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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K

(Mark One)



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

For the fiscal year ended December 31, 2007

or



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

For the transition period from                      to

Commission
File Number: 000-26223





TUMBLEWEED COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 94-3336053                          
|(State of other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|700 Saginaw Drive Redwood City, CA                             |  | 94063                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

(650) 216-2000

(Registrants telephone number, including area code)





Securities registered pursuant
to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value
per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes   ̈    No  x

Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not
contained herein, and will not be contained, to the best of 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    x

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2
of the Exchange Act). Check one:

Large accelerated filer   ̈
    Accelerated filer  x     Non-accelerated filer     ̈    Smaller
reporting company   ̈

The approximate aggregate market value of the Common Stock
held by non-affiliates of the Registrant, based upon the last sale price of the Common Stock reported on the Nasdaq National Market on June 30, 2007, was approximately $98,521,008. Shares held by each officer, director, and holder of 5% or more
of the outstanding Common Stock have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares of common stock outstanding as of February 15, 2008 was 51,144,795.

DOCUMENTS INCORPORATED BY REFERENCE



|                                                                                    |  |                              
|----------------------------------------------------------------------------------- |  | -----------------------------
|Document                                                                            |  | Parts Into Which Incorporated
|Proxy Statement for the Annual Meeting of Stockholders to be held (Proxy Statement) |  | Part III                     









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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, which are subject to the safe harbor created by those sections. The forward-looking statements are based on our current expectations and projections about future events.
Discussions containing such forward-looking statements may be found in Managements Discussion and Analysis of Financial Condition and Results of Operations. In some cases, forward-looking statements can be identified by terminology
such as may, will, should, could, predicts, projects, potential, continue, expects, anticipates, future,
intends, plans, believes, estimates, or the negative of these terms and other comparable terminology, including, but not limited to, the following:



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



| |  |  | any revenue expected to be realized from backlog;
| | - |  | -------------------------------------------------



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



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



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



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



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



| |  |  | any statements regarding competition in, or size of, our market; and
| | - |  | --------------------------------------------------------------------



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

These forward-looking statements are only predictions, not historical facts. These forward-looking statements involve certain risks and uncertainties, as well as assumptions. Actual results, levels of activity,
performance, achievements and events could differ materially from those stated, anticipated or implied by such forward-looking statements. The factors that could contribute to such differences include those discussed under the caption Risk
Factors in Part II, Item 1A contained herein, as well as those discussed in our Form 10-K and other filings with the Securities and Exchange Commission. These risks should be considered carefully, among other things, in evaluating our
prospects and future financial performance. The occurrence of the events described in the risk factors could harm our business, results of operations and financial condition. These forward-looking statements are made as of the date of this Annual
Report on Form 10-K. We disclaim any obligation to update or alter these forward-looking statements.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

INDEX



|               |  |                                                                                                                  |  |     
|-------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|               |  |                                                                                                                  |  | Page
|PART I        
|               |  |                                                                                                                 
|Item 1         |  | Business                                                                                                         |  | 4   
|Item 1A        |  | Risk Factors                                                                                                     |  | 13  
|Item 1B        |  | Unresolved Staff Comments                                                                                        |  | 21  
|Item 2         |  | Properties                                                                                                       |  | 21  
|Item 3         |  | Legal Proceedings                                                                                                |  | 21  
|Item 4         |  | Submission of Matters to a Vote of Security Holders                                                              |  | 22  
|              
|PART II       
|               |  |                                                                                                                 
|Item 5         |  | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 23  
|Item 6         |  | Selected Financial Data                                                                                          |  | 25  
|Item 7         |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 29  
|Item 7A        |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 42  
|Item 8         |  | Financial Statements and Supplementary Data                                                                      |  | 43  
|Item 9         |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                             |  | 70  
|Item 9A        |  | Controls and Procedures                                                                                          |  | 70  
|Item 9B        |  | Other Information                                                                                                |  | 70  
|              
|PART III      
|               |  |                                                                                                                 
|Item 10        |  | Directors and Executive Officers of the Registrant                                                               |  | 71  
|Item 11        |  | Executive Compensation                                                                                           |  | 71  
|Item 12        |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters                  |  | 71  
|Item 13        |  | Certain Relationships and Related Transactions                                                                   |  | 71  
|Item 14        |  | Principal Accountant Fees and Services                                                                           |  | 71  
|              
|PART IV       
|               |  |                                                                                                                 
|Item 15        |  | Exhibits and Financial Statement Schedules                                                                       |  | 72  
|Signatures     |  | 74                                                                                                              
|Certifications |  |                                                                                                                 

TRADEMARKS

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



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PART I

Item 1Business

Overview

Tumbleweed Communications Corp. (Tumbleweed or we) is a recognized expert in providing managed file transfer, email security, and identity validation products for enterprise and government
customers of all sizes. We provide comprehensive solutions that enable organizations to safely and confidently conduct business over the Internet, protecting data in motion and at rest with intuitive, pragmatic solutions that promote collaboration,
prevent data loss, and reduce the cost of doing business. Our customers deploy our security products between their network and the Internet to effectively protect against inbound threats and outbound vulnerabilities, and to automatically encrypt and
securely deliver data to third parties. In addition, all of our products are designed to integrate with existing business and email systems, requiring no significant change in existing firewall or system infrastructures. Our products can be used
independently or in combination to create a comprehensive, secure Internet communications solution for our customers. All of our products offer multi-level security using industry standards, universal access, and proven scalability for high volume
data traffic. Our suite is comprised of four products:



| |  |  | Tumbleweed SecureTransport is a managed file
transfer product that enables customers to securely manage the exchange of large files and transactions without having to change internal infrastructure.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Tumbleweed Secure Messenger is a policy-based email
encryption product that enables deep-content inspection of incoming and outgoing mail, and dynamic application of user-defined encryption and routing preferences.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Tumbleweed MailGate® is a comprehensive email
security product that provides inbound and outbound protection with protection against virus outbreaks, spam, and denial of service attacks, eliminating illegitimate email traffic before it can penetrate corporate firewalls.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Tumbleweed Validation Authority is a leading
product for determining the validity of digital certificates.
| | - |  | -----------------------------------------------------------------------------------------------------------

We are trusted by more than 3,200 enterprise and
government customers who use our products to securely connect with employees, partners, and customers. Our traditional market focus has been in the financial services, healthcare, and government markets, but we are expanding into other market
sectors, such as retail, manufacturing, energy, transportation and technology. Many of the worlds most security conscious organizations use our products to safely exchange data, protect information assets, block email security threats, and
ensure identity validation.

Industry Background

In todays business environment, most enterprises rely on the use of corporate File Transfer Protocol (FTP) clients, email systems, customer service applications and numerous point
solutions to securely communicate and exchange information with customers and business partners. Initially, companies simply opened their networks to the Web in pursuit of this goal. Predictably, hackers and other kinds of high-tech
criminals soon exploited these vulnerabilities, and the rate of accidental data loss from otherwise well-meaning employees has increased substantially.

As a result, content security has become mission-critical for businesses. Organizations of all kinds are struggling to balance the operational need to increase the volume and frequency of customer and partner
communications with the challenges of protecting highly sensitive company, business partner, and customer information. The Internet sits at a crossroads of this challenge: it is the enabler of enhanced communications and linked business processes
across company boundaries, but also a sieve that has allowed hundreds of data breaches and unauthorized disclosures over the past several years.



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To fully leverage the business advantage of secure content delivery over the Internet, enterprises and
government organizations now understand that they must address issues of security, centralized management, automation, legacy integration, and end-user behavior. The policies and management protocols traditionally applied to paper or voice-based
processes within an organization are now being applied to electronic communications of all kinds. The adoption of these policies and protocols is critical to establishing compliance with regulatory requirements, and to providing enterprises the same
audit trail and confidentiality protections that paper processes supply.

There are four key areas of security readiness enterprises must now address:



| | 1. | Secure, reliable, and auditable managed file transfer: File movement has become a central feature of established and emerging business processes, and failure to securely move
large files with high-value, sensitive transactions has resulted in well-publicized data breaches and consequent negative repercussions.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. | Powerful, easy-to-implement email encryption that does not require additional staff or disrupt established workflow:Organizations must protect confidential information and
intellectual property, comply with increasingly stringent government and industry regulations, and meet the security demands of partners, suppliers and customers.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | Robust email security capabilities that eliminate illegitimate traffic and email threats at the corporate gateway: More and more enterprises are losing the battle against
spam and other forms of attack against their email infrastructure because they lack the sophisticated protection systems necessary to adequately secure email communications. This security shortfall can result in expensive network downtime and
reduced employee productivity.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. | Digital certificate validation to facilitate trusted transactions: Trusting an invalid certificate can expose an organization to potential fraud, theft, and compromise.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Through deployment of comprehensive secure content delivery products, organizations can implement and enforce policies
enterprise-wide, provide critical management of sensitive communications, and leverage existing systems to conduct business over the Internet.

Tumbleweed Solutions

We are a recognized expert in providing managed file transfer, email security, and identity validation
products for enterprise and government customers of all sizes. We provide comprehensive solutions that enable organizations to safely and confidently conduct business over the Internet, protecting data in motion and at rest with intuitive, pragmatic
solutions that promote collaboration, prevent data loss, and reduce the cost of doing business.

