 as
compared to 1997.

     Maintenance,  installation and training  revenues were $3.8 million in 1998
as compared to $4.5 million in 1997 and $4.5 million in 1996, representing a 15%
decrease from fiscal 1997 to 1998 and no change from fiscal 1996 to fiscal 1997.
Maintenance, installation, and training revenue in 1998 decreased as compared to
1997  primarily as a result of lower  maintenance,  installation  and consulting
revenues  associated  with  the  older  UNIX-based   NetJunction  product  line.
Maintenance,  installation,  and training revenue for fiscal 1997 was consistent
with  fiscal  1996 due to an  increase  in the number of  maintenance  contracts
associated with new software licenses,  the renewal of maintenance  contracts by
existing  customers,  and increases in demand for  customization  consulting and
training  services  offset by various other  factors.  The Company  expects that
maintenance,  installation and training  revenues will increase in the future as
the  Company's  sales  of the  WorldSecure  product  line  increase  and  annual
maintenance agreements with existing WorldSecure customers are renewed.

Cost of Revenues

     The  Company's  total cost of revenues was $3.3 million in 1998 as compared
to $4.0 million in 1997 and $3.4 million in 1996, representing a decrease of 17%
from  fiscal  1997 to fiscal  1998 and an  increase  of 16% from  fiscal 1996 to
fiscal 1997.

     Cost of  product  revenues  consists  of the  costs  of  royalties  paid to
third-party  vendors,  product media and  duplication,  packaging  materials and
shipping expenses.  Cost of product revenues was $737,000 in 1998 as compared to
$1.0  million in 1997 and $1.1 million for 1996,  representing  decreases of 28%
and 5% from  fiscal  1997 to  fiscal  1998  and  fiscal  1996  to  fiscal  1997,
respectively. The decrease from fiscal 1997 to 1998 was primarily as a result of
product  mix and certain  fixed  price  royalty  arrangements  with  third-party
vendors.  The slight  decrease  from  fiscal  1996 to fiscal 1997 was due to the
decrease  in  license  revenues,  as  the  license  costs  fluctuate  in  direct
proportion to license revenues.  This decrease was offset by certain fixed price
royalty  arrangements with third-party  vendors which do not fluctuate in direct
proportion to license revenues.

     Maintenance,   installation  and  training  costs  consist  principally  of
personnel-related   costs  for  consulting,   training  and  technical  support.
Maintenance,  installation  and  training  costs  were $2.6  million  in 1998 as
compared  to $3.0  million  in 1997 and $2.4  million  in 1996,  representing  a
decrease of 13% from fiscal 1997 to 1998 and an increase of 26% from fiscal 1996
to fiscal 1997.  The reduction from 1997 to 1998 was primarily the result of the
continued impact of the headcount reduction in the second half of 1997 and lower
outside  contracting  expenses.  The increase in fiscal 1997 as compared to 1996
was due to the significant expansion of the Company's customer service personnel
across all  categories,  including  consulting,  support and account  management
staff,  offset by the Company's later reduction of headcount early in the second
half of 1997. The Company expects that  maintenance,  installation  and training
costs will remain approximately flat with the higher support requirements of new
WorldSecure  customers offset by the lesser requirements of the decreased number
of support intensive NetJunction customers.


                                       15
<PAGE>

Product Development

     Product development expenses consist primarily of personnel-related  costs,
including salaries and benefits of personnel,  as well as equipment and facility
costs.  Product development  expenses are incurred for the research,  design and
development  of new  products,  enhancements  of existing  products  and quality
assurance  activities.  Costs  related to research,  design and  development  of
products  are  charged to product  development  expenses  as  incurred.  Product
development  expenses  were $3.9  million in 1998 as compared to $4.3 million in
1997 and $3.6 million in 1996, representing a decrease of 8% from fiscal 1997 to
1998 and an increase of 21% from fiscal 1996 to fiscal 1997. Product development
expenses  represented  29%, 38% and 25% of total revenues for fiscal 1998,  1997
and 1996,  respectively.  The  decrease  in dollar  terms  from 1997 to 1998 was
primarily attributable to the reduction of headcount early in the second half of
1997. The increase in absolute dollars from 1996 to 1997 in product  development
was due to increased staffing and associated support costs of software engineers
and  consultants  required  primarily to expand product lines and secondarily to
enhance the  Company's  existing  product  lines.  The  fluctuations  in product
development  expenses as a percentage of total revenues were attributable to the
fluctuations  in revenues for the  respective  periods and the fact that product
development  expenses do not fluctuate in direct  proportion to total  revenues.
The  Company  believes  that  continued  commitment  to product  development  is
required  for the  Company's  products to obtain a  competitive  advantage.  The
Company  intends to continue  to  allocate  resources  to product  research  and
development.  Consequently,  such  expenses  may increase in dollar terms in the
future.

Sales and Marketing

     Sales and marketing  expenses consist  primarily of salaries,  benefits and
commissions  of  sales  and  marketing   personnel  and  marketing  program  and
promotional expenses.  Sales and marketing expenses were $7.5 million in 1998 as
compared  to $7.4  million  in 1997  and  $6.8  million  in  1996,  representing
increases  of 1% and 9% from  fiscal 1997 to fiscal 1998 and from fiscal 1996 to
fiscal 1997, respectively. Sales and marketing expenses represented 56%, 65% and
48% of total  revenues  for  fiscal  1998,  1997  and  1996,  respectively.  The
increases in absolute  dollars were primarily the result of the expansion of the
Company's  sales and marketing  personnel and marketing  program and promotional
costs  associated with the WorldSecure  product line. The  fluctuations in sales
and marketing  expenses as a percentage of total revenues were  attributable  to
the  fluctuations  in  revenues  for the  respective  periods  and the fact that
certain  sales and marketing  expenses do not fluctuate in direct  proportion to
total revenues. In the future, the Company expects to continue hiring additional
sales  and  marketing  personnel,  increase  marketing  program,  promotion  and
advertising  efforts  and  expand  internationally   through  a  combination  of
distributors,  VARs and direct sales personnel.  Consequently, such expenses may
increase in dollar amounts in the future.

General and Administrative

     General and  administrative  expenses  primarily consist of personnel costs
for finance and  accounting,  human  resources  and  general  management  of the
Company.  General  and  administrative  expenses  were $4.2  million  in 1998 as
compared  to $2.7  million  in 1997  and  $1.7  million  in  1996,  representing
increases of 56% and 55% from fiscal 1997 to fiscal 1998 and from fiscal 1996 to
fiscal 1997, respectively.  General and administrative expenses represented 31%,
24% and 12% of total revenues for fiscal 1998, 1997 and 1996, respectively. As a
result  of  the  termination   and  associated   non-payments  by  the  Japanese
distributor, general and administrative expenses in 1998 included an approximate
$1.7 million  allowance  for  doubtful  accounts for the full amount owed by the
Japanese  distributor.   Excluding  the  $1.7  million  allowance  for  doubtful
accounts,   general  and   administrative   expenses  would  have  decreased  by
approximately  $200,000 in 1998 as compared to 1997.  The  increases  in 1997 as
compared to 1996 was attributable primarily to increased staffing and associated
expenses necessary to manage and support the Company's business,  which included
public  company  related  expenses.  A  secondary  factor for this  increase  in
absolute  dollars was the  continuing  amortization  of goodwill  related to the
acquisition  of Deming  Software,  Inc.  which occurred in the fourth quarter of
1996, as well as legal expenses and other costs  associated with the negotiation
of new reseller  arrangements.  The  fluctuations in general and  administrative
expenses as a


                                       16
<PAGE>

percentage of total revenues were  attributable  to the  fluctuations in revenue
for the respective periods and the fact that general and administrative expenses
do not fluctuate in direct  proportion to total revenues.  The Company  believes
that  general  and  administrative  expenses  (excluding  the impact of the $1.7
million  allowance for doubtful  accounts) will be relatively  flat from 1998 to
1999 through the utilization of existing infrastructure.

Purchased Research and Development

     In November 1996, the Company  acquired Deming  Software,  Inc. for a total
purchase price of approximately $4.8 million of which $4.5 million was allocated
to purchased research and development. For allocation of the purchase price, see
Item 8  "Financial  Statements  and  Supplemental  Data,  Note  (2) of  Notes to
Consolidated Financial Statements."

Net Interest Income

     Net  interest  income  consists  of  interest  income and expense and other
miscellaneous  income and  expense  items.  Net  interest  income was  $375,000,
$508,000  and  $544,000  for  fiscal  1998,  1997 and  1996,  respectively.  The
fluctuations  in net  interest  income  from fiscal 1997 to fiscal 1998 and from
fiscal 1996 to fiscal 1997 were primarily  attributable  to  fluctuations in the
Company's cash and cash equivalent and short-term investments balances,  coupled
with interest rate fluctuations during the comparable periods.

Liquidity and Capital Resources

     In April 1996,  the Company  completed its initial  public  offering of 2.1
million  shares  of  Common  Stock.   The  Company   received  net  proceeds  of
approximately   $13.8   million,   after   deducting   expenses  which  included
underwriting  discounts and  commissions.  At December 31, 1998, the Company had
cash, cash  equivalents,  and short-term  investments  totaling $6.0 million and
working capital of $2.6 million.

     The Company has a $1.75 million bank line of credit and equipment term loan
facility,  which was entered into in December 1998. As of December 31, 1998, the
Company had no monies  outstanding  on the $1.5  million  line of credit and had
fully utilized the $250,000 equipment term loan facility.

    Net cash used in  operating  activities  amounted  to $5.1  million in 1998,
which was comprised  principally of the Company's net loss of $5.1 million.  Net
cash provided by investing  activities  amounted to $4.1 million in 1998,  which
mainly  included  maturities of  short-term  investments  of $4.2  million.  The
Company currently has no significant capital commitments for fiscal 1999.

     Net cash  provided  by  financing  activities  amounted to $138,000 in 1998
which  primarily  included  net  proceeds  from the  issuance of common stock of
$474,000  offset by  principal  payments  under  capital  lease  obligations  of
$343,000.

     The Company  may,  in the  future,  pursue  acquisitions  of  complementary
companies or technologies,  or divest certain products and related services,  to
further strategic  corporate  objectives.  Such  transactions  could result in a
significant  use of cash and  earnings  per share  dilution  caused  by  reduced
interest  income and/or the issuance of additional  stock.  Additionally,  costs
associated  with the  acquisition  or  divestiture  of  companies,  products and
related  services or  technologies  could  materially  impact  future  operating
results.  Such costs could  result in  significant  losses in one or more fiscal
quarters.

     The Company  believes that its cash balances and credit  facilities will be
sufficient to meet its anticipated cash needs to fund operating losses,  working
capital  requirements,  capital expenditures and business expansion for at least
the next  twelve  months.  Thereafter,  if cash  generated  from  operations  is
insufficient to satisfy the Company's  liquidity  requirements,  the Company may
seek  to sell  additional  equity  or  convertible  debt  securities  or  obtain
additional credit facilities.  The sale of additional equity or convertible debt
securities could result in additional dilution to the Company's stockholders and
may not be available on terms favorable to the Company, if at all.

                                       17
<PAGE>

Additional Factors That May Affect Future Results

     The Company was founded in February 1992 and has incurred  operating losses
in each of its fiscal years since  inception and had an  accumulated  deficit of
$28.7 million as of December 1998. The Company's prospects must be considered in
light  of  the  risks,  expenses  and  difficulties  frequently  encountered  by
companies in the early stage of new product development,  particularly companies
in new and rapidly evolving markets.  There can be no assurance that the Company
will be successful in addressing such risks.

     The Company's  quarterly and annual operating results have in the past, and
may in the future, vary significantly depending on many factors.  Because of the
reasons described in this paragraph, the Company's first quarter revenue of 1999
may or may not increase sequentially. Historically, a substantial portion of the
Company's revenues has been recognized in the last two weeks of the quarter as a
result of many customers' purchasing practices.  The inability of the Company to
recognize expected revenues during the last month of the quarter could result in
substantial fluctuations from period to period. The Company anticipates that its
marketing strategy for the WorldSecure product line will, in the future,  depend
more significantly on distribution by third-party  resellers and on managing the
international  distribution  channel.  In  addition,   significant  revenue  was
reported  during 1998 from  non-refundable  minimum  commitments  from two large
resellers  which do not  directly  reflect  sales to  end-users,  including  the
Japanese  distributor who failed to make payments  associated with the first and
second  quarter  revenue.  During the first two  quarters  of 1999,  the Company
expects to report  additional  revenue from the  recognition of the balance of a
non-refundable prepaid purchase commitment from one reseller based on guaranteed
quarterly  minimum  commitments  from a reseller.  The realization of revenue in
excess of the  non-refundable  prepaid  amount  noted  above will  depend on the
success  of these  resellers  in the  marketplace.  The  Company  believes  that
reaching  and  maintaining   profitability   will  depend  on  increased  market
acceptance of its WorldSecure  Internet content  security and policy  management
solutions.  Failure of the Company's resellers and international distributors to
successfully market the Company's products would cause a material adverse effect
on the Company's  anticipated future revenue, and there can be no assurance that
the Company's  resellers and  international  distributors  will be successful in
marketing the Company's products. Also, new direct sales and telesales personnel
can take up to three quarters to be fully productive  against quotas that are in
line with industry norms.  Additional  factors that may affect operating results
include  the  timing of  customers'  decision-making  processes,  the  timing of
research,  development and marketing  expenses in relation to product  releases,
the timing of product  introductions by the Company and its competitors,  market
acceptance  of new versions of the Company's  products,  product mix and general
economic factors. Any unfavorable changes in these or other factors could have a
material  adverse  effect on the  Company's  business,  financial  condition and
results of operations.

     The Company's success also depends on the performance of management and key
personnel. There have been several executive level changes during 1998 and early
1999.  A key  element in the  Company's  future  success  is the  ability of the
Company's management team to implement the Company's business strategy.

    The Company's  Common Stock is listed on the Nasdaq National  Market.  There
are two sets of  criteria  used to  determine  if a company,  once listed on the
National Market,  can remain listed.  Each National Market company must meet all
of the  requirements  of at least one set of criteria to maintain  its  listing.
Criteria 1, among other  things  requires the Company to maintain a net tangible
worth (total assets, excluding goodwill, minus total liabilities) of at least $4
million.  Although the Company met this requirement as of December 31, 1998, the
Company expects  continued losses in the current and following  quarters and may
not meet this  continued  listing  requirement  in the future if it is unable to
raise additional  capital in the interim.  The second criteria  requires,  among
other  things,  that the Company  maintain a minimum  bid price on the  National
Market of at least $5.00 per share.  The Company  does not  currently  meet this
requirement and,  therefore,  until the Company's bid price exceeds $5.00,  this
set of criteria  will not apply to the Company.  Should the Company fail to meet
either set of  criteria,  it believes  it would be  eligible  for listing on the
Nasdaq Small Cap Market.

     The  Company's  success is also  dependent  upon market  acceptance  of its
WorldSecure  product line in preference to competing  products and products that
may be developed by others.  There can be no assurance  that the Company will be
successful in developing and marketing product enhancements or new products that
respond to  


                                       18
<PAGE>

technological   change,   evolving  industry  standards  and  changing  customer
requirements or that such new products will achieve a sufficient level of market
acceptance to result in profitable operations.  In addition, the introduction or
announcement of new product  offerings by the Company or its  competitors  could
cause  customers  to defer or cancel  purchases  of existing  Company  products.
Failure  of the  Company to develop  and  introduce  new  products  and  product
enhancements in a timely and cost-effective  manner or to anticipate and respond
adequately to changing market  conditions,  as well as any significant  delay in
product  development or  introduction,  could cause customers to delay or decide
against purchases of the Company's product,  which could have a material adverse
effect on the Company's business, financial condition and results of operations.

     There are a number of  factors  that must be  addressed  for the  Company's
products to achieve broad market acceptance.  These factors include performance,
functionality,  interoperability,  price and the  customer's  assessment  of the
Company's technical,  managerial,  service and support expertise and capability.
Failure to succeed  with  respect to any of these  factors  could  result in the
Company failing to achieve broad market acceptance of its products,  which could
have a material adverse effect on the Company's future revenue growth.

     International  sales accounted for 28% of the Company's total sales in 1998
and 1997.  As part of the financial  results for the third quarter of 1998,  the
Company announced that the distribution  relationship with ASG in Japan had been
terminated  by  Worldtalk   for  ASG's   failure  to  make   payments   totaling
approximately  $1.7 million for software  product fees and  maintenance  for the
first  and  second  quarters  of  1998.  ASG  accounted  for  18% and 63% of the
Company's total license sales and total international  software license sales in
1998, respectively. International sales involve a number of risks, including the
impact of  possible  recessionary  economic  environments  outside of the United
States, longer receivables collection periods,  unexpected changes in regulatory
requirements,  reduced  protection  for  intellectual  property  rights  in some
countries,   tariffs  and  other  trade  barriers.   Exports  of  the  Company's
WorldSecure   products  require  export  authorization  by  license  or  license
exception pursuant to the Export Administration  Regulations administered by the
United States  Department of Commerce,  Bureau of Export  Administration.  These
licenses contain certain  restrictions as well as  administrative  requirements,
which must be assumed by the  Company.  There is no  assurance  that the Company
will be  successful  in  obtaining  additional  licenses or license  exceptions.
Failure to do so would  adversely  affect  international  sales of the Company's
WorldSecure products. Additionally,  United States government policy relative to
encryption  software is subject to change and any change  resulting in increased
restrictions could adversely affect sales of the Company's WorldSecure products.
There can be no  assurance  that the Company will be able to sustain or increase
revenue derived from international  licensing and service. Any failure to expand
sales in foreign  markets,  and the risks of doing  business  in those  markets,
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and results of operations.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk 

     Interest rate sensitivity

     The primary objective of the Company's investment activities is to preserve
principal while at the same time maximizing the income received from investments
without  significantly  increasing risk. Some of the securities that the Company
has invested in may be subject to market  risk.  Market risk means that a change
in prevailing interest rates may cause the principal amount of the investment to
fluctuate.  To minimize  this risk,  the Company  maintains a portfolio  of cash
equivalents and short-term  investment in a variety of securities.  In addition,
the Company  invests in  relatively  short-term  securities.  As of December 31,
1998, all of the Company's investments mature in less than one year.



                                       19
<PAGE>

Item 8. Financial Statements and Supplementary Data

                                                                            Page
                                                                            ----
Index to Consolidated Financial Statements:
Independent Auditor's Report ..............................................  21
Consolidated Balance Sheets as of December 31, 1998 and 1997 ..............  22
Consolidated Statements of Operations for the years ended
   December 31, 1998, 1997 and 1996 .......................................  23
Consolidated  Statements of  Stockholders'  Equity  (Deficit)
   for the years ended December 31, 1998, 1997 and 1996 ...................  24
Consolidated Statements of Cash Flows for the years ended
   December 31, 1998, 1997 and 1996 .......................................  26
Notes to Consolidated Financial Statements ................................  27


                                       20
<PAGE>

                          INDEPENDENT AUDITOR'S REPORT

The Board of Directors and Stockholders
Worldtalk Corporation:

     We have audited the accompanying  consolidated  balance sheets of Worldtalk
Corporation  and  subsidiary  as of December 31, 1998 and 1997,  and the related
consolidated statements of operations,  stockholders' equity (deficit), and cash
flows for each of the years in the three-year period ended December 31, 1998. In
connection with our audits of the  consolidated  financial  statements,  we also
have  audited  the  financial  statement  schedule  listed  in the Index at Item
14(a)(2).  These  consolidated  financial  statements  and  financial  statement
schedule are the responsibility of the Company's management.  Our responsibility
is to  express  an  opinion  on  these  consolidated  financial  statements  and
financial statement schedule based on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable  assurance  about  whether  the  financial  statements  are free from
material  misstatement.  An audit includes examining,  on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present fairly, in all material  respects,  the financial  position of Worldtalk
Corporation  and subsidiary as of December 31, 1998 and 1997, and the results of
their  operations  and their cash flows for each of the years in the  three-year
period ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole,  presents  fairly,  in all material  respects,  the information set forth
therein.