Tumbleweed SecureTransport

Tumbleweed SecureTransport is an industry-leading, enterprise-class managed file transfer solution that allows organizations to adeptly control and manage
the transfer of files inside and outside of the corporate firewall in support of mission-critical business processes. SecureTransport securely exchanges financial transactions, critical business files, large documents, Extensible Markup Language,
and Electronic Data Interchange (EDI) transactions over the Internet and private Internet protocol networks. SecureTransport is a winner of numerous awards, including Best Intellectual Property Protection by Secure
Computing magazine and an A rating from Government Computing News Lab.

SecureTransport is a centrally managed,
client-server solution supporting a broad set of open standard file transfer protocols that forms the core of many financial networks, healthcare agencies, and state, local, and federal governments. Financial networks use SecureTransport to
move the data associated with billions of dollars



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of financial transactions daily. Healthcare providers, payers, producers, and clearing houses are linked through SecureTransport, transferring private
health information. Government agencies leverage SecureTransport to communicate and share documents with other agencies. SecureTransport replaces outdated forms of data transfers such as EDI, leased lines, and un-secured FTP.

With SecureTransport, organizations can:



| |  |  | Secure business-critical data and intellectual property: SecureTransport enables organizations to easily convert paper-based, courier-based, or proprietary
electronic data transfers to a secure, standards-based, Internet model, with auditing and reporting capabilities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Comply with policies and regulations:SecureTransport enables organizations to securely send and receive private information in conformance with industry,
government, or corporate regulations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Flexibly integrate for superb business enablement:Many organizations have developed their own file transfer
applications that do not scale and are not interoperative with other applications. SecureTransport offers a standards-based, tiered architecture and supports multiple protocols, delivering a cost-effective, highly scalable solution that allows for
rapid on-boarding of business partners, customers and constituents.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leverage industry standard protocols:SecureTransport enables businesses to conduct EDI and business-to-business transactions without virtual private
networks, additional infrastructure, or proprietary software.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

SecureTransport is a centrally managed, client-server
solution supporting a broad set of open standard file transfer protocols.

Tumbleweed Secure
Messenger

Tumbleweed Secure Messenger is an industry leading solution for securing and encrypting email communications. Deployed by
some of the most demanding enterprises in the Global 2000, Secure Messenger enables organizations to meet their unique security needs, from compliance with government privacy regulations in Healthcare (Health Insurance Portability and Accountability
Act, or HIPAA) and Financial Services (Gramm-Leach-Bliley Act, or GLBA) to enforcement of corporate policies (Sarbanes-Oxley Act, or SOX) and protection of intellectual property. Tumbleweed was positioned in the Leaders Quadrant of the Gartner Magic
Quadrant for Email Encryption in 2007, and Secure Messenger has won several awards including the Secure Computing Recommended product ranking.

Secure Messenger inspects all outbound email at the network gateway, identifies email content that is in violation of enterprise-defined security policies, and automatically redirects suspect messages to a secure,
encrypted channel for further action, such as deletion, quarantine, or encrypted delivery. This perimeter-based encryption strategy ensures that all users comply with enterprise privacy and security policies all the time, with no need to install
client software on the desktop.

With Secure Messenger, organizations can:



| |  |  | Encrypt and authenticate inbound and outbound email streams:Secure Messenger inspects and appropriately handles email messages based on centralized policies
and automated message routing.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Guarantee adoption of secure messaging:Secure Messenger enforces enterprise and trading-network messaging security policies for all internal and external
users.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Deploy secure messaging to any user with a browser and email client:Secure Messenger provides message delivery
options that rely only on existing email client software and ubiquitous browser-based technologies.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Automate and track message delivery:Secure Messenger tracks message delivery all the way to the recipients desktop, creating a paper trail
for compliance and auditing purposes.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leverage existing email infrastructures: Secure Messenger ensures across-the-board authentication and role discovery for all email servers and clients, as
well as for existing Public Key Infrastructure (PKI), enterprise directories, and identity management solutions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Tumbleweed
MailGate

Tumbleweed MailGate delivers a robust, effective, and easy-to-manage email security solution to secure an
enterprises mission-critical email systems. Through its content filtering, antivirus, anti-spam, and Intelligent Edge Defense capabilities, MailGate protects enterprises of any size against virus outbreaks, spam, and denial-of-service attacks.
MailGate is a winner of the 2006 Recommended product rating from Secure Computingmagazine.

Tumbleweed MailGate is
unique both in its depth and breadth. Unlike some competitors who rely solely on other vendors for encryption and anti-spam technology, we have developed our own, integrated components that enable scalability and interoperability.

With the MailGate family of products, organizations can:



| |  |  | Protect their network: MailGate stops attacks (e.g. virus, spam, worms, denial-of-service and directory harvest) both at the Internet gateway and within
the corporate network.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Comply with regulations and policies:MailGate is one of the most comprehensive content filtering and intelligent routing solutions available.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reduce communication costs:MailGate eliminates potentially costly email security threats and enables optimal network performance.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------

Tumbleweed Validation Authority Suite

Tumbleweed Validation Authority Suite offers a comprehensive, scalable, and reliable framework for real-time validation of digital certificates, and is the worlds most widely deployed Online Certificate Status
Protocol responder.

Banks, governments, and businesses worldwide rely on their PKI and digital certificates to secure everything from
corporate network access to electronic transactions to physical access to military facilities. Trusting an invalid certificate can expose an organization to potential fraud, theft and compromise. PKI-enabled systems depend on digital
certificateselectronic credentials issued by a certificate authorityto establish identity and trust. However, digital certificates alone are not enough to ensure the integrity of PKI solutions. Electronic credentials, such as passports,
credit cards, security badges and other physical credentials, can expire, be revoked or otherwise become invalid over time. Just like point-of-sale credit card authorizations, digital certificate status must be validated each and every time the
certificate is to be trusted. Organizations trust Tumbleweed Validation Authority suite, the leading identity validation solution, to protect the integrity of their PKI.

Tumbleweed Validation Authority is a proven solution that has been deployed by hundreds of
customers worldwide. Customers include the U.S. Department of Defense, all branches of the U.S. military, the Department of Homeland Security, United States Intelligence communities and major financial institutions globally. Tumbleweed Validation
Authority is Identrus and Joint Interoperability Technology Center certified.



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Tumbleweed Professional Services

The following are examples of the professional services we offer:



| |  |  | Support and maintenance: Assists customers in managing deployment and the use of our products.
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | Integration consulting: Helps customers integrate our solutions with existing technology infrastructure, including legacy systems, customer databases,
support systems, and billing systems.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Technical training: Provides customers with formal training in administration and operation of our products and deployment of our application programming
interfaces.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our products are typically deployed in business-critical environments in which highly responsive customer
support is critical to the continuing success of the deployed solution. We maintain a technical support group that is responsible for first-line and second-line customer support as well as distribution of product and documentation updates. This
group works closely with our professional services and engineering organizations in order to ensure continuity in the areas of problem resolution and priority response.

We also offer extended customer assistance 24 hours a day, 7 days a week, for those customers requiring around-the-clock support. Pricing for such support is in addition to standard maintenance fees. Professional
services are performed for an additional fee and are offered in conjunction with the licensing or deployment of our products.

Strategy

Our objective is to be a leading provider of managed file transfer, email security, and identity validation products for enterprises and government
organizations. Our strategy for growth is to:



| |  |  | Continue to build our channel or indirect distribution model, with the addition of leading national and regional partners, both in the United States and
internationally.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leverage our channel partnerships to grow adoption and penetration in mid-sized enterprises and new vertical industries.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | Expand internationally, particularly in Europe and parts of the Asia Pacific regions.
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Leverage and expand our core products of managed file transfer and email security to provide a broad platform of secure content delivery solutions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

Customers

We
provide our customers with managed file transfer, email security, and identity validation products. We are trusted by more than 3,200 enterprise and government customers who use our products to connect with over ten thousand
corporations and millions of end-users. While our market focus has been in the financial services, healthcare, and government markets, our products are sold across all industries. Our products are sold directly and through
channel partners to enterprises and governments.

The loss of one or more of our major customers, the failure to attract new customers
on a timely basis, or a reduction in usage and revenue associated with the existing or proposed customers would harm our business and prospects. For 2007, 2006, and 2005, five customers comprised in the aggregate approximately 9%, 27%, and 11%,
respectively, of our revenue. For the years ended December 31, 2007 and 2005, respectively, no single customer comprised 10% or more of our revenue. For the year ended December 31, 2006, one customer comprised 13% of our revenue.



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Backlog

Our backlog consists of deferred revenue as well as contractual commitments that are not due and payable as of the balance sheet date, or for which the product or service has not yet been delivered, and/or for which collectibility is not
considered probable. Our backlog excludes all items relating to consulting and training services. Backlog was $26.7 million and $26.0 million at December 31, 2007 and 2006, respectively. We believe that $20.2 million of the backlog at
December 31, 2007 will be recognized as revenue in the next 12 months in accordance with our revenue recognition policy, with the balance to be recognized thereafter.

Sales

Historically, we were primarily a direct sales organization that sold primarily to large
enterprises, particularly in heavily regulated industries like financial services, healthcare, and government. During 2007, we re-focused our efforts on building our reseller channel. This change in emphasis reflects our belief that there is a
growing opportunity for our products to be sold into small and medium-sized organizations. We believe that the best way to reach these potential customers is through reseller partners as they often have greater selling resources and customer
relationships in this market segment. Additionally, reseller partners are expected to broaden and deepen our vertical market base into such areas as retail, technology, and manufacturing. As such, we have focused our efforts on partnering with
national, regional, and vertically focused channel sales organizations, through our Tumbleweed Alliance Program and other means.