                                                 KPMG LLP



Mountain View, California
January 28, 1999


                                       21
<PAGE>
<TABLE>

                      WORLDTALK CORPORATION AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS
                (All amounts in thousands, except per share data)

                                     ASSETS
<CAPTION>
                                                                 As of December 31,
                                                                --------------------
                                                                  1998        1997
                                                                --------    --------
<S>                                                             <C>         <C>     
Current assets:
  Cash and cash equivalents .................................   $  3,858    $  4,662
  Short-term investments ....................................      2,166       6,415
  Accounts receivable,  net of allowance for doubtful
     accounts of $1,840 and $121, respectively ..............      2,960       3,039
  Prepaid expenses ..........................................        613         935
                                                                --------    --------
          Total current assets ..............................      9,597      15,051

Property and equipment, net .................................      1,108       1,658
Other assets ................................................        441         556
                                                                --------    --------
                                                                $ 11,146    $ 17,265
                                                                ========    ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
  Accounts payable ..........................................   $    787    $    760
  Short-term debt ...........................................        250         243
  Current portion of capital lease obligations ..............        115         339
  Accrued expenses ..........................................      3,419       3,041
  Deferred revenue ..........................................      2,474       4,094
                                                                --------    --------
          Total current liabilities .........................      7,045       8,477

Capital lease obligations, less current portion .............         13         132
                                                                --------    --------
          Total liabilities .................................      7,058       8,609
                                                                --------    --------

Commitments and contingencies 
Stockholders' equity:
   Preferred stock, $.01 par value; 6,500 authorized, none
   designated or outstanding ................................       --          --
  Common stock, $.01 par value; 25,000 shares authorized,
   10,686 and 10,487 shares issued and outstanding
   in 1998 and 1997, respectively ...........................        107         105
  Additional paid-in capital ................................     32,773      32,301
  Deferred compensation .....................................        (47)        (89)
  Accumulated deficit .......................................    (28,745)    (23,661)
                                                                --------    --------
          Total stockholders' equity ........................      4,088       8,656
                                                                --------    --------
                                                                $ 11,146    $ 17,265
                                                                ========    ========
<FN>

          See accompanying notes to consolidated financial statements.
</FN>
</TABLE>

                                       22
<PAGE>

<TABLE>

                      WORLDTALK CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                (All amounts in thousands, except per share data)
<CAPTION>
                                                    Years ended December 31,
                                               --------------------------------
                                                 1998        1997        1996
                                               --------    --------    --------
<S>                                            <C>         <C>         <C>     
Revenues:
  Software licenses .........................  $  9,631    $  6,860    $  9,711
  Maintenance, installation and training ....     3,817       4,467       4,494
                                               --------    --------    --------
          Total revenues ....................    13,448      11,327      14,205
                                               --------    --------    --------
Cost of revenues:
  Software licenses .........................       737       1,027       1,083
  Maintenance, installation and training ....     2,569       2,964       2,355
                                               --------    --------    --------
          Total cost of revenues ............     3,306       3,991       3,438
                                               --------    --------    --------
     Gross profit ...........................    10,142       7,336      10,767
                                               --------    --------    --------
Operating expenses:
  Product development .......................     3,934       4,294       3,563
  Sales and marketing .......................     7,477       7,378       6,751
  General and administrative ................     4,189       2,689       1,733
  Purchased research and development ........      --          --         4,500
                                               --------    --------    --------
          Total operating expenses ..........    15,600      14,361      16,547
                                               --------    --------    --------
Operating loss ..............................    (5,458)     (7,025)     (5,780)
Interest income, net ........................       375         508         544
                                               --------    --------    --------
          Loss before income taxes ..........    (5,083)     (6,517)     (5,236)
Income taxes ................................         1         183           4
                                               --------    --------    --------
          Net loss ..........................  $ (5,084)   $ (6,700)   $ (5,240)
                                               ========    ========    ========
Basic and diluted net loss per share ........  $  (0.48)   $  (0.65)   $  (0.68)
                                               ========    ========    ========
Shares used in computing basic and
     diluted net loss per share .............    10,584      10,355       7,669
                                               ========    ========    ========
<FN>
          See accompanying notes to consolidated financial statements.
</FN>

</TABLE>

                                       23
<PAGE>

                                 WORLDTALK CORPORATION AND SUBSIDIARY
<TABLE>

                      CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                             Years ended December 31, 1996, 1997 and 1998
                                      (All amounts in thousands)
<CAPTION>

                                                                  Common Stock         
                                                              --------------------     Additional
                                                               Shares      Amount    Paid-in capital 
                                                              --------    --------   ---------------
<S>                                                              <C>      <C>           <C>     
Balances as of December 31, 1995 ............................    1,505    $     15      $    670
Issuance of common stock in initial public offering, net ....    2,000          20        13,812
Conversion of redeemable preferred stock to common stock ....    6,025          60        12,756
Exercise of common stock options and warrants ...............      178           2            49
Purchases under the Employee Stock Purchase Plan ............       35        --             238
Issuance of shareholders' notes receivable ..................     --          --            --
Issuance of common stock in acquisition .....................      547           6         4,125
Amortization of deferred compensation .......................     --          --            --
Net loss ....................................................     --          --            --
                                                              --------    --------      --------
Balances as of December 31, 1996 ............................   10,290    $    103      $ 31,650
Exercise of common stock options ............................      148           2           202
Purchases under the Employee Stock Purchase Plan ............      124           1           461
Repurchased common stock ....................................      (75)         (1)          (12)
Repayment of shareholders' notes receivable .................     --          --            --
Amortization of deferred compensation .......................     --          --            --
Net loss ....................................................     --          --            --
                                                              --------    --------      --------
Balances as of December 31, 1997 ............................   10,487    $    105      $ 32,301
Exercise of common stock options ............................       90           1           129
Purchases under the Employee Stock Purchase Plan ............      155           1           357
Repurchased common stock ....................................      (46)       --             (14)
Amortization of deferred compensation .......................     --          --            --
Net loss ....................................................     --          --            --
                                                              --------    --------      --------
Balances as of December 31, 1998 ............................   10,686    $    107      $ 32,773
                                                              ========    ========      ========
<FN>
                     See accompanying notes to consolidated financial statements.

</FN>
</TABLE>

                                       24
<PAGE>

<TABLE>

                                        WORLDTALK CORPORATION AND SUBSIDIARY

                             CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                    Years ended December 31, 1996, 1997 and 1998
                                             (All amounts in thousands)
<CAPTION>
                                                                                                       Total
                                                           Stockholder                               Stockholders'
                                                              Note        Deferred     Accumulated     Equity 
                                                           Receivable   Compensation    Deficit       (Deficit) 
                                                            --------      --------      --------      --------
<S>                                                         <C>           <C>           <C>           <C>      
Balances as of December 31, 1995 ........................   $   (194)     $   (175)     $(11,721)     $(11,405)
Issuance of common stock in initial public offering, net        --            --            --          13,832
Conversion of redeemable preferred stock to common  stock       --            --            --          12,816
Exercise of common stock options and warrants ...........       --            --            --              51
Purchases under the Employee Stock Purchase Plan ........       --            --            --             238
Issuance of shareholders' notes receivable ..............        (68)         --            --             (68)
Issuance of common stock in acquisition .................         (3)         --            --           4,128
Amortization of deferred compensation ...................       --              44          --              44
Net loss ................................................       --            --          (5,240)       (5,240)
                                                            --------      --------      --------      --------
Balances as of December 31, 1996 ........................   $   (265)     $   (131)     $(16,961)     $ 14,396
Exercise of common stock options ........................       --            --            --             204
Purchases under the Employee Stock Purchase Plan ........       --            --            --             462
Repurchased common stock ................................       --            --            --             (13)
Repayment of shareholders' notes receivable .............        265          --            --             265
Amortization of deferred compensation ...................       --              42          --              42
Net loss ................................................       --            --          (6,700)       (6,700)
                                                            --------      --------      --------      --------
Balances as of December 31, 1997 ........................   $   --        $    (89)     $(23,661)     $  8,656
Exercise of common stock options ........................       --            --            --             130
Purchases under the Employee Stock Purchase Plan ........       --            --            --             358
Repurchased common stock ................................       --            --            --             (14)
Amortization of deferred compensation ...................       --              42          --              42
Net loss ................................................       --            --          (5,084)       (5,084)
                                                            --------      --------      --------      --------
Balances as of December 31, 1998 ........................   $   --        $    (47)     $(28,745)     $  4,088
                                                            ========      ========      ========      ========
<FN>
                            See accompanying notes to consolidated financial statements.

</FN>
</TABLE>

                                       25
<PAGE>
<TABLE>

                                  WORLDTALK CORPORATION AND SUBSIDIARY

                                  CONSOLIDATED STATEMENTS OF CASH FLOWS
                                       (All amounts in thousands)
<CAPTION>
                                                                           Years ended December 31,
                                                                      --------------------------------
                                                                        1998        1997         1996
                                                                      --------    --------    --------
<S>                                                                   <C>         <C>         <C>      
Cash flows from operating activities:
  Net loss .........................................................  $ (5,084)   $ (6,700)   $ (5,240)
  Adjustments  to reconcile  net loss to net cash used
    in operating activities:
    Depreciation and amortization ..................................       783         703         452
    Change in allowance for doubtful accounts ......................     1,719         (28)         (1)
    Amortization of deferred compensation ..........................        42          42          44
    Purchased research and development .............................      --          --         4,500
    Changes in operating assets and liabilities:
      Accounts receivable ..........................................    (1,640)      2,513      (3,956)
      Prepaid expenses .............................................       322        (313)       (507)
      Accounts payable .............................................        27        (841)        647
      Accrued expenses .............................................       378         (53)        714
      Deferred revenue .............................................    (1,620)      2,528         561
      Other liabilities ............................................      --          (350)       (280)
                                                                      --------    --------    --------
         Net cash used in operating activities .....................    (5,073)     (2,499)     (3,066)
                                                                      --------    --------    --------
Cash flows from investing activities:
  Restricted cash ..................................................      --          --         2,000
  Purchase of property and equipment ...............................      (233)       (520)     (1,413)
  Purchase of short-term investments ...............................   (56,383)     (7,418)     (9,469)
  Sales and maturities of short-term investments ...................    60,632       7,030       3,442
  Other assets .....................................................       115         247          39
                                                                      --------    --------    --------
         Net cash provided by (used in) investing activities .......     4,131        (661)     (5,401)
                                                                      --------    --------    --------
Cash flows from financing activities:
  Net proceeds from issuance of common stock .......................       474         653      14,053
  Repayment of shareholder receivable ..............................      --           265        --
  Principal payments under capital lease obligations ...............      (343)       (351)       (256)
  Proceeds from bank borrowings ....................................         7         243         698
                                                                      --------    --------    --------
         Net cash provided by financing activities .................       138         810      14,495
                                                                      --------    --------    --------
Change in cash and cash equivalents ................................      (804)     (2,350)      6,028
Cash and cash equivalents at beginning of year .....................     4,662       7,012         984
                                                                      --------    --------    --------
Cash and cash equivalents at end of year ...........................  $  3,858    $  4,662    $  7,012
                                                                      ========    ========    ========
Supplemental disclosures:
  Cash paid for interest: ..........................................  $     54    $     92    $    106
                                                                      ========    ========    ========
  Noncash investing and financing activities:
    Common stock issued in acquisition of Deming Software, Inc. ....  $   --      $   --      $  4,131
                                                                      ========    ========    ========
    Conversion of convertible preferred stock to common stock ......  $   --      $   --      $ 12,816
                                                                      ========    ========    ========
    Notes receivable from stockholders .............................  $   --      $   --      $     68
                                                                      ========    ========    ========
    Equipment acquired under capital lease agreements ..............  $   --      $    110    $    506
                                                                      ========    ========    ========
<FN>

                      See accompanying notes to consolidated financial statements.
</FN>
</TABLE>

                                       26
<PAGE>

                      WORLDTALK CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  Years ended December 31, 1998, 1997 and 1996
                (All amounts in thousands, except per share data)

(1) Summary of the Company and Significant Accounting Policies

The Company

     Worldtalk  Corporation  (the  "Company") is a leading  provider of Internet
content  security and policy  management  solutions.  The Company's  WorldSecure
policy management  platform enables  organizations to define and manage Internet
e-mail  security  and  usage  policies,   reducing  the  risks  and  liabilities
associated  with  Internet   communications.   The  Company's  products  include
WorldSecure Server (also known as WorldSecure/Mail),  a Windows NT-based content
firewall and policy management  solution,  WorldSecure  Client, a desktop e-mail
encryption  product,  NetTalk, a Windows NT-based e-mail and directory solution,
and NetJunction, a UNIX-based directory and messaging switch.