Our sales
team includes field sales executives, inside sales personnel and seasoned sales engineers that work in partnership with our channel partners as well as on direct sales. We currently have sales offices in Redwood City, California; McLean, Virginia;
New York, New York; Oakbrook Terrace, Illinois; Hurst, United Kingdom; Sofia, Bulgaria; Sydney, Australia; and Singapore.

Marketing

Our marketing strategy is to generate opportunities for sales transactions and to build awareness of Tumbleweed as a leading secure content delivery
solutions vendor. We raise awareness and increase Tumbleweed mindshare through targeted, integrated campaigns highlighting both our company and our product offerings. We use public relations and online marketing to build general awareness, as
well as targeted demand generation and channel enablement to fuel the pipeline of qualified sales opportunities. We utilize independent testing groups to demonstrate our competitive superiority in security effectiveness and ease of use of our
products. We run direct marketing campaigns and events with our channel partners to generate sales opportunities for both our direct sales force and our channel partners.

Our marketing efforts are organized around the following four areas:



| |  |  | Product Management translates customer and market requirements into product plans and works with our engineering team to deliver high quality products.
Product management also trains sales people on product information.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Product Marketing identifies target markets and customer opportunities, and develops the positioning, programs and materials to reach customers and support
sales activities.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Channel Marketing oversees channel enablement and demand generation programs in order to generate qualified sales opportunities for our sales force and
channel partners.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Corporate Marketing drives overall market awareness of Tumbleweed as a company and of our products through analyst and investor relations, media, events, and
speaking engagements. Corporate marketing is also responsible for branding, corporate identity, and our website.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Governmental Regulation

All of our products are subject to U.S. export control laws and applicable foreign government import, export and/or use requirements. Minimal U.S. export restrictions apply to all products, whether or not they perform
encryption functions. The violation of U.S. export control laws can result in the imposition of civil and criminal penalties and the denial of export privileges.

The Export Administration Regulations of the U.S. Department of Commerce regulate the export of most commercial products with encryption features. Under the Export Administration Regulations, except for exports
involving embargoed countries and specific prohibited end-users, most encryption products may be exported, after a one-time technical review and classification, to non-governmental end-users around the world and to governmental end-users in certain
favored countries. In a limited number of circumstances, such as exports to governmental end-users outside of favored countries, the prior technical review and classification is not sufficient to provide export authority. In these cases, encryption
products may be exported under special Encryption Licensing Arrangements or individual export licenses that may be issued at the discretion of the Department of Commerce. We believe that we have completed the necessary technical reviews of the
products and services we currently export, but new products that we acquire or develop may require technical review before we can export them. For the export of some of our products, we are subject to various post-shipment reporting requirements.

After inter-agency review, the Department of Commerce has liberalized the Export Administration Regulations numerous times over the past
decade, including actions to relax certain reporting requirements, to remove the export licensing requirement for shipments to governmental end-users in 30 countries, including most of the United States major trading partners, and to remove
the license requirement and prior review and classification requirement in limited circumstances. Liberalization of export regulations allows our products to be exported more quickly, at lower cost, and with more strength and, therefore, to be more
competitive with products from foreign producers. However, export regulations may be modified at any time. As the U.S. government continues to examine its national security and foreign policy goals, particularly in relationship to its anti-terrorism
efforts, there continues to be some risk that export regulations could become more restrictive in the future. Modifications to the encryption rules in the export regulations could reduce or eliminate our ability to export some or all of our products
from the U.S. without a license in the future, which could put us at a disadvantage in competing for international sales compared to companies located outside of the U.S. that would not be subject to these restrictions.

Intellectual Property

We own 28 U.S. patents issued
by the U.S. Patent and Trademark Office including 27 utility patents and one design patent. We have filed additional utility patent applications that are now pending in the U.S. Patent and Trademark Office, and also have numerous patent applications
now pending in foreign jurisdictions. In addition, we currently have registered trademarks in the U.S. and internationally, including the mark Tumbleweed, and pursue other key trademarks and service marks from time to time.

Competition

The markets for our products are
intensely competitive and rapidly changing. We believe there is no single competitor that offers the complete array of security products that we sell. We are aware of competitors that exist for each of our product lines and for some combined
components of our solution sets.



| |  |  | Principal competition for SecureTransport: File transfer software and service providers such as Axway, Inc., Sterling Commerce, Inc. (a unit of AT&T
Corp.), and GlobalSCAPE, Inc.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Principal competition for Secure Messenger: Companies offering email encryption products, such as Cisco Systems, Inc. (PostX and IronPort Systems), Voltage
Security, Inc., PGP Corp., and Zix Corp.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Principal competition for MailGate: Companies offering various email content filtering, anti-spam, and antivirus products, such as Cisco Systems, Inc.
(IronPort Systems), Clearswift Limited, Google, Inc. (Postini, Inc.), Proofpoint, Inc., and Secure Computing Corp.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Principal competition for Validation Authority: Identity validation software providers such as Alacris, Inc., CoreStreet Ltd., and SyTrust Technologies GmbH.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

In addition to the competitors listed above, companies against which we do not presently directly compete may become
competitors in the future, either through the expansion of our products or through their own product development in the area of secure online communication services.

Employees

As of December 31, 2007, we employed 332 people worldwide, including 144 in
engineering, 74 in sales, 69 in professional services, 8 in marketing, and 37 combined in corporate management, finance, human resources, information technology, legal, and other administration. Our employees are not represented by any collective
bargaining organization. We have never experienced a work stoppage and consider our relations with our employees to be good.

Our Executive Officers

Listed below are our executive officers as of March 17, 2008. There are no family relationships between any of the executive
officers and there is no arrangement or understanding between any executive officer and any other person pursuant to which the executive officer was selected. At the annual meeting of our Board of Directors, which follows the annual meeting of
stockholders, executive officers are appointed by the Board to hold office until their resignation or removal.



|                     |  |                                                                |  |    
|-------------------- |  | -------------------------------------------------------------- |  | ---
|Name                 |  | Title                                                          |  | Age
|James P. Scullion    |  | Chairman of the Board of Directors and Chief Executive Officer |  | 51 
|Timothy G. Conley    |  | Senior Vice President of Finance and Chief Financial Officer   |  | 59 
|Dr. Taher A. Elgamal |  | Director and Chief Technology Officer                          |  | 52 
|Nicholas W. Hulse    |  | Executive Vice President of Worldwide Field Operations         |  | 42 
|Bernard J. Cassidy   |  | Senior Vice President and General Counsel                      |  | 53 
|Jorge E. Rodriguez   |  | Senior Vice President of Product Development                   |  | 42 

James P. Scullion, Chairman of the Board of Directors and Chief Executive Officer, is
responsible for our vision, strategy and overseeing our operations. Before being appointed as Chairman and Chief Executive Officer of Tumbleweed in January 2006, Mr. Scullion served as President and Chief Executive Officer of ComnetiX, Inc.
from April 2004 to January 2006. Prior to ComnetiX, Mr. Scullion held several leadership positions at Identix, Inc., where he served as President and Chief Operating Officer from April 1999 to June 2002, Executive Vice President from 1996 to
April 1999, and Chief Financial Officer from 1990 to April 2001. Mr. Scullion has served on the Board of Directors of Tumbleweed since April 2003 and was Chairman of Tumbleweeds Audit Committee from April 2003 to January 2006.
Mr. Scullion also was a member of the Board of Directors of ComnetiX, Inc., a position he has held from January 2004 to February 2007. Mr. Scullion holds a B.S. in Accounting from San Jose State University.

Timothy G. Conley, Senior Vice President of Finance and Chief Financial Officer, is responsible for finance and administration. Prior to joining
Tumbleweed in July 2003, Mr. Conley served as Vice President, Finance and Chief Financial Officer for Valicert, Inc. (Valicert) from January 2000 to June 2003 when it was acquired by Tumbleweed. Prior to joining Valicert,
Mr. Conley was Vice President of Finance and Chief Financial Officer of Longboard, Inc. from September 1998 to January 2000. Prior to joining Longboard, Mr. Conley served as Vice President of Finance and Chief Financial Officer of
Logicvision, from June 1997 to August 1998. Previously, Mr. Conley was Vice President of Finance and Chief Financial Officer of Verilink Corporation from November 1989 to May 1997. Mr. Conley holds a B.S. in Business Administration from
Wisconsin State University.



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Dr. Taher A. Elgamal,Director and Chief Technology Officer, is responsible for technical
direction and for driving innovative research and development initiatives for Tumbleweed. Prior to joining Tumbleweed in October 2006, Dr. Elgamal served as Chairman and Chief Executive Officer of Ektasis, Inc. from April 2005 to September
2006. Prior to joining Ektasis, Inc., Dr. Elgamal was a founder, Chairman and Chief Technology Officer of Securify, Inc. from June 1998 to March 2005. Prior to founding Securify, Inc., Dr. Elgamal served as the Chief Scientist at Netscape,
Inc. from April 1995 to June 1998. Dr. Elgamal has served on the Board of Directors of Tumbleweed since April 2003, and has also served on the Board of Directors of Phoenix Technology, RSA Security, and Valicert. Dr. Elgamal holds a Ph.D.
and M.S. in Computer Science from Stanford University and a B.S. in Electrical Engineering from Cairo University.

Nicholas W.
Hulse, Executive Vice President of Worldwide Field Operations, is responsible for overseeing sales, channel development, and professional services. Prior to joining Tumbleweed in March 2007, Mr. Hulse was Senior Vice President of Sales,
Marketing, and Channel Development at FrontBridge Technologies, Inc. from January 2005 to August 2006, prior to which Mr. Hulse was Vice President Global Alliances at FrontBridge Technologies, Inc. from March 2003 to January 2005. Prior to
joining FrontBridge Technologies, Inc., Mr. Hulse was General Manager/Senior Vice President at Cybertek Holdings/Secos, Inc. from May 2001 to December 2002. Prior to joining Cybertek Holdings/Secos, Inc., Mr. Hulse was a Vice President of
Marketing, Product, and Channel Sales at Epoch Internet from January 2000 to May 2001. Prior to joining Epoch Internet, Mr. Hulse was Vice President of Marketing and Business Development at Aris Corporation from April 1997 to September 1999.
Mr. Hulse holds a H.N.D. in Marketing and Finance and O.N.D. in Business Administration from Northumberland University, Newcastle-Upon-Tyne, United Kingdom.

Bernard J. Cassidy, Senior Vice President and General Counsel, is responsible for legal, corporate development, and human resources matters. Before joining Tumbleweed in May 1999, Mr. Cassidy was in
private practice at Wilson Sonsini Goodrich & Rosati from August 1992 to May 1999, and at Skadden, Arps, Slate Meagher & Flom LLP from September 1989 to July 1992. Mr. Cassidy holds a B.A. in Philosophy
from Loyola University, an M.A. in Philosophy from the University of Toronto and a J.D. from Harvard Law School.

Jorge E.
Rodriguez, Senior Vice President of Product Development, is responsible for overseeing day-to-day engineering operations while playing a hands-on role in delivering on our product vision and roadmap. Prior to joining Tumbleweed in December 2007,
Mr. Rodriguez was Vice President of Engineering at Borland Software Corporation from April 2005 to July 2007, prior to which Mr. Rodriguez was Senior Director of Engineering at Borland Software Corporation from May 2002 to April 2005.
Prior to joining Borland Software Corporation, Mr. Rodriguez was Vice President of Research and Development at Highlander Engineering, Inc. from February 1997 to May 2002. Prior to joining Highlander Engineering, Inc., Mr. Rodriguez was
Senior Systems Engineer at Nortel Networks Corporation from July 1993 to January 1997. Mr. Rodriguez holds a B.S. in Computer Science from University of South Florida.

Available Information

Our Internet address is www.tumbleweed.com. Information contained on our
website is not part of this annual report on Form 10-K or any other report filed with or furnished to the Securities and Exchange Commission (SEC). We make available free of charge on www.tumbleweed.com our annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC. Statements of changes in beneficial ownership of our securities by our executive officers and directors are made available on our web site by the end of the business day following the submission of such
filings to the SEC.

The public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 450 Fifth
Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-732-0330. The SEC maintains an Internet site (http://www.sec.gov)that contains reports, proxy and
information statements, and other information regarding us.



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In addition, a copy of these filings, excluding exhibits, may be requested at no cost by writing or
telephoning the following address or telephone number:

Tumbleweed Communications Corp.

700 Saginaw Drive, Redwood City, CA 94063

Attention: Investor Relations

Telephone: (650) 216-2000

Item 1ARisk Factors

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

We have a history of losses and may experience losses in the future. Our prospects must be considered in light of the risks, expenses, delays and
difficulties frequently encountered by companies engaged in rapidly evolving technology markets like ours. We incurred net losses of $10.8 million, $4.9 million, and $3.9 million in 2007, 2006, and 2005, respectively. As of December 31, 2007,
we had incurred cumulative net losses of $306.7 million.

Our success may depend in large part upon the adoption and use of our products
and technology, as well as our ability to effectively maintain existing relationships and develop new relationships with customers, both in new vertical markets and new segments, and via direct sales, channel sales partners, and strategic partners.
In particular, we intend to expend significant financial and management resources on product development, sales and marketing, strategic relationships, technology, and operating infrastructure. As a result, we may incur additional losses and
continued negative cash flow from operations for the foreseeable future and may not achieve or maintain profitability.

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

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

As a result of these factors, we believe that quarter-to-quarter comparisons of
our revenue and operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. Because our staffing and operating expenses are based on anticipated revenue levels, and because a
high percentage of our costs are fixed, small variations in the timing of the recognition of specific revenue could cause significant variations in our operating results from quarter to quarter. In addition, many of our customers delay purchases of
our products until the end of each quarter. If we are unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, any significant revenue shortfall would likely have an immediate negative effect on our operating
results. Moreover, we believe the challenges and difficulties that we face, as outlined above with respect to financial forecasts, also apply to securities analysts that may publish estimates of our financial results. Our operating results in the
past have, and in future quarters may, fail to meet our expectations or those of securities analysts or our investors due to any of a wide variety of factors, including fluctuations in our performance as measured by any of a variety of metrics
employed by such persons. If this occurs, we would expect to experience an immediate and significant decline in the trading price of our stock.



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

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

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

We may have difficulty in executing our business operations.

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



| |  |  | maintaining a strong balance sheet and positive or neutral cash flow;
| | - |  | ---------------------------------------------------------------------



| |  |  | retaining and hiring, as required, the appropriate number of qualified employees, in both domestic and international offices;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



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



| |  |  | growing our international sales;
| | - |  | --------------------------------



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



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



| |  |  | training our sales force and channel partners, particularly its newer members, to sell more products and services;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | developing products with strong market appeal;
| | - |  | ----------------------------------------------



| |  |  | transitioning from our historical waterfall engineering practices to an agile product development model;
| | - |  | ------------------------------------------------------------------------------------------------------------



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



| |  |  | controlling expenses, particularly sales, product development, and general and administrative expenses;
| | - |  | -------------------------------------------------------------------------------------------------------



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



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

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



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

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

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

Our objective is to leverage and expand our core products of managed file transfer and email security to be a leading provider of a broad platform of
secure content delivery solutions. We believe there is substantial growth opportunity in the emerging secure content delivery market, which combines both secured email exchanges and managed file transfers. We have developed a strategic and operating
plan based on what we believe to be critical success factors for growing our business in secure content delivery solutions. The plan includes four key initiatives: continuing to build our channel or indirect distribution model, leveraging our
channel partnerships to address mid-sized enterprises and new vertical industries, expanding our international sales, and focusing on our core secure email and managed file transfer products. If the strategy we have elected to pursue turns out to be
ineffective, it could significantly limit our ability to compete successfully against current and future competitors and otherwise negatively impact our business.

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

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

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

The markets in which we compete are intensely competitive and rapidly changing, through
consolidation and otherwise. In particular, the inbound email security market has been exhibiting significant pricing pressures. Vendors in our markets use different methods of marketing and distribution in order to meet expected customer demand.
For example, our competitors include multiple software-only vendors, appliance-only vendors, and service providers, as well as vendors that offer a combination of some or all of the foregoing. Moreover, our competitors offerings range from
single-function point products and services to more sophisticated and scalable multi-functional offerings. In addition, pricing and other terms and conditions of sales contracts also vary considerably among our competition. Because it is difficult
to predict demand in our rapidly changing markets, we may not be able to manage our product development, marketing, and sales efforts in an optimal way, which may disadvantage our business in comparison to competitors.

Competitors may develop new technologies or products in advance of us or establish business models or technologies disruptive to us. Our business may be
materially adversely affected by the announcement or introduction of new products, including hardware and software products and services by our competitors, and the implementation of effective marketing or sales strategies by our competitors. We may
experience product



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performance challenges that create negative publicity or otherwise inhibit our ability to maintain or increase our sales, which may also adversely affect our
business. The material adverse effect to our business in any of the foregoing scenarios could include a decrease in demand for our products and services and an increase in the length of our sales cycle due to customers taking longer to compare
products and services and to complete their purchases.

Competitive factors in our industry include customer-driven requirements such as
high quality, additional functionality, improved product performance, ease of use, integration capacity, platform coverage, and the quality of each vendors global technical support. Some of our competitors have greater financial, technical,
sales, marketing and other resources than we do, as well as greater name recognition and a larger installed customer base. Additionally, some of these competitors have research and development capabilities that may allow them to develop new or
improved products that may compete with product lines we market and distribute. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could harm our business.

We expect that the market for messaging security products and especially inbound email security products will continue to become more consolidated with
larger companies being better positioned to compete in such an environment in the long term. As this market has continued to develop, a number of companies with greater resources than ours have increased their presence in this market and others
could attempt to increase their presence in this market by acquiring or forming strategic alliances with our competitors or business partners.

Our success will depend on our ability to adapt our strategy to these competing forces, to develop and successfully launch more effective products more rapidly and less expensively than our competitors, and to educate potential customers as
to the benefits of licensing our products rather than developing their own products or licensing our competitors products. In particular our product development team is transitioning to an agile software development process, a transition that
may cause delays, attrition, and near-term inefficiencies with respect to product development.

In particular, our success depends on our
ability to grow and develop our indirect distribution channels, both in the United States and internationally, and the inability to do so could adversely affect future operating results. We must continue to increase the number of strategic and other
third-party relationships with vendors of Internet-related systems and application software, resellers and systems integrators. Our existing or future channel partners may choose to devote greater resources to marketing and supporting the products
of other companies, which could have a negative impact on our company.

In addition, our success depends in part on our ability to sell our
appliance-based products. In comparison to several of our leading competitors, we have less experience in managing the product development, marketing, and sales of appliance-based products. Historically most of our revenue has been derived from
software-based products, not appliance-based products, and our business could be harmed if we do not successfully execute our plans with respect to our appliance-based products.

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

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



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

Risks inherent in the
transition to new products include:



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



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



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



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

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

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

Because we
focus on selling enterprise-wide software products to enterprises and government entities, the process of contractual negotiation is critical and may be lengthy. Additionally, many factors may require us to defer recognition of license revenue for a
significant period of time after entering into a license agreement.