Basis of Presentation

     The accompanying  consolidated financial statements include the accounts of
the  Company  and its wholly  owned  subsidiary.  All  significant  intercompany
transactions and accounts have been eliminated in consolidation.

Use of Estimates

     The  preparation  of financial  statements  in  conformity  with  generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect the  reported  amounts of assets and  liabilities  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

Financial Instruments and Concentration of Credit Risk

     Cash equivalents  consist of highly liquid  investments,  principally money
market accounts and marketable debt securities,  with maturities of three months
or less at the time of purchase.

     The  Company  has  classified  its  short-term  marketable  investments  as
"available-for-sale."  Available-for-sale  securities are carried at fair market
value,  with material  unrealized  gains and losses,  net of tax,  reported in a
separate component of stockholders'  equity. Gains and losses on securities sold
are based on the specific identification method.

     Fair values of short-term marketable investments are based on quoted market
values as of December 31, 1998 and 1997.  As of December 31, 1998 and 1997,  the
difference  between the fair value and amortized  cost of short-term  marketable
investments  was not material.  As of December 31, 1998,  short-term  marketable
investments consisted of commercial paper due within one year or less.

     Financial   instruments,   which   potentially   subject   the  Company  to
concentrations  of credit  risk,  are  primarily  cash  equivalents,  short-term
marketable  investments and accounts receivable.  The Company's cash equivalents
and short-term marketable investments consist primarily of commercial paper with
various  maturities  during 1999.  Concentrations of credit risk with respect to
trade  receivables  are limited due to the large number of customers  comprising
the Company's customer base and their dispersion across different industries and
geographic  areas.  Generally,  the  Company  requires  no  collateral  on trade
receivables.   The  Company   believes  that  its  credit   evaluation   process
substantially mitigates any credit risks.

                                       27
<PAGE>

Property and Equipment

     Property and equipment are recorded at cost. Depreciation is provided using
the straight-line  method over the estimated useful lives of the related assets,
generally  three to five years.  Equipment  recorded  under  capital  leases and
leasehold  improvements  are amortized using the  straight-line  method over the
shorter of the respective useful lives of the assets or the lease term.

Other Assets

     Other assets consist of long-term  deposits and certain  intangible  assets
and goodwill acquired in the purchase of Deming Software, Inc. in November 1996.
The intangible  assets and goodwill are being amortized using the  straight-line
method over the expected life of the assets of four years.

Impairment of Long-lived Assets

     The Company reviews  property and equipment for impairment  whenever events
or changes in  circumstances  indicate that the carrying  amount,  including the
unamortized  portion of goodwill allocated to the property and equipment,  of an
asset may not be  recoverable.  Recoverability  of  property  and  equipment  is
measured  by  comparison  of its  carrying  amount to  future  net cash flow the
property and equipment are expected to generate.  If such assets are  considered
to be impaired,  the  impairment  to be  recognized is measured by the amount by
which the carrying amount of the property and equipment, including the allocated
goodwill,  if any,  exceeds its fair market value. To date, the Company has made
no adjustments to the carrying amount of its property and equipment.

Revenue Recognition

     For software  transactions  entered into after January 1, 1998, the Company
adopted the  American  Institute  of  Certified  Public  Accountants'  ("AICPA")
Statement of Position ("SOP") No. 97-2, "Software Revenue  Recognition." SOP No.
97-2  generally  requires  revenue  earned on  software  arrangements  involving
multiple  elements to be allocated to each  element  based on its relative  fair
value. The fair value of the element must be based on objective evidence that is
specific to the vendor.  If the vendor does not have  objective  evidence of the
fair value of all elements in a multiple-element  arrangement,  all revenue from
the  arrangement  must be  deferred  until  such  evidence  exists  or until all
elements  have been  delivered.  The revenue  allocated to software  products is
generally  recognized upon shipment of the products provided there is persuasive
evidence  that  an  agreement  exists,  the  fee  is  fixed,   determinable  and
collectible  and the  arrangement  does not involve  significant  customization,
modification  or  production.  The revenue  allocated to post contract  customer
support is recognized ratably over the term of the support and revenue allocated
to service elements is recognized as the services are performed. The adoption of
SOP No. 97-2 did not have a material effect on the Company's operating results.

Research and Development

     Development  costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as incurred
until  technological  feasibility  in the  form  of a  working  model  has  been
established.  To date,  the Company's  software  development  has been completed
concurrent  with  the   establishment   of   technological   feasibility,   and,
accordingly, no costs have been capitalized.

Stock-Based Compensation

     The Company  accounts for its stock option plans using the intrinsic  value
method.  As such,  compensation  expense is recorded if on the date of grant the
current market price of the underlying stock exceeds the exercise price.


                                       28
<PAGE>

Income Taxes

     The Company uses the asset and liability  method of  accounting  for income
taxes.  Deferred tax assets and  liabilities  are  recognized  for the estimated
future tax  consequences  attributable  to  differences  between  the  financial
statement  carrying  amounts  of  existing  assets  and  liabilities  and  their
respective  tax bases.  Deferred tax assets and  liabilities  are measured using
enacted  tax rates in effect for the year in which those  temporary  differences
are expected to be  recovered or settled.  Deferred tax assets are reduced by an
allowance to an amount whose realization is more likely than not.

Earnings per Share

     Basic EPS is computed  using the weighted  average  number of common shares
outstanding during the period.  Diluted earnings per share is computed using the
weighted  average  number  of  potentially  dilutive  common  equivalent  shares
outstanding for the period, if any. For the years ending December 31, 1998, 1997
and 1996, common stock options totaling 2,143,  1,853, and 1,251,  respectively,
were omitted from the computation, as their impact would be anti-dilutive.

Other Comprehensive Income (Loss)

     The  Company  has no  material  components  of other  comprehensive  income
(loss).

Recent Accounting Pronouncements

     In March 1998, the AICPA issued SOP No. 98-1, "Accounting  for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP No. 98-1 requires
that entities  capitalize  certain costs related to  internal-use  software once
certain criteria have been met. The Company expects that the adoption of SOP No.
98-1  will  have no  material  impact  on its  financial  position,  results  of
operations or cash flows. The Company will be required to implement SOP No. 98-1
for the year ending December 31, 1999.

     In April 1998,  the AICPA issued SOP No. 98-5,  "Reporting  on the Costs of
Start-Up  Activities."  SOP No. 98-5 requires that all start-up costs related to
new  operations  must be expensed as incurred.  In addition,  all start-up costs
that were  capitalized  in the past  must be  written  off when SOP No.  98-5 is
adopted.  The  Company  expects  that the  adoption of SOP No. 98-5 will have no
material impact on its financial position,  results of operations or cash flows.
The  Company  will be  required  to  implement  SOP No. 98-5 for the year ending
December 31, 1999.

     In June 1998 the Financial  Accounting  Standards Board issued Statement of
Financial  Accounting  Standards  ("SFAS") No. 133,  "Accounting  for Derivative
Instruments  and  Hedging  Activities."  SFAS No.  133  established  methods  of
accounting for derivative  financial  instruments and hedging activities related
to those  instruments as well as other hedging  activities.  Because the Company
currently  holds  no  derivative  instruments  and does not  engage  in  hedging
activities,  the Company  expects that the adoption of SFAS No. 133 will have no
material impact on its financial position,  results of operations or cash flows.
The  Company  will be  required  to  implement  SFAS No.  133 for the year ended
December 31, 2000.

     In December 1998, the AICPA issued SOP No. 98-9, "Modification of SOP 97-2,
Software Revenue  Recognition,  with Respect to Certain  Transactions."  SOP No.
98-9 establishes the method of recognizing revenue for certain  multiple-element
software  arrangements.  The Company will be required to implement  SOP No. 98-9
for the year ending December 31, 2000. SOP No. 98-9 also extends the deferral of
the  application  of SOP No.  97-2 to certain  other  multiple-element  software
arrangements  through the Company's  year ending  December 31, 1999. The Company
expects  that the  adoption of SOP No. 98-9 will have no material  impact on its
financial position, results of operations or cash flows.

                                       29
<PAGE>

Reclassifications

     Certain  prior year amounts have been  reclassified  to conform to the 1998
presentation.

(2) Business Combination

     In November  1996,  the Company  acquired all of the  outstanding  stock of
Deming Software,  Inc. ("Deming"),  a privately held company specializing in the
development of electronic mail security  software for the Internet,  for a total
purchase  price of $4,773,  including 569 shares of the Company's  common stock,
$225 in  cash,  and  $418 of  direct  acquisition  costs.  The  acquisition  was
accounted for using the purchase method, and, accordingly, the operating results
of Deming have been  included in the  consolidated  financial  statements of the
Company from the date of the acquisition.  The purchase price has been allocated
as follows:

      Net liabilities assumed ...................................   $  (226) 
      Goodwill, covenant not to compete and workforce in place ..       499
      Purchased research and development ........................     4,500
                                                                    -------
                                                                    $ 4,773
                                                                    =======
      
    The $4,500  allocated to purchased  research and  development was charged to
operations  in the quarter  ended  December  31, 1996.  The amount  allocated to
goodwill, covenant not to compete and workforce in place will be amortized using
the straight-line method over 48 months.