Many customers negotiate software licenses near the end of each
quarter. In part, this is because customers are able, or believe that they are able, to negotiate lower prices and more favorable terms at that time. Our reliance on a large portion of software license revenue occurring at the end of the quarter and
the increase in the dollar value of transactions that occur at the end of a quarter can result in increased uncertainty relating to quarterly revenues. Due to end of period variances, forecasts may not be achieved, either because expected sales do
not occur or because they occur at lower prices or on terms that are less favorable to us.

A limited number of customers and vertical markets have
accounted for a high percentage of our revenue, and either the failure to maintain or expand these customer relationships or the failure to penetrate new vertical markets could adversely affect our future revenue.

The loss of one or more of our major customers, the failure to attract new customers on a timely basis, or a reduction in revenue associated with existing
or proposed customers would harm our future revenue and prospects. For 2007 and 2005, respectively, no single customer comprised 10% or more of Tumbleweed revenue. For 2006, one customer comprised 13% of our revenue. For 2007, 2006, and 2005, five
customers comprised in the aggregate approximately 9%, 27%, and 11%, respectively, of our revenue.

In addition, a significant amount of
our past business has been in three vertical markets: financial services, healthcare, and government. This concentration, especially with respect to the financial services market, which has constituted approximately 30% of our business, poses risks,
particularly the risk that adverse conditions within the vertical market could result in reduced information technology spending in that vertical, which in turn could adversely impact our operating results.



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

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



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



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



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



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



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



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



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

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

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

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

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

We currently rely on a combination of patents, trade secrets, copyrights,
trademarks and licenses, together with non-disclosure and confidentiality agreements, to establish and protect our proprietary rights in our products. We hold certain patent rights with respect to some of our products. Our existing patents or
trademarks, as well as any future patents or trademarks obtained by us, may be challenged, invalidated or circumvented, or our competitors may independently develop or patent technologies that are substantially equivalent or superior to our
technology. We also rely on unpatented trade secrets and other unpatented proprietary information. Although we take precautionary measures to maintain our unpatented proprietary information, others may acquire equivalent information or otherwise
gain access to or disclose our proprietary information, and we may be unable to meaningfully protect our rights to our proprietary information. As a result, our operating results could suffer.

Third parties could assert patent or other intellectual property infringement claims against us and the cost of responding to such assertions, regardless
of their validity, could be significant. We may increasingly be subject to claims of intellectual property infringement as the number of our competitors grows and the functionality of their products and services increasingly overlap with ours. In
addition, we may infringe upon patents that may be issued to third parties in the future. It may be time consuming and costly to defend ourselves against any of these



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claims and we may not prevail. Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief that could block our
ability to further develop or commercialize some or all of our products in the United States and abroad. In the event of a claim of infringement, we may be required to obtain one or more licenses from or pay royalties to third parties. We may be
unable to obtain any such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain such license could harm our business.

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

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

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

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

Our
international business exposes us to additional risks that may result in future additional costs or limit the market for product sales.

Products and services provided to our international customers accounted for 12%, 7%, and 10% of our revenues for 2007, 2006, and 2005, respectively. Conducting business outside of the United States subjects us to additional risks,
including:



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



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



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



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



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



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

Managing these risks may subject us to additional costs that may not be justified in light of the market opportunity, and the inability to comply with or manage foreign laws and related risks may preclude or limit
sales in foreign jurisdictions.



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Fluctuations in foreign currency exchange rates could affect our financial results.

We earn revenues, pay expenses, acquire assets and incur liabilities in countries using currencies other than the U.S. dollar. Because
our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses as well as assets and liabilities into U.S. dollars at exchange rates in effect during or at the end of each reporting period.
Therefore, increases or decreases in the value of the U.S. dollar against other currencies affect our revenues, net income or loss, and the value of balance sheet items denominated in foreign currencies. We do not use derivative financial
instruments to reduce our net exposure to currency exchange rate fluctuations, and we cannot provide assurance that fluctuations in foreign currency exchange rates would not materially affect our financial results. We have evaluated the use of such
instruments in the past and will continue to do so in the future.

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

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

Our
stock price could be adversely affected if we are unable to continue to favorably assess the effectiveness of our internal control over financial reporting.

In the future, we may encounter problems or delays in completing the implementation of any changes necessary to make a favorable assessment of our internal controls over financial reporting. If we cannot favorably
assess the effectiveness of our internal controls over financial reporting, investor confidence and our stock price could be adversely affected.

If our
goodwill or intangible assets become impaired we may be required to record a significant charge to earnings.

We assess the impairment
of intangible assets and goodwill whenever events or changes in circumstances indicate the carrying value of those assets may not be recoverable, and also test goodwill for impairment at least annually. Factors that may be considered a change in
circumstances indicating that the carrying value of our goodwill or intangible assets may not be recoverable include a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry.
We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or intangible assets is determined, negatively impacting our results of operations.

A principal stockholder of the Company could disrupt operations or increase our operating costs if it seeks influence or control of the Company in a manner that is
not supported by our Board of Directors.

A principal stockholder of the Company, Empire Capital Partners and its affiliates, has
announced it is considering alternative courses of action to maximize its investment in the Company. This action may include seeking representation of the Board of Directors, making recommendations to management concerning business strategies,
strategic partnerships, dividend policies and other matters, or seeking to acquire control of the Company through a merger, proxy solicitation, tender offer, exchange offer, or otherwise. Although members of



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our management and our board of directors have met and may continue to meet with representatives of Empire with a view to soliciting and when appropriate
incorporating their views, the Company may be unwilling or unable to satisfy Empires expectations. If Empire were to initiate a proxy solicitation to elect its own slate of directors or to seek to acquire control of the Company in a manner
that is opposed by the Board of Directors, the Company would be required to aggressively respond, which could disrupt operations and have a material adverse effect on operating results. According to their public filings, Empire Capital Partners and
its affiliates beneficially own 6,613,984 shares of common stock, or 12.9% of the Companys outstanding shares.

Item 1BUnresolved Staff Comments

None.

Item 2Properties

We have an operating lease covering approximately 40,000 square feet of office
space in Redwood City, California. The lease expires in July 2008 with current monthly rent payments of approximately $88,000. We are in the process of determining whether to renew this lease or relocate to a new leased office facility.

We also maintain sales offices in Hurst, United Kingdom; McLean, Virginia; New York, New York; Oakbrook Terrace, Illinois; and Sydney, Australia; all
of which with a lease term expiring in 2008, and Singapore with a lease term expiring in 2009. Other offices we maintain include Pfaffikon, Switzerland, and Sofia, Bulgaria. The Pfaffikon lease has a lease term expiring in 2008. The Sofia lease has
a lease term expiring in 2012.

Other than our office space in Redwood City, California, and Sofia, Bulgaria, none of our offices
individually exceed 12,000 square feet in size. We are currently utilizing all of our leased facility space. We believe our current facilities, or available replacement space, will be adequate to meet our needs for the foreseeable future.

Item 3Legal Proceedings

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



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

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

In
April 2007, the Court of Appeals Circuit denied plaintiffs petition for rehearing, but clarified that the plaintiffs may seek to certify a more limited class in the District Court. Accordingly, the stay remains in place and the plaintiffs
and issuers have stated that they are prepared to discuss how the settlement might be amended or renegotiated to comply with the ruling of the Court of Appeals.

Failure of the District Court to approve the settlement (or an amended or renegotiated settlement) followed by an adverse outcome could harm our business and operating results. Moreover, the costs in
defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve for any potential loss, as we do not consider a loss to be probable at this time.

All costs incurred as a result of this legal proceeding are charged to expense as incurred. We indemnify our customers from third party claims of
intellectual property infringement relating to the use of our products. Historically, costs related to these guarantees have not been significant and we are unable to estimate the potential impact of these guarantees on our future results of
operations.

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

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

No matters were submitted to a vote of our
shareholders during the fourth quarter of 2007.



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PART II

Item 5Market for Registrants Common Equity and Related Stockholder Matters and Issuer Purchase of Equity Securities

Our common stock is listed and quoted on the Nasdaq National Market under the symbol TMWD. The following table sets forth, for the calendar quarters indicated, the high and low trading prices per share for
our common stock, as reported on the Nasdaq National Market.



|                                 |  |                              |      |     |   |     
|-------------------------------- |  | ---------------------------- | ---- | --- | - | ----
|                                 |  | TumbleweedCommon StockPrices
|                                 |  | High                         |      | Low
|2007 Year                        |  |                              |      |     |   |     
|First Quarter Ended March 31     |  | $                            | 3.58 |     | $ | 2.66
|Second Quarter Ended June 30     |  | $                            | 3.12 |     | $ | 2.50
|Third Quarter Ended September 30 |  | $                            | 2.60 |     | $ | 1.83
|Fourth Quarter December 31       |  | $                            | 2.16 |     | $ | 1.23
|2006 Year                        |  |                              |      |     |   |     
|First Quarter Ended March 31     |  | $                            | 3.08 |     | $ | 2.44
|Second Quarter Ended June 30     |  | $                            | 3.28 |     | $ | 2.70
|Third Quarter Ended September 30 |  | $                            | 2.97 |     | $ | 2.67
|Fourth Quarter December 31       |  | $                            | 2.88 |     | $ | 2.46

As of February 15, 2008, there were approximately 892 holders of record of our common stock.
This does not include the number of persons whose stock is in nominee or street name accounts held through brokers.