    The following pro forma  combined  results of operations  for the year ended
December  31,  1996 is  presented  as if the  acquisition  had  occurred  at the
beginning of the period.  The charge for in process research and development has
not been  reflected in the  following pro forma  summary.  The pro forma summary
does not  necessarily  reflect the results of  operations  as if the Company and
Deming had been consolidated during such periods:

                                                           Year ended
                                                           December 31,
                                                              1996
                                                           ---------
                  Net revenues .........................   $ 14,734
                  Net loss .............................   $ (1,507)
                  Basic and diluted net loss per share .   $  (0.18)

(3) Property and Equipment

    Property and equipment consisted of the following:

                                                         As of December 31,
                                                         ------------------
                                                          1998        1997
                                                         -------    -------
        Equipment ....................................   $ 2,672    $ 2,515 
        Furniture and fixtures .......................       657        655
        Purchased software ...........................       268        224
        Leasehold improvements .......................       111        111
                                                         -------    -------
                                                           3,708      3,505
        Less accumulated depreciation and amortization    (2,600)    (1,847)
                                                         -------    -------
                                                         $ 1,108    $ 1,658
                                                         =======    =======
        
        
     Equipment  recorded under capital leases  aggregated $1,533 and $1,533 with
related accumulated amortization of $1,461 and $997 for the years ended December
31, 1998 and 1997, respectively.


                                       30
<PAGE>

(4) Accrued Expenses

    Accrued expenses consisted of the following:

                                              As of December 31,
                                              -----------------
                                                1998      1997
                                              -------   -------
Accrued employee compensation...........      $   935   $ 1,021
Accrued commissions.....................          236       177
Other accrued liabilities...............        2,248     1,843
                                              -------   -------
                                              $ 3,419   $ 3,041
                                              =======   =======

(5) Income Taxes
<TABLE>

    The Company's effective tax rate differs from the federal income tax rate of
34%, as follows:
<CAPTION>
                                                        Years ended December 31,
                                                     -----------------------------
                                                      1998       1997       1996
                                                     -------    -------    -------
<S>                                                  <C>        <C>        <C>    
Income tax benefit at statutory rate .............   $ 1,728    $ 2,216    $ 1,780
Nondeductible purchased research and development .      --         --       (1,652)
Losses for which no benefit is currently  realized    (1,728)    (2,157)      (101)
State income tax .................................        (1)       (37)        (4)
Foreign withholding tax ..........................      --         (115)      --
Other ............................................      --          (90)       (27)
                                                     -------    -------    -------
Actual tax expense ...............................   $    (1)   $  (183)   $    (4)
                                                     =======    =======    =======
</TABLE>

     The tax  effects of  temporary  differences  that give rise to  significant
portions of deferred tax assets and liabilities are as follows:

                                                        As of December 31,
                                                      --------------------
                                                        1998        1997
                                                      --------    --------
Accruals and reserves ..............................  $  1,013    $    923
Deferred research and development costs ............     3,889       3,828
Net operating loss carryforward -- federal .........     3,736       2,313
Net operating loss carryforward -- state ...........       226         131
Research and development credit carryforward .......     1,481       1,090
Other ..............................................       (78)         34
                                                      --------    --------
                                                        10,267       8,319
Less valuation allowance ...........................   (10,267)     (8,319)
                                                      --------    --------
          Net deferred tax assets ..................  $   --      $   --
                                                      ========    ========

     The net change in the valuation  allowance for the year ended  December 31,
1998 was an increase  of $1,948.

     For  federal  income tax  purposes,  the  Company  has net  operating  loss
carryforwards  of  approximately  $10,989 expiring in the tax years 2008 through
2018.  For  California  income tax purposes,  the Company has net operating loss
carryforwards  of approximately  $3,870,  expiring in the tax years 1998 through
2003. The Company has a taxable year ending March 31 but reports on the calendar
year for financial statement purposes.  The difference between the net operating
loss  carryforward  for federal  income tax  purposes  and for state  income tax
purposes  results  primarily  from  a 50%  limitation  on  the  California  loss
carryforwards.

     The Company has  research  and  development  tax credit  carryforwards  for
federal  and   California   tax  purposes  of   approximately   $835  and  $646,
respectively.  The federal credits expire in various years through 2018, and the
California credits may be carried forward indefinitely.

     Internal  Revenue Code Section 382 limits the  utilization of net operating
losses incurred prior to an "ownership change," as defined. The Company believes
an ownership  change  resulted from the issuance of the Series B preferred stock
on December 31, 1993.

                                       31
<PAGE>

     The Company has not yet determined whether an ownership change occurred due
to an  initial  public  offering  in April  1996.  If an  ownership  change  has
occurred,   utilization  of  the  net  operating  loss  carryforwards  could  be
significantly reduced.

(6) Bank Borrowings and Convertible Secured Promissory Notes

     On  December  30,  1998,  the  Company  entered  into a loan  and  security
agreement  comprised of a $1,500 line of credit,  which  expires on December 29,
1999 and a $250 term  facility,  which  expires on December  29,  2000,  bearing
interest at the prime rate (7.75% as of December 1998) plus 0.25% and prime rate
plus 0.50%,  respectively.  The agreement is collateralized by the assets of the
Company,  contains  certain  financial  covenants  and  restricts  the Company's
ability to incur other indebtedness and pay dividends.  As of December 31, 1998,
there  were no  outstanding  balances  under the line of credit  agreement.  The
outstanding balance under the term facility was $250 as of December 31, 1998.

(7) Preferred Stock and Stockholders' Equity (Deficit)

Preferred Stock

     As of December 31, 1998,  there were 6,500  authorized  shares of preferred
stock,  none of which are designated or outstanding,  with a $0.01 per share par
value.

Stock Option and Purchase Plans

     In February 1996, the Company  adopted the 1996 Equity  Incentive Plan (the
"1996  Plan"),  under  which  1,000  shares of common  stock were  reserved  for
issuance.  The 1996 Plan became effective in April 1996 on the effective date of
the Company's  initial public offering.  The 1996 Plan provides for the grant of
options,  stock bonuses and restricted stock purchase  rights.  The compensation
committee of the Board of Directors has the authority to set exercise  dates (no
longer than 10 years from date of grant), payment terms and other provisions for
each grant.  Options are subject to vesting as  determined  by the  compensation
committee,  generally  over 48 months.  Vesting  and  exercisability  of certain
outstanding  options and other stock awards under the 1996 Plan will  accelerate
upon certain change of control  transactions.  In August 1997 and April 1998, an
additional 750 and 1,000 shares of common stock, respectively, were reserved for
issuance under the Company's 1996 Plan.

     The  Company's  1992 Stock Option Plan (the "1992 Plan")  terminated at the
effective date of the Company's initial public offering,  at which time the 1996
Plan became effective.  As a result, no further options may be granted under the
1992 Plan.  However,  termination  of the 1992 Plan does not affect  outstanding
options, all of which remain outstanding until exercised or until they terminate
or  expire.   The  terms  of  options  granted  under  the  1992  Plan  and  the
administration  of the 1992 Plan are  substantially  the same as the 1996  Plan,
except that vesting of options under the 1992 Plan does not  accelerate  upon an
acquisition.


                                       32
<PAGE>

    Activity under the option plans follows:

                                                                     Weighted-
                                               Shares                 average
                                              Available    Options   exercise
                                              For grant  outstanding   price
                                              ---------  -----------   -----

Balances as of December 31, 1995 ..........       133        827      $ 0.83
Additional shares reserved ................     1,200       --          --
Options granted ...........................      (722)       722        9.23
Options exercised .........................      --         (171)       0.33
Options canceled ..........................       127       (127)       3.62
                                                -----      -----      ------
Balances as of December 31, 1996 ..........       738      1,251      $ 5.46
Additional shares reserved ................       750       --          --
Options granted ...........................    (1,990)     1,990        4.74
Options exercised .........................      --         (148)       1.38
Options canceled ..........................     1,240     (1,240)       7.42
                                                -----      -----      ------
Balances as of December 31, 1997 ..........       738      1,853      $ 3.70
Additional shares reserved ................     1,000       --          --
Options granted ...........................    (1,138)     1,138        2.82
Options exercised .........................      --          (91)       1.05
Options canceled ..........................       658       (658)       4.98
                                                -----      -----      ------
Balances as of December 31, 1998 ..........     1,258      2,242      $ 2.99
                                                =====      =====      ======
<TABLE>

    The following table summarizes  information about options  outstanding under
the plans as of December 31, 1998:
<CAPTION>
                                                   Outstanding                    Exercisable
                                      ----------------------------------   ----------------------
                                                    Weighted-
                                                     Average    Weighted-                Weighted-
                                         Number     Remaining    average     Number       average
                                        of shares  Contractual  exercise    of shares    exercise
Range of exercise prices               outstanding    Life        price    Exercisable     price
------------------------              ------------ -----------  --------   -----------    -------
<S>                                      <C>        <C>           <C>          <C>        <C>   
     $0.20........................         150      6.2 years     $ 0.20       139        $ 0.20
From $0.50 to $ 3.50..............       1,316      9.0             2.84       263          2.99
From $3.75 to $ 5.00..............         776      7.6             3.79       388          3.75
                                         -----                                 ---
                                         2,242                                 790          2.88
                                         =====                                 ===
</TABLE>

     Certain outstanding options under the stock option plan granted to officers
are  immediately  exercisable but subject to repurchase by the Company at a rate
equivalent  to the current  vesting  schedule of each option.  During 1998,  the
Company  repurchased  46 shares.  As of December  31,  1998 and 1997,  36 and 82
shares were subject to repurchase, respectively.

     The  Company  initially  recorded  deferred  compensation  of $175  for the
difference between the grant price and the deemed fair value of the common stock
underlying  the options  granted in November and December  1995.  This amount is
being  amortized over the vesting period of the  individual  options,  generally
four years.

     In February 1996, the Company adopted the 1996 Employee Stock Purchase Plan
(the  "Purchase  Plan") and reserved a total of 1,000 shares of common stock for
issuance  thereunder.  The Purchase Plan became  effective in April 1996, on the
effective date of the Company's  initial public offering and permitted  eligible
employees  to acquire  shares of the  Company's  common  stock  through  payroll
deductions  at a price equal to 85% of the lower of the fair market value at the
beginning or end of each six-month  offering period.  As of December 31, 1998, a
cumulative total of 314 shares had been issued under the Purchase Plan.

     In April 1997,  the Company  offered  option holders under its stock option
plans the opportunity to have outstanding  unvested options repriced to the then
current  fair market  value of the  Company's  common  stock of $3.75 per share.
Employees electing to have options repriced were required to accept an extension
of their vesting schedule. The other terms of the options remained unchanged. On
April 28, 1997, the Company amended 852 options pursuant to this offer.

                                       33
<PAGE>

     In December 1998, the Company granted option holders under its stock option
plans  with  options  at a price  over  $5.00  per share to have  those  options
repriced to the then current fair market value of the Company's  common stock of
$3.50 per share. The other terms of the options remained unchanged.  In December
1998, the Company amended 162 options pursuant to this offer.