Tumbleweed Dividend
Policy

We have not declared or paid any cash dividends on our common stock during any period for which financial information is
provided in this report. We currently intend to retain future earnings, if any, to fund the development and growth of our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Tumbleweed Equity Compensation Plan Information

The
following table sets forth, as of December 31, 2007, our outstanding warrants and the number of stock options outstanding under our stock option plans, the weighted-average exercise price of the stock options and warrants, and the number of
stock options available for grant under our plans.



|                                                             |  |                                                                                            |  |                                                                          |      |                                                                                                                                      |          
|------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------ | ---- | ------------------------------------------------------------------------------------------------------------------------------------ | ---------
|Plan Category                                                |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and
rights(a) |  | Weighted-averageexercise price ofoutstanding options,warrants and rights |      | Number of securitiesremaining availablefor futureissuance under equitycompensation plans(excluding
securitiesreflectedin column (a))
|Stock option plans approved by stockholders                  |  | 10,592,761                                                                                 |  | $                                                                        | 3.12 |                                                                                                                                      | 3,147,570
|Warrants and stock option plans not approved by stockholders |  | 4,399,935                                                                                  |  | $                                                                        | 3.49 |                                                                                                                                      | 6,672,540
|                                                             |  |                                                                                            |  |                                                                          |      |                                                                                                                                      |          
|Total                                                        |  | 14,992,696                                                                                 |  | $                                                                        | 3.23 |                                                                                                                                      | 9,820,110
|                                                             |  |                                                                                            |  |                                                                          |      |                                                                                                                                      |          

The Valicert 1998 Stock Option Plan provides for an automatic annual increase, without the
approval of stockholders, in the number of stock options available for grant of the lesser of 1,413,913 shares or 5% of the number of our shares that are issued and outstanding on the last day of the immediately preceding fiscal year.



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##### Table of Contents

The 1999 Omnibus Stock Incentive Plan provides for an automatic annual increase, without the approval of
stockholders, in the number of stock options available for grant of the lesser of 2,000,000 shares or 5% of the number of our outstanding shares on the last day of the immediately preceding fiscal year.

The following table summarizes information about stock options outstanding as of December 31, 2007:



|                        |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      
|----------------------- |  | ------------------- |  | ---------------------------- | ----- | --------------------------------------- | --- | ----------------- | --------- | ---------------------------- | - | -----
|                        |  | Options Outstanding |  | Options Exercisable         
|Range ofExercise Prices |  | NumberOutstanding   |  | WeightedAverageExercisePrice |       | AverageRemainingContractualLife (Years) |     | NumberExercisable |           | WeightedAverageExercisePrice
|$0.00$0.99             |  | 704,624             |  | $                            | 0.91  |                                         | 4.7 |                   | 704,624   |                              | $ | 0.91 
|1.002.52               |  | 2,715,626           |  |                              | 2.03  |                                         | 8.4 |                   | 1,025,339 |                              |   | 2.06 
|2.532.99               |  | 6,336,491           |  |                              | 2.73  |                                         | 7.8 |                   | 4,087,185 |                              |   | 2.71 
|3.004.59               |  | 3,938,019           |  |                              | 3.32  |                                         | 6.8 |                   | 2,179,928 |                              |   | 3.39 
|4.805.99               |  | 668,434             |  |                              | 4.83  |                                         | 6.3 |                   | 668,434   |                              |   | 4.83 
|6.009.99               |  | 215,390             |  |                              | 6.84  |                                         | 5.4 |                   | 215,390   |                              |   | 6.84 
|10.0017.99             |  | 208,780             |  |                              | 13.83 |                                         | 2.1 |                   | 208,780   |                              |   | 13.83
|20.00118.99            |  | 136,317             |  |                              | 27.47 |                                         | 2.4 |                   | 136,317   |                              |   | 27.47
|                        |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      
|$0.05$118.44           |  | 14,923,681          |  | $                            | 3.21  |                                         | 7.3 |                   | 9,225,997 |                              | $ | 3.53 
|                        |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      

In conjunction with various financing arrangements and employment recruitment services provided to
us in 1998, 1999, and 2001, we issued warrants to purchase an aggregate of approximately 583,113 shares of common stock. Additional warrants to purchase an aggregate of 289,789 shares of common stock were assumed in 2003 as a result of the merger
with Valicert, none of which remained outstanding at December 31, 2007. As of December 31, 2007 and 2006, respectively, there were 69,015 and 72,845 warrants outstanding to purchase our common stock. Of the warrants that remain outstanding
at December 31, 2007, 21,129 expire in April 2008 with an exercise price of $4.91; 10,266 expire in April 2008 with an exercise price of $5.84; 2,566 expire in February 2010 with an exercise price of $49.09; 1,283 expire in April 2010 with an
exercise price of $49.09; and the remaining 33,771 expire in June 2011 with an exercise price of $6.66. During 2007 and 2006 no warrants were exercised.



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Cumulative Total Return Graph

The following Corporate Performance Graph and related information shall not be deemed soliciting material or to be filed with the SEC, nor shall such information be incorporated by reference
into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing. The following graph compares the cumulative five-year total stockholder return on our common
stock with the total cumulative returns of the NASDAQ Composite Index and the Standard & Poors Internet Software & Services Index for the period beginning on December 31, 2002 through December 31, 2007. Total
cumulative stockholder return assumes $100 invested at the beginning of the period in our common stock and each index (including reinvestment of dividends), respectively, and tracks the return on the investment through December 31, 2007.

LOGO

Item 6Selected Financial Data

Our 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 consolidated financial statements and notes to the consolidated financial statements included elsewhere in this
report. The selected consolidated statements of operations data for the years ended December 31, 2007, 2006 and 2005 and the selected consolidated balance sheet data as of December 31, 2007 and 2006 are derived from our audited
consolidated financial statements contained elsewhere in this report. The consolidated statements of operations data for the years ended December 31, 2004 and 2003 and the consolidated balance sheet data as of December 31, 2005, 2004, and
2003 are derived from our audited consolidated financial statements not included or incorporated by reference in this report.



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Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of
Financial Accounting Standards (SFAS) 123 (revised 2004), Share-Based Payment (SFAS 123R), using the modified prospective transition method and therefore have not restated results for prior periods.



|                                                                |  |                                       |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|--------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                |  | Year Ended December 31,               |        
|                                                                |  | 2007                                  |         |   | 2006 |   |        | 2005 |  |   | 2004   |   |  | 2003 |       
|                                                                |  | (in thousands, except per share data) |        
|Consolidated Statements of Operations Data:                     |  |                                       |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Revenue                                                         |  | $                                     | 57,455  |   |      | $ | 61,994 |      |  | $ | 50,001 |   |  | $    | 43,438 |   |  | $ | 30,595 |  
|Gross profit(1)                                                 |  |                                       | 42,989  |   |      |   | 48,528 |      |  |   | 39,634 |   |  |      | 35,477 |   |  |   | 24,924 |  
|Operating expenses                                              |  |                                       | 55,074  |   |      |   | 54,501 |      |  |   | 44,502 |   |  |      | 43,171 |   |  |   | 34,834 |  
|Operating loss(2)                                               |  |                                       | (12,085 | ) |      |   | (5,973 | )    |  |   | (4,868 | ) |  |      | (7,694 | ) |  |   | (9,910 | )
|Net loss                                                        |  |                                       | (10,765 | ) |      |   | (4,882 | )    |  |   | (3,909 | ) |  |      | (7,497 | ) |  |   | (9,187 | )
|Net loss per sharebasic and diluted                            |  | $                                     | (0.21   | ) |      | $ | (0.10  | )    |  | $ | (0.08  | ) |  | $    | (0.16  | ) |  | $ | (0.26  | )
|Shares used in calculating basic and diluted net loss per share |  |                                       | 51,028  |   |      |   | 50,007 |      |  |   | 48,627 |   |  |      | 46,777 |   |  |   | 36,007 |  
|                                                                | 
|                                                                |  | December 31,                          |        
|                                                                |  | 2007                                  |         |   | 2006 |   |        | 2005 |  |   | 2004   |   |  | 2003 |       
|                                                                |  | (in thousands, except per share data) |        
|Consolidated Balance Sheet Data:                                |  |                                       |         |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Cash and cash equivalents                                       |  | $                                     | 26,299  |   |      | $ | 30,511 |      |  | $ | 26,952 |   |  | $    | 21,435 |   |  | $ | 25,351 |  
|Total assets                                                    |  |                                       | 91,836  |   |      |   | 96,931 |      |  |   | 91,104 |   |  |      | 87,716 |   |  |   | 56,346 |  
|Long-term debt, excluding current installments                  |  |                                       |        |   |      |   |       |      |  |   |       |   |  |      | 200    |   |  |   | 467    |  
|Total stockholders equity                                      |  | $                                     | 57,811  |   |      | $ | 62,710 |      |  | $ | 61,217 |   |  | $    | 62,404 |   |  | $ | 32,595 |  



|(1) | Includes stock-based compensation expense of $142,000, $151,000, $2,000, $12,000, and $27,000, for the years ended December 31, 2007, 2006, 2005, 2004, and 2003, respectively.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes stock-based compensation expense of $4.4 million, $4.5 million, $508,000, $628,000, and $139,000, for the years ended December 31, 2007, 2006, 2005, 2004, and 2003,
respectively.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

The tables below present unaudited selected quarterly financial data. All necessary adjustments have been
included in the amounts stated below to present fairly the results of such periods when read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included elsewhere in this report.