     The per share  weighted-average  fair value of stock options granted during
1998, 1997 and 1996 was $1.54,  $2.12, and $4.26,  respectively,  on the date of
grant  using  the   Black-Scholes   option-pricing   model  with  the  following
assumptions:  1998 expected dividend yield 0%, risk-free interest rate of 4.98%,
expected  volatility  of  80% and  expected  life of 3.2  years;  1997  expected
dividend yield 0%, risk-free interest rate of 6.32%, expected volatility of 57%,
and expected  life of 3.2 years;  1996  expected  dividend  yield 0%,  risk-free
interest rate of 6.25%, expected volatility of 57% and expected life of 4 years.

     The per share  weighted-average  fair value of  employees'  stock  purchase
rights under the Purchase  Plan  included in the pro forma amounts was estimated
using the  Black-Scholes  model with the  following  assumptions:  1998 dividend
yield  of 0%,  expected  life  of 15  months,  expected  volatility  of 80%  and
risk-free  interest rate of 4.97%;  1997 expected dividend yield of 0%, expected
life of 6 months,  expected  volatility  of 57% and  risk-free  interest rate of
5.31%; 1996 expected  dividend yield of 0%, expected life of 6 months,  expected
volatility of 57% and risk free rate of 6.25%. The  weighted-average  fair value
of purchase  rights granted in 1998,  1997 and 1996 was $1.28,  $1.89 and $4.39,
respectively.

     The  Company  uses  the  intrinsic  value  method  in  accounting  for  its
stock-based  compensation  plans.  Accordingly,  no  compensation  cost has been
recognized  for  these  plans  in the  financial  statements.  Had  the  Company
determined  compensation cost for its stock-based  compensation plans under SFAS
No.  123,  the  Company's  net loss would have been  increased  to the pro forma
amounts indicated below:

                                                Years ended December 31,
                                             -------------------------------
                                               1998       1997        1996
                                             --------   --------    --------
Net loss:                                                           
  As reported...........................      $5,084     $6,700      $5,240
  Pro forma.............................       6,262      8,146       5,870
                                           
Basic and diluted net loss per share:                               
  As reported...........................      $ 0.48     $ 0.65      $ 0.68
  Pro forma.............................        0.59       0.79        0.77

     Pro forma net income reflects only options granted in 1998,  1997, 1996 and
1995.  Therefore,  the full impact of  calculating  compensation  cost for stock
options  under SFAS No. 123 is not  reflected  in the pro forma net loss amounts
presented above because compensation cost is reflected over the options' vesting
period of three to four years and compensation cost for options granted prior to
January 1, 1995, is not considered.

Warrants

     In conjunction with various financing  arrangements in 1994, 1995 and 1998,
the Company  issued  warrants  to  purchase 53 shares of common  stock at prices
ranging  from  $1.50  per  share to  $18.16  per  share and 7 shares of Series B
redeemable  preferred  stock now  exercisable  for  common  stock in lieu of the
preferred  stock at $2.24 per share.  These  warrants  expire at  various  dates
through 2004.

                                       34
<PAGE>

(8) Commitments and Contingencies

Leases

     The Company  leases its facilities and certain  equipment  under  operating
lease  agreements.  The  equipment  operating  leases  expire  in  1999  and the
facilities  lease  expires in 2005.  Additionally,  the Company  leases  certain
equipment under capital lease  agreements.  These leases expire at various dates
through  2000.  Future  minimum  lease  payments as of December  31, 1998 are as
follows:

                                                     Capital    Operating
                                                     leases      leases
                                                     ------      ------
1999 .............................................      121         511
2000 .............................................       15         480
2001 .............................................     --           499
2002 .............................................     --           517
2003 .............................................     --           535
Thereafter .......................................     --           930
                                                     ------      ------
Future minimum lease payments ....................      136      $3,472
                                                                 ======
Less amount representing interest ................        8
                                                     ------
Present value of future minimum lease payments ...      128
Less current portion .............................      115
                                                     ------
Long-term portion ................................   $   13
                                                     ======

     Rent  expense  for the years ended  December  31,  1998,  1997 and 1996 was
approximately $664, $660 and $367, respectively.

Employee Benefit Plan

     The Company has a 401(k) plan that allows eligible  employees to contribute
up to  20%  of  their  compensation  to a  statutory  maximum  amount.  Employee
contributions  and  earnings  thereon  vest  immediately.  The  Company may make
discretionary contributions to the 401(k) plan; none have been made to date.

Legal Actions

     The Company is engaged in certain  legal  actions  arising in the  ordinary
course of business. The Company believes that it has adequate legal defenses and
that ultimate  outcome of these  actions will not have a material  effect on the
Company's financial position and results of operation.

     As part of the financial results for the third quarter of 1998, the Company
announced  that  the  distribution   relationship   with  Ascii  Something  Good
Corporation (now known as I4 Corporation,  a Japanese  corporation)  ("ASG") had
been  terminated  by  Worldtalk  for ASG's  failure to make agreed  payments for
software product fees and maintenance then totaling  approximately  $1.7 million
for the first and second  quarters of 1998.  On December 11,  1998,  the Company
filed a lawsuit against ASG in the United States District Court for the Northern
District of  California,  which case was assigned  Case Number  C-98-21231.  The
Complaint alleges the breach by ASG of the Distribution Agreement by ASG through
default  of its  payment  obligations.  The  lawsuit  seeks  payment  of  unpaid
balances,  currently in excess of $2.7 million, interest thereon, and reasonable
attorneys' fees and costs. ASG has until May 12, 1999 in which to respond to the
Complaint.

(9) International Sales and Major Customers

     International  license  sales  accounted  for 28% and 37% of the  Company's
total  software  license  revenues in 1998 and 1997,  respectively.  In 1998 and
1997,  sales to one customer,  ASG, accounted for 18% and 14%, respectively,  of
the Company's total software  license  revenue.  In 1998, sales to one customer,
Securities  Dynamics  Technologies,  Inc.  ("SDTI"),  accounted  for  17% of the
Company's total software license revenue. No other single customer accounted for
greater than 10% of the Company's  total software  license revenue in 1998, 1997
or 1996.

                                       35
<PAGE>

(10) Segment Information

     The Company operates in the United States and  internationally  and derives
its revenue from  software  license  sales and  associated  services of Internet
content  security  and  policy  management  solutions  and  e-mail  productivity
products. In 1998 and continuing into 1999, the Company's sales, marketing,  and
development  efforts  will  be  almost  entirely  focused  on the  server  based
WorldSecure product line.

     Geographic Information

                                         Years ended December 31,
                                         ------------------------
                                              1998     1997
                                             ------   ------
Software license revenue:
  United States ..........................   $6,937   $4,326
  All other countries ....................    2,694    2,534
                                             ------   ------
  Total ..................................   $9,631   $6,860
                                             ======   ======

     Product Line Information

                                         Years ended December 31,
                                         ------------------------
                                               1998     1997
                                             ------   ------
Software license revenue:
  WorldSecure Server .....................   $6,980   $1,119
  All other products .....................    2,651    5,741
                                             ------   ------
  Total ..................................   $9,631   $6,860
                                             ======   ======

Item 9.  Changes  in   and  Disagreements with  Accountants  on  Accounting  and
Financial Disclosure

     Not applicable.

                                    PART III

Item 10. Directors and Executive Officers of the Registrant

     The executive  officers and directors of the Company,  their ages and their
positions  with  the  Company  are  provided  in  the  table  below.  The  other
information  called  for  by  Item  10  is  incorporated  by  reference  to  the
Registrant's  Proxy  Statement being sent to stockholders in connection with the
1999  Annual  Meeting of  Stockholders  to be held on June 11,  1999 (the "Proxy
Statement").

        Name              Age                 Position
        ----              ---                 --------
Bernard J. Harguindeguy   40  President, Chief Executive Officer and Director
Todd Hagen                39  Vice President, Finance and Administration, 
                              Chief Financial Officer and Secretary
Robert D. Dickinson       33  Vice President, Engineering-- Bellevue
Simon Khalaf              33  Vice President, Marketing
Joseph Longo              45  Vice President, Consulting and Customer Services
Colin Crosby              55  Vice President, Sales
Eric Colard               39  Vice President, Business Development
Max D. Hopper             64  Director
David J. Cowan            33  Director
Anthony Sun               46  Director
Wade Woodson              40  Director

     Executive  officers  serve at the pleasure of the Board of Directors of the
Company.

     Mr.  Harguindeguy has served as Worldtalk's  President since April 1997 and
as Worldtalk's  Chief  Executive  Officer and a director  since July 1997.  From
April 1997 to July 1997,  Mr.  Harguindeguy  also served as the Company's  Chief
Operating  Officer.  From  December  1996  to  March  1997,  he  served  as Vice
President, Marketing

                                       36
<PAGE>

and Business  Development for Worldtalk.  From August 1994 to December 1996, Mr.
Harguindeguy  served as Vice  President,  Marketing  of emotion  Inc., a company
focused on the delivery of digital  video and  graphics  over public and private
networks.  From  February  1989 to August  1994,  he served at Novell,  Inc.  in
various  management  positions,   including  acting  general  manager  and  Vice
President of marketing for the Enterprise  Division.  Mr.  Harguindeguy  holds a
Masters in  Engineering  Management  from Stanford  University and a Bachelor of
Science in Electrical Engineering from University of California, Irvine.

     Mr. Hagen has served as Vice President,  Finance and Administration,  Chief
Financial  Officer and  Secretary  of Worldtalk  from May 1998 to present.  From
November  1994 to May 1998,  Mr.  Hagen  served as Vice  President,  Finance and
Administration, and Chief Financial Officer of HyperMedia Communications,  Inc.,
an Internet publisher.  Previous to that position,  Mr. Hagen was Vice President
of Finance and Chief  Financial  Officer at Coactive  Computing  Corporation,  a
computer  networking  company,  and Resumix,  Inc., a human  resources  software
company.  Mr.  Hagen holds a Masters in Business  Administration  in Finance and
Accounting  from  the  Anderson  Graduate  School  of  Management  at UCLA and a
Bachelor in Science in Finance  and  Marketing  from the  Wharton  School at the
University of Pennsylvania.

     Mr.  Dickinson has served as Vice  President,  Engineering  -- Bellevue for
Worldtalk since December 1997. From November 1996 to December 1997, he served as
Director,  Research and Development for the Deming Internet Security division of
the Company.  In December 1995, Mr. Dickinson  founded Deming Software,  Inc., a
developer of electronic mail security solutions. He served as President, CEO and
Chairman  of Deming  Software,  Inc.  from  December  1995 until its merger with
Worldtalk  in  November  1996.  From June 1991 to  November  1995,  he served in
various  executive  positions  and was a member  of the  board of  directors  of
ConnectSoft,  Inc., a communications  software  development and consulting firm.
From June 1988 to May 1991,  he held various  product  development  positions at
Boeing  Company.   Mr.  Dickinson  received  a  Bachelor  of  Arts  in  Business
Administration from Washington State University.