|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------ | - | ------ | ------- |  | - | -------- | - |  | - | ------ | -
|                                                            |  | Quarters Ended                        |       
|                                                            |  | December 31                           |        |   | September 30 |   |        | June 30 |  |   | March 31 |  
|                                                            |  | (in thousands, except per share data) |       
|Fiscal 2007                                                 |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Revenue:                                                    |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Product revenue                                             |  | $                                     | 5,957  |   |              | $ | 5,554  |         |  | $ | 5,121    |   |  | $ | 5,897  |  
|Service revenue                                             |  |                                       | 8,259  |   |              |   | 8,305  |         |  |   | 7,973    |   |  |   | 9,022  |  
|Intellectual property revenue                               |  |                                       | 44     |   |              |   | 191    |         |  |   | 1,036    |   |  |   | 96     |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total revenue                                               |  |                                       | 14,260 |   |              |   | 14,050 |         |  |   | 14,130   |   |  |   | 15,015 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of revenue:                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of product revenue                                     |  |                                       | 1,473  |   |              |   | 1,158  |         |  |   | 1,307    |   |  |   | 1,756  |  
|Provision for excess inventory                              |  |                                       |       |   |              |   |       |         |  |   |         |   |  |   | 164    |  
|Cost of service revenue(1)                                  |  |                                       | 1,953  |   |              |   | 1,890  |         |  |   | 1,929    |   |  |   | 1,899  |  
|Amortization of intangible assets                           |  |                                       | 234    |   |              |   | 234    |         |  |   | 234      |   |  |   | 234    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total cost of revenue                                       |  |                                       | 3,660  |   |              |   | 3,282  |         |  |   | 3,470    |   |  |   | 4,053  |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Gross profit                                                |  |                                       | 10,600 |   |              |   | 10,768 |         |  |   | 10,660   |   |  |   | 10,962 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Operating expenses:                                         |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Research and development(1)                                 |  |                                       | 3,537  |   |              |   | 3,816  |         |  |   | 3,859    |   |  |   | 3,896  |  
|Sales and marketing(1)                                      |  |                                       | 6,842  |   |              |   | 7,806  |         |  |   | 7,311    |   |  |   | 6,617  |  
|General and administrative(1)                               |  |                                       | 2,608  |   |              |   | 2,545  |         |  |   | 2,516    |   |  |   | 2,487  |  
|Amortization of intangible assets                           |  |                                       | 39     |   |              |   | 39     |         |  |   | 44       |   |  |   | 183    |  
|Restructuring costs                                         |  |                                       | 930    |   |              |   |       |         |  |   |         |   |  |   |       |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total operating expenses                                    |  |                                       | 13,956 |   |              |   | 14,206 |         |  |   | 13,730   |   |  |   | 13,183 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Operating loss                                              |  |                                       | (3,356 | ) |              |   | (3,438 | )       |  |   | (3,070   | ) |  |   | (2,221 | )
|Other income, net                                           |  |                                       | 294    |   |              |   | 322    |         |  |   | 381      |   |  |   | 339    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Loss before provision for (benefit from) for income taxes   |  |                                       | (3,062 | ) |              |   | (3,116 | )       |  |   | (2,689   | ) |  |   | (1,882 | )
|Provision for (benefit from) for income taxes               |  |                                       | 15     |   |              |   | (33    | )       |  |   | 21       |   |  |   | 13     |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Net loss                                                    |  |                                       | (3,077 | ) |              |   | (3,083 | )       |  |   | (2,710   | ) |  |   | (1,895 | )
|Other comprehensive income (loss)translation adjustments   |  |                                       | 48     |   |              |   | 35     |         |  |   | (6       | ) |  |   | 17     |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Comprehensive loss                                          |  | $                                     | (3,029 | ) |              | $ | (3,048 | )       |  | $ | (2,716   | ) |  | $ | (1,878 | )
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Net loss per sharebasic and diluted                        |  | $                                     | (0.06  | ) |              | $ | (0.06  | )       |  | $ | (0.05    | ) |  | $ | (0.04  | )
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Weighted-average sharesbasic and diluted                   |  |                                       | 51,124 |   |              |   | 51,092 |         |  |   | 51,052   |   |  |   | 50,841 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|(1)  Including stock-based compensation expense as follows: |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of service revenue                                     |  | $                                     | 37     |   |              | $ | 40     |         |  | $ | 39       |   |  | $ | 26     |  
|Research and development                                    |  |                                       | 186    |   |              |   | 200    |         |  |   | 257      |   |  |   | 303    |  
|Sales and marketing                                         |  |                                       | 164    |   |              |   | 502    |         |  |   | 319      |   |  |   | 220    |  
|General and administrative                                  |  |                                       | 501    |   |              |   | 574    |         |  |   | 575      |   |  |   | 561    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total stock-based compensation expense                      |  | $                                     | 888    |   |              | $ | 1,316  |         |  | $ | 1,190    |   |  | $ | 1,110  |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  



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|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------------------------- | ------ | - | ------------ | - | ------ | ------- |  | - | -------- | - |  | - | ------ | -
|                                                            |  | Quarters Ended                        |       
|                                                            |  | December 31                           |        |   | September 30 |   |        | June 30 |  |   | March 31 |  
|                                                            |  | (in thousands, except per share data) |       
|Fiscal 2006                                                 |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Revenue:                                                    |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Product revenue                                             |  | $                                     | 8,731  |   |              | $ | 7,273  |         |  | $ | 5,254    |   |  | $ | 7,425  |  
|Service revenue                                             |  |                                       | 7,597  |   |              |   | 7,469  |         |  |   | 7,343    |   |  |   | 7,255  |  
|Intellectual property revenue                               |  |                                       | 366    |   |              |   | 357    |         |  |   | 2,549    |   |  |   | 375    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total revenue                                               |  |                                       | 16,694 |   |              |   | 15,099 |         |  |   | 15,146   |   |  |   | 15,055 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of revenue:                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of product revenue(1)                                  |  |                                       | 1,092  |   |              |   | 1,531  |         |  |   | 970      |   |  |   | 723    |  
|Provision for excess inventory                              |  |                                       | 933    |   |              |   |       |         |  |   |         |   |  |   |       |  
|Cost of service revenue(1)                                  |  |                                       | 1,901  |   |              |   | 1,704  |         |  |   | 1,606    |   |  |   | 1,539  |  
|Amortization of intangible assets                           |  |                                       | 234    |   |              |   | 234    |         |  |   | 489      |   |  |   | 510    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total cost of revenue                                       |  |                                       | 4,160  |   |              |   | 3,469  |         |  |   | 3,065    |   |  |   | 2,772  |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Gross profit                                                |  |                                       | 12,534 |   |              |   | 11,630 |         |  |   | 12,081   |   |  |   | 12,283 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Operating expenses:                                         |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Research and development(1)                                 |  |                                       | 3,833  |   |              |   | 3,783  |         |  |   | 3,800    |   |  |   | 3,420  |  
|Sales and marketing(1)                                      |  |                                       | 8,016  |   |              |   | 6,937  |         |  |   | 6,596    |   |  |   | 6,453  |  
|General and administrative(1)                               |  |                                       | 2,308  |   |              |   | 2,365  |         |  |   | 2,593    |   |  |   | 3,356  |  
|Amortization of intangible assets                           |  |                                       | 204    |   |              |   | 204    |         |  |   | 312      |   |  |   | 321    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total operating expenses                                    |  |                                       | 14,361 |   |              |   | 13,289 |         |  |   | 13,301   |   |  |   | 13,550 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Operating loss                                              |  |                                       | (1,827 | ) |              |   | (1,659 | )       |  |   | (1,220   | ) |  |   | (1,267 | )
|Other income, net                                           |  |                                       | 363    |   |              |   | 278    |         |  |   | 301      |   |  |   | 264    |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Loss before provision for (benefit from) for income taxes   |  |                                       | (1,464 | ) |              |   | (1,381 | )       |  |   | (919     | ) |  |   | (1,003 | )
|Provision for (benefit from) for income taxes               |  |                                       | 56     |   |              |   | (7     | )       |  |   | 31       |   |  |   | 35     |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Net loss                                                    |  |                                       | (1,520 | ) |              |   | (1,374 | )       |  |   | (950     | ) |  |   | (1,038 | )
|Other comprehensive income (loss)translation adjustments   |  |                                       | (14    | ) |              |   | 5      |         |  |   | (2       | ) |  |   | 9      |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Comprehensive loss                                          |  | $                                     | (1,534 | ) |              | $ | (1,369 | )       |  | $ | (952     | ) |  | $ | (1,029 | )
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Net loss per sharebasic and diluted                        |  | $                                     | (0.03  | ) |              | $ | (0.03  | )       |  | $ | (0.02    | ) |  | $ | (0.02  | )
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Weighted-average sharesbasic and diluted                   |  |                                       | 50,310 |   |              |   | 50,111 |         |  |   | 49,937   |   |  |   | 49,662 |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|(1)  Including stock-based compensation expense as follows: |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Cost of product revenue                                     |  | $                                     | 3      |   |              | $ | 2      |         |  | $ | 2        |   |  | $ | 2      |  
|Cost of service revenue                                     |  |                                       | 36     |   |              |   | 33     |         |  |   | 34       |   |  |   | 39     |  
|Research and development                                    |  |                                       | 287    |   |              |   | 442    |         |  |   | 268      |   |  |   | 259    |  
|Sales and marketing                                         |  |                                       | 69     |   |              |   | 144    |         |  |   | 167      |   |  |   | 189    |  
|General and administrative                                  |  |                                       | 445    |   |              |   | 487    |         |  |   | 488      |   |  |   | 1,209  |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  
|Total stock-based compensation expense                      |  | $                                     | 840    |   |              | $ | 1,108  |         |  | $ | 959      |   |  | $ | 1,698  |  
|                                                            |  |                                       |        |   |              |   |        |         |  |   |          |   |  |   |        |  



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Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates
and beliefs. Our actual results could differ materially from those discussed in the forward- looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and at Part I,
Item 1A, Risk Factors to this Annual Report.