     Mr. Longo has served as Vice President, Consulting and Customer Services of
Worldtalk  from April 1997 to  current.  Previously,  he served as  Director  of
Professional  Services for the Company from January 1995 to April 1997. From May
1989 to January  1995,  Mr.  Longo held  various  positions  including  his last
position as the  Director  of Custom  Engineering  at The Santa Cruz  Operation,
Inc.,  a supplier of UNIX  operating  systems for Intel  PC's.  Mr.  Longo has a
Bachelor of Science  degree in Applied  Sciences and Computer  Science from RMIT
(Melbourne, Australia).

     Mr.  Khalaf  has  served as  Worldtalk's  Vice  President,  Marketing  from
November 1996 to current. Previously, he served as Director of Product Marketing
for the Company, from January 1996 to October 1996. From August 1994 to December
1995, Mr. Khalaf was a Product Line Manager for Worldtalk. Prior to that, he was
an  Engineering  Team Lead for the Company from October 1993 to July 1994.  From
March 1992 to September 1993, he was a Senior  Software  Engineer for Worldtalk.
Before  joining   Worldtalk,   Mr.  Khalaf  was  a  Senior   Engineer  at  Touch
Communications   Inc.,  a  software   company   specializing   in  OSI  Protocol
Development. Mr. Khalaf has received a Bachelor of Science degree in Engineering
from the American University of Beirut.

     Mr.  Crosby has  served as the Vice  President  of  Worldwide  sales  since
November of 1998 joining  Worldtalk  after  working for the  previous  year as a
consultant  in various  privately  held startup  companies.  Mr. Crosby was with
Oracle from August 1994 to March of 1997, his last position being Vice President
of Sales Operations for the North American Channel program.  Prior to Oracle Mr.
Crosby  was  employed  by  Tandem  Computers  for 7 years  holding  a number  of
positions  including Vice President of Commercial  sales for Tandem Canada.  Mr.
Crosby  began his career  with Univac  after his  honorable  discharge  from the
Marine   Corps.   Mr.   Crosby  did  his   undergraduate   studies  in  Business
Administration  at New York  University  and post graduate  level studies in the
Executive MBA program at the University of Western Ontario.


     Mr. Colard has served as Vice President, Business Development for Worldtalk
since  October  1998.  From July 1997 to October  1998, he served as Director of
Business  Development.  From July 1991 to June 1997,  Mr.  Colard  

                                       37
<PAGE>

held  various  positions  including  his last  position  as acting  Director  of
Business Development for the Internet Infrastructure Division at Novell, Inc., a
supplier of networking and directory-based software. From September 1984 to July
1991, Mr. Colard held various  marketing and software  development  positions at
Alcatel,  Cap Gemini Telecom and Societe  Generale in the USA, France and Italy.
Mr.   Colard  has  a  Masters  of  Science   degree  in  Computer   Science  and
Telecommunications from Ecole Nationale Superieure des Telecommunications (ENST)
Paris, France.

     Mr. Hopper has served as a director of the Company since September 1995. He
has been Principal and Chief Executive Officer of Max D. Hopper & Associates,  a
consulting and  information  management  firm since January 1995.  From November
1985 to January 1995, Mr. Hopper served AMR Corporation as Chairman of the SABRE
Group and Senior Vice President,  Information  Systems. Mr. Hopper is a director
of Gartner Group, VTEL Corporation, USDATA Corporation,  Payless Cashways, Inc.,
United Stationers,  Inc., Metrocall,  Inc., and Exodus Communications,  Inc. Mr.
Hopper  holds a Bachelor  of  Science  in  Mathematics  from the  University  of
Houston.

     Mr. Cowan has served as a director of the Company since March 1993. He is a
general partner of Deer II & Co., a venture capital  investment firm that is the
general partner of Bessemer  Venture  Partners III, L.P., with which he has been
affiliated  since  August  1992.  Mr.  Cowan is a director  of Finjan,  Inc.,  a
provider  of Java  security  software,  VeriSign,  Inc.,  an  Internet  security
company, and Flycast, an Internet advertising  exchange.  Mr. Cowan received his
A.B.   degree  in  Math  and  Computer   Science  and  his  Master  of  Business
Administration degree from Harvard University.

     Mr. Sun has served as a director  of the Company  since March 1995.  He has
been a general  partner of Venrock  Associates,  a venture  capital firm,  since
1979.  He is a  director  of Cognex  Corporation,  a computer  systems  company,
Phoenix  Technologies  Ltd., a computer systems software company,  Komag Inc., a
computer storage component  company and 3Dfx  Interactive,  Inc., a real-time 3D
semiconductor  company. He is also a director of several private companies.  Mr.
Sun  received  S.B.E.E,  S.M.E.E.  and Engineer  degrees from the  Massachusetts
Institute  of  Technology  and a Master of Business  Administration  degree from
Harvard University.

     Mr. Woodson has served as a director of the Company since March 1993. He is
a general partner with Sigma  Partners,  a venture  capital  organization,  with
which he has been  affiliated  since  1987.  He is also a  director  of  several
private companies.  Mr. Woodson received his B.S. in Electrical Engineering from
Stanford University,  his J.D. degree from Harvard University and his Masters in
Business Administration degree from the University of California, Berkeley.

ITEM 11. Executive Compensation

     Incorporated by reference from the information under the caption "Executive
Compensation"  in the Company's  Proxy  Statement to be filed in connection with
the 1999 Annual Meeting of Stockholders.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

     Incorporated by reference from the information  under the caption "Security
Ownership of Certain  Beneficial  Owners and  Management" in the Company's Proxy
Statement  to  be  filed  in  connection   with  the  1999  Annual   Meeting  of
Stockholders.

ITEM 13. Certain Relationships and Related Transactions

     Incorporated by reference from the information  under the caption  "Certain
Transactions"  in the Company's  Proxy  Statement to be filed in connection with
the 1999 Annual Meeting of Stockholders.


                                       38
<PAGE>

                                     PART IV

Item 14. Exhibits, Financial Statements Schedules, and Reports on Form 8-K

(a)(1)   Financial Statements and Financial Statement  Schedules.  The following
         financial  statements  are  filed as part of this  report  on Form 10-K
         beginning on page 18 under the caption,  "Item 8. Financial  Statements
         and Supplementary Data."

         Independent Auditors' Report

         Consolidated Balance Sheet as of December 31, 1998 and 1997

         Consolidated  Statements of Operation for the years ended  December 31,
         1998, 1997 and 1996

         Consolidated Statements of Stockholders' Equity (Deficit) for the years
         ended December 31, 1998, 1997 and 1996

         Consolidated  Statements of Cash Flows for the years ended  December 31
         1998, 1997 and 1996

         Notes to Consolidated Financial Statements

   (2)   Schedule II -- Valuation and Qualifying Accounts

(b) Report on Form 8-K

   None


                                       39
<PAGE>

(c) Exhibits:

    Exhibit No.                          Description
    -----------                          -----------

       2.01       Agreement and Plan of  Reorganization  between  Registrant and
                  Worldtalk Corporation, a California corporation,  and material
                  exhibits thereto (A)

       2.02       Agreement  and Plan of Merger dated as of November 12, 1996 by
                  and between Worldtalk Merger corporation and Deming Software,,
                  Inc. (B)

       2.03       Escrow Agreement dated November 12, 1996 among Registrant, the
                  Deming Shareholders,  Robert D. Dickinson,  as Representative,
                  and Harris Trust and Savings Bank, as Escrow Agent. (B)

       3.01       Registrant's Certificate of Incorporation. (A)

       3.02       Registrant's Certificate of Designation. (A)

       3.03       Registrant's Certificate of Elimination. (A)

       3.04       Registrant's Bylaws. (A)

       4.01       Form of Specimen  Certificate for  Registrant's  Common Stock.
                  (A)

       4.02       Third  Amended and  Restated  Registration  Rights  Agreements
                  between  Registrant and certain investors dated March 3, 1996,
                  as amended. (A)

       4.03       Shareholders'   Agreement   dated   November  12,  1996  among
                  Registrant, Deming and the Deming Shareholders. (B)(1)

       10.01      Registrant's  1992 Stock  Option Plan and  related  documents.
                  (A)(3)

       10.02      Registrant's 1996 Equity Incentive Plan and related documents.
                  (A)(3)

       10.03      Registrant's  1996  Directors  Stock  Option  Plan and related
                  documents (A)(3)

       10.04      Registrant's  1996  Employee  Stock  Purchase Plan and related
                  documents (A)(3)

       10.05      Form  of  Identification  Agreement  to  be  entered  into  by
                  Registrant  with each of its directors and executive  officer.
                  (A)(3)

       10.06      Lease Agreement,  dated June 15, 1995,  between Registrant and
                  John Arrillaga. (A)

       10.07      Consulting and  Development  Services  Agreement and Copyright
                  Assignment between Microsoft  Corporation and Registrant dated
                  September 7, 1995. (A)(1)

       10.08      Restricted Stock Purchase Agreement,  dated December 15, 1995,
                  between Registrant and Max Hopper. (A)(3)

       10.09      Secured Full  Recourse  Promissory  Note and related  Security
                  Agreement,  dated  October 24, 1996,  between  Registrant  and
                  Christopher J. Andrews. (C)(3)

       10.10      Agreement and Plan of  Reorganization  dated as of November 9,
                  1996 by and among  Registrant,  Deming Software,  Inc. and the
                  Deming Shareholders. (B)(1)

       10.11      Form of Employment  Agreement entered into by Deming with each
                  of the Deming Shareholders on November 12, 1996. (B)

       10.12      Amendment to Loan and  Security  Agreement,  dated  January 9,
                  1997, between Registrant and General Bank (D)

       10.13      Form of Employment Agreement,  dated January 23, 1997, between
                  Registrant  and  Christopher  J. Andrews,  Simon A. Khalaf and
                  Sathvik Krishnamurthy (D)(3)

       10.14      Form of Employment Agreement,  dated January 23, 1997, between
                  Registrant  and Stephen R. Bennion,  Steve M. Goldner and Mark
                  A. Jung (D)(3)

       10.15      Separation,  Consulting and Release  Agreement  dated July 23,
                  1997 between Mark A. Jung and the Registrant (E)(1)(3)

       10.16      Settlement,  Consulting and Release  Agreement  dated July 15,
                  1997 between Christopher Andrews and the Registrant (E)(1)(3)

       10.17      Settlement,  Consulting and Release  Agreement  dated July 15,
                  1997 between Steven Goldner and the Registrant (E)(1)(3)

       10.18      Secure Messaging Distribution Agreement between Registrant and
                  Security Dynamics Technologies,  Inc., dated September 8, 1997
                  (F)(1)

       10.19      License and  Distribution  Agreement  between  Registrant  and
                  ASCII  Something  Good  Corporation,  dated  September 8, 1997
                  (F)(1)

       10.20      Employment  Termination  Agreement  dated  April 10, 1998 with
                  Stephen R. Bennion (G)(1)(2)

       10.21      Employment  Termination  Agreement  dated  June 29,  1998 with
                  Sathvik  Krisnamurthy (G)(1)(2) 

                                       40
<PAGE>
    Exhibit No.                          Description
    -----------                          -----------

       10.22      Form of  Employment  Agreement  entered  into with each of its
                  executive officers (H)(2)

       10.23      Loan and Security Agreement,  dated December 30, 1998, between
                  Registrant and Silicon Valley Bank (I)

       23.01      Consent of Independent Auditors (I)

       27.01      Financial Data Schedule (I)

----------

(1)  Confidential treatment has been granted with respect to certain portions of
     this  agreement.   Such  portions  have  been  filed  separately  with  the
     Securities and Exchange Commission.

(2)  Management contract or compensatory plan.

(A)  Incorporated  by reference to the  Exhibits to the  Company's  Registration
     Statement on form S-1, as amended (File No. 333-1482) as declared effective
     by the Securities and Exchange Commission.

(B)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     8K, as amended (File No.  0-27886)  filed with the  Securities and Exchange
     Commission on November 12, 1996.

(C)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10K (File No. 0-27886) filed with the Securities and Exchange Commission on
     March 31, 1997.

(D)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q (File No. 0-27886) filed with the Securities and Exchange Commission on
     May 14, 1997.

(E)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q (File No. 0-27886) filed with the Securities and Exchange Commission on
     November 14, 1997.

(F)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10K (File No. 0-27886) filed with the Securities and Exchange Commission on
     March 31, 1998.

(G)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q/A (File No. 0-27886) filed with the Securities and Exchange  Commission
     on September 4, 1998.

(H)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q/A (File No. 0-27886) filed with the Securities and Exchange  Commission
     on November 13, 1998.


(I)  Filed herewith.


                                       41
<PAGE>

                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.

Date:  March 31, 1999
                                   WORLDTALK COMMUNICATIONS
                                   CORPORATION


                                   By:  /s/ TODD HAGEN                
                                       --------------------------------------
                                        Todd Hagen
                                        Vice President, Finance and 
                                        Administration,
                                        Chief Financial Officer and Secretary
<TABLE>

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report has been signed by the following  persons on behalf of registrant  and in
the capacities and on the dates indicated.
<CAPTION>

<S>                                   <C>                                                        <C> 
/s/  BERNARD HARGUINDEGUY             President and Chief Executive Officer                      March 31, 1999
---------------------------

/s/  TODD HAGEN                       Vice President, Finance and Administration, Chief          March 31, 1999
---------------------------           Financial Officer and Secretary  (Principal
                                      Accounting Officer)

/s/  WADE WOODSON                     Director                                                   March 31, 1999
---------------------------

/s/  MAX HOPPER                       Director                                                   March 31, 1999
---------------------------

/s/  DAVID COWAN                      Director                                                   March 31, 1999
---------------------------

/s/  ANTHONY SUN                      Director                                                   March 31, 1999
---------------------------  
</TABLE>

                                       42
<PAGE>


                                              SCHEDULE II
<TABLE>

                                 WORLDTALK COMMUNICATIONS CORPORATION
                            VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<CAPTION>
                                                                            Deductions:
                                                  Balance at                Write-offs    
                                                 Beginning of                   of        Balance at
Classification                                       Year       Additions    Accounts     End of year
--------------                                       ----       ---------    --------     -----------
                                                                   (In thousands)
<S>                                                  <C>        <C>            <C>          <C>   
Allowance for doubtful accounts
  Year ended December 31, 1998..............         $ 121      $1,720 (1)     $ (1)        $1,840
                                                     =====      =========      ====         ======
                                                              
  Year ended December 31, 1997..............         $ 149        $ 41         $(69)        $  121
                                                     =====        ====         ====         ======
  Year ended December 31, 1996..............         $ 150        $ 10         $(11)        $  149
                                                     =====        ====         ====         ======
<FN>

(1)      As a result of the termination and associated  non-payments,  Worldtalk
         established  an allowance for doubtful  accounts for the full amount of
         approximately $1,700,000 owed by ASG.
</FN>
</TABLE>


                                       43


<PAGE>
    Exhibit No.                          Description
    -----------                          -----------

        2.01      Agreement and Plan of  Reorganization  between  Registrant and
                  Worldtalk Corporation, a California corporation,  and material
                  exhibits thereto (A)
        
        2.02      Agreement  and Plan of Merger dated as of November 12, 1996 by
                  and between Worldtalk Merger corporation and Deming Software,,
                  Inc. (B)
        
        2.03      Escrow Agreement dated November 12, 1996 among Registrant, the
                  Deming Shareholders,  Robert D. Dickinson,  as Representative,
                  and Harris Trust and Savings Bank, as Escrow Agent. (B)
        
        3.01      Registrant's Certificate of Incorporation. (A)
        
        3.02      Registrant's Certificate of Designation. (A)
        
        3.03      Registrant's Certificate of Elimination. (A)
        
        3.04      Registrant's Bylaws. (A)
        
        4.01      Form of Specimen  Certificate for  Registrant's  Common Stock.
                  (A)
        
        4.02      Third  Amended and  Restated  Registration  Rights  Agreements
                  between  Registrant and certain investors dated March 3, 1996,
                  as amended. (A)
        
        4.03      Shareholders'   Agreement   dated   November  12,  1996  among
                  Registrant, Deming and the Deming Shareholders. (B)(1)
        
       10.01      Registrant's  1992 Stock  Option Plan and  related  documents.
                  (A)(3)

       10.02      Registrant's 1996 Equity Incentive Plan and related documents.
                  (A)(3)

       10.03      Registrant's  1996  Directors  Stock  Option  Plan and related
                  documents (A)(3)

       10.04      Registrant's  1996  Employee  Stock  Purchase Plan and related
                  documents (A)(3)

       10.05      Form  of  Identification  Agreement  to  be  entered  into  by
                  Registrant  with each of its directors and executive  officer.
                  (A)(3)

       10.06      Lease Agreement,  dated June 15, 1995,  between Registrant and
                  John Arrillaga. (A)

       10.07      Consulting and  Development  Services  Agreement and Copyright
                  Assignment between Microsoft  Corporation and Registrant dated
                  September 7, 1995. (A)(1)

       10.08      Restricted Stock Purchase Agreement,  dated December 15, 1995,
                  between Registrant and Max Hopper. (A)(3)

       10.09      Secured Full  Recourse  Promissory  Note and related  Security
                  Agreement,  dated  October 24, 1996,  between  Registrant  and
                  Christopher J. Andrews. (C)(3)

       10.10      Agreement and Plan of  Reorganization  dated as of November 9,
                  1996 by and among  Registrant,  Deming Software,  Inc. and the
                  Deming Shareholders. (B)(1)

       10.11      Form of Employment  Agreement entered into by Deming with each
                  of the Deming Shareholders on November 12, 1996. (B)

       10.12      Amendment to Loan and  Security  Agreement,  dated  January 9,
                  1997, between Registrant and General Bank (D)

       10.13      Form of Employment Agreement,  dated January 23, 1997, between
                  Registrant  and  Christopher  J. Andrews,  Simon A. Khalaf and
                  Sathvik Krishnamurthy (D)(3)

       10.14      Form of Employment Agreement,  dated January 23, 1997, between
                  Registrant  and Stephen R. Bennion,  Steve M. Goldner and Mark
                  A. Jung (D)(3)

       10.15      Separation,  Consulting and Release  Agreement  dated July 23,
                  1997 between Mark A. Jung and the Registrant (E)(1)(3)

       10.16      Settlement,  Consulting and Release  Agreement  dated July 15,
                  1997 between Christopher Andrews and the Registrant (E)(1)(3)

       10.17      Settlement,  Consulting and Release  Agreement  dated July 15,
                  1997 between Steven Goldner and the Registrant (E)(1)(3)

       10.18      Secure Messaging Distribution Agreement between Registrant and
                  Security Dynamics Technologies,  Inc., dated September 8, 1997
                  (F)(1)

       10.19      License and  Distribution  Agreement  between  Registrant  and
                  ASCII  Something  Good  Corporation,  dated  September 8, 1997
                  (F)(1)

       10.20      Employment  Termination  Agreement  dated  April 10, 1998 with
                  Stephen R. Bennion (G)(1)(2)

       10.21      Employment  Termination  Agreement  dated  June 29,  1998 with
                  Sathvik  Krisnamurthy  (G)(1)(2) 

       10.22      Form of  Employment  Agreement  entered  into with each of its
                  executive officers (H)(2)




                                       44
<PAGE>

    Exhibit No.                          Description
    -----------                          -----------

       10.23      Loan and Security Agreement,  dated December 30, 1998, between
                  Registrant and Silicon Valley Bank (I)

       23.01      Consent of Independent Auditors (I)

       27.01      Financial Data Schedule (I)

----------

(1)  Confidential treatment has been granted with respect to certain portions of
     this  agreement.   Such  portions  have  been  filed  separately  with  the
     Securities and Exchange Commission.

(2)  Management contract or compensatory plan.

(A)  Incorporated  by reference to the  Exhibits to the  Company's  Registration
     Statement on form S-1, as amended (File No. 333-1482) as declared effective
     by the Securities and Exchange Commission.

(B)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     8K, as amended (File No.  0-27886)  filed with the  Securities and Exchange
     Commission on November 12, 1996.

(C)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10K (File No. 0-27886) filed with the Securities and Exchange Commission on
     March 31, 1997.

(D)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q (File No. 0-27886) filed with the Securities and Exchange Commission on
     May 14, 1997.

(E)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q (File No. 0-27886) filed with the Securities and Exchange Commission on
     November 14, 1997.

(F)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10K (File No. 0-27886) filed with the Securities and Exchange Commission on
     March 31, 1998.

(G)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q/A (File No. 0-27886) filed with the Securities and Exchange  Commission
     on September 4, 1998.

(H)  Incorporated  by reference to the Exhibits to the Company's  report on Form
     10Q/A (File No. 0-27886) filed with the Securities and Exchange  Commission
     on November 13, 1998.


(I)  Filed herewith.


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