Overview

Tumbleweed Communications Corp. (Tumbleweed or we) is a recognized expert in providing managed file transfer, email security, and
identity validation products for enterprise and government customers of all sizes. We provide comprehensive solutions that enable organizations to safely and confidently conduct business over the Internet, protecting data in motion and at rest with
intuitive, pragmatic solutions that promote collaboration, prevent data loss, and reduce the cost of doing business.

We offer solutions in four comprehensive product suites: Tumbleweed SecureTransport,
Tumbleweed Secure Messenger, Tumbleweed MailGate®, Tumbleweed Validation Authority. Tumbleweed SecureTransport is an enterprise-class managed file product that enables customers
to securely manage the exchange of large files and transactions without having to change internal infrastructure. Tumbleweed Secure Messenger is a policy-based email encryption product that enables deep-content inspection of incoming and outgoing
mail, and dynamic application of user-defined encryption and routing preferences. Tumbleweed MailGate is a comprehensive email security product that provides inbound and outbound protection with protection against virus outbreaks, spam, and denial
of service attacks, eliminating illegitimate email traffic before it can penetrate corporate firewalls. Tumbleweed Validation Authority is a leading product for determining the validity of digital certificates.

We are trusted by more than 3,200 enterprise and government customers who use our products to securely connect with employees, partners, and
customers. Our traditional market focus has been in the financial services, healthcare, and government markets, but we are expanding into other market sectors, such as retail, manufacturing, energy, transportation and technology. The worlds
most security conscious organizations use our products to safely exchange data, protect information assets, block email security threats, and ensure identity validation.

Revenue during 2007 decreased 7%, or $4.5 million, to $57.5 million from $62.0 million in 2006. This decrease was mainly due to a $7.8 million decrease in revenue from our Validation Authority products and a $2.3
million decrease in revenue from the licensing of intellectual property. These declines were partially offset by a 13%, or $5.5 million, combined increase in revenue from our SecureTransport, Secure Messenger, and MailGate products. The decrease in
revenue from our Validation Authority products was due to five license transactions of $1.0 million or more in 2006 with no comparable transactions in 2007. The increase in total license revenue from our other products was due to the increased
market adoption of those products due to an increase in the volume of license transactions and an increase in the size of our customer base. The impact of a decrease in our license revenue was partially offset by an increase in our service revenue
due to the expansion of our customer base under support agreements.

Net loss increased 121%, or $5.9 million, as compared to 2006. Our
increase in net loss was primarily due to a decrease in revenue and an increase in our cost of service revenue of $922,000 in 2007 as compared to 2006. Our cost of service revenue increased as professional services revenue increased in 2007 as
compared to 2006 while cost of service revenue as a percentage of service revenue remained flat at 23% in both 2007 and 2006.



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Outlook

We believe that our success in 2008 will depend on our ability to effectively manage the transition from being primarily a direct sales organization to having a greater portion of our business come through reseller partners, to expand our
international revenue, to introduce competitive products while transitioning from our historic waterfall engineering practices to an agile product development model, and to maintain control over expenses and cash. We believe
that key risks include overall economic conditions and the overall level of information technology spending; economic and business conditions within our main vertical market segments of financial services, healthcare, and government industries;
timing of the closure of customer contracts; operational execution in growing our sales internationally; and competitive factors in our rapidly changing industry. Our prospects must be considered in light of the risks, expenses and difficulties
encountered by companies of a similar size and industry, particularly given that we operate in rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful in addressing such
risks and difficulties. Please refer to the Risk Factors section for additional information.



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The following table sets forth the consolidated statements of operations for the periods indicated (in
thousands). These statements have been derived from the consolidated financial statements contained in this Annual Report. The operating results for any period should not be considered indicative of results for any future period. This information
should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included elsewhere in this report.



|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                            |  | Years Ended December 31, |        
|                                                            |  | 2007                     |         |   | 2006 |   |        | 2005 | 
|Revenue:                                                    |  |                          |         |   |      |   |        |      |  |   |        |  
|Product revenue                                             |  | $                        | 22,529  |   |      | $ | 28,683 |      |  | $ | 20,945 |  
|Service revenue                                             |  |                          | 33,559  |   |      |   | 29,664 |      |  |   | 26,103 |  
|Intellectual property revenue                               |  |                          | 1,367   |   |      |   | 3,647  |      |  |   | 2,953  |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Total revenue                                               |  |                          | 57,455  |   |      |   | 61,994 |      |  |   | 50,001 |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of revenue:                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of product revenue (1)                                 |  |                          | 5,694   |   |      |   | 4,316  |      |  |   | 2,597  |  
|Provision for excess inventory                              |  |                          | 164     |   |      |   | 933    |      |  |   | 323    |  
|Cost of service revenue(1)                                  |  |                          | 7,672   |   |      |   | 6,750  |      |  |   | 5,407  |  
|Amortization of intangible assets                           |  |                          | 936     |   |      |   | 1,467  |      |  |   | 2,040  |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Total cost of revenue                                       |  |                          | 14,466  |   |      |   | 13,466 |      |  |   | 10,367 |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Gross profit                                                |  |                          | 42,989  |   |      |   | 48,528 |      |  |   | 39,634 |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Operating expenses:                                         |  |                          |         |   |      |   |        |      |  |   |        |  
|Research and development (1)                                |  |                          | 15,107  |   |      |   | 14,836 |      |  |   | 12,107 |  
|Sales and marketing (1)                                     |  |                          | 28,575  |   |      |   | 28,002 |      |  |   | 25,194 |  
|General and administrative (1)                              |  |                          | 10,157  |   |      |   | 10,622 |      |  |   | 6,013  |  
|Amortization of intangible assets                           |  |                          | 305     |   |      |   | 1,041  |      |  |   | 1,284  |  
|Merger-related and other credit                             |  |                          |        |   |      |   |       |      |  |   | (96    | )
|Restructuring costs                                         |  |                          | 930     |   |      |   |        |      |  |   |        |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Total operating expenses                                    |  |                          | 55,074  |   |      |   | 54,501 |      |  |   | 44,502 |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Operating loss                                              |  |                          | (12,085 | ) |      |   | (5,973 | )    |  |   | (4,868 | )
|Other income, net                                           |  |                          | 1,336   |   |      |   | 1,206  |      |  |   | 982    |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Loss before provision for income taxes                      |  |                          | (10,749 | ) |      |   | (4,767 | )    |  |   | (3,886 | )
|Provision for income taxes                                  |  |                          | 16      |   |      |   | 115    |      |  |   | 23     |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Net loss                                                    |  | $                        | (10,765 | ) |      | $ | (4,882 | )    |  | $ | (3,909 | )
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|(1)  Including stock-based compensation expense as follows: |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of product revenue                                     |  | $                        |        |   |      | $ | 9      |      |  | $ |       |  
|Cost of service revenue                                     |  |                          | 142     |   |      |   | 142    |      |  |   | 2      |  
|Research and development                                    |  |                          | 946     |   |      |   | 1,256  |      |  |   | 219    |  
|Sales and marketing                                         |  |                          | 1,205   |   |      |   | 569    |      |  |   | 168    |  
|General and administrative                                  |  |                          | 2,211   |   |      |   | 2,629  |      |  |   | 121    |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  
|Total stock-based compensation expense                      |  | $                        | 4,504   |   |      | $ | 4,605  |      |  | $ | 510    |  
|                                                            |  |                          |         |   |      |   |        |      |  |   |        |  

Years ended December 31, 2007 and 2006

Revenue. Revenue, which consists of product revenue, service revenue, and intellectual property revenue, results from new contracts and
backlog. We define backlog as deferred revenue, contractual commitments that are not due and payable as of the balance sheet date, or for which the product or service has not yet been delivered and/or for which collectibility is not considered
probable. Product revenue consists of license fees and



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appliance fees (for products that are delivered on an appliance platform), and subscription-based license fees. Service revenue includes support and
maintenance fees, consulting fees, and training fees. Intellectual property revenue consists of patent license agreement fees. Total revenue decreased to $57.5 million in 2007 from $62.0 million in 2006. The decrease in total revenue was primarily
due to a $6.2 million decrease in product revenue and a $2.3 million decrease in patent license revenue, partially offset by a $2.4 million increase in support and maintenance revenue and a $1.4 decrease in professional services revenue.

Product revenue decreased to $22.5 million in 2007 from $28.7 million in 2006. The decrease in product revenue was due to a decrease in license
revenue from our Validation Authority products of $9.1 million, partially offset by a total combined increase in license revenue from our SecureTransport, Secure Messenger, and MailGate products of $2.9 million. The decrease in license revenue from
our Validation Authority products was due to five license transactions of $1.0 million or more in 2006 with no comparable transactions in 2007. The increase in total license revenue from our other products was due to the increased market adoption of
those products due to an increase in the volume of license transactions and an increase in the size of our customer base.

Service revenue
increased to $33.6 million in 2007 from $29.7 million in 2006 due to an increased number of customers covered by support agreements due to the expansion of our customer base and due to an increased customer demand for consulting and training
services related to our SecureTransport product line.

Intellectual property revenue decreased to $1.4 million in 2007 from $3.6 million in
2006. The decrease in intellectual property revenue was due to a decrease in patent license revenue caused by having a large patent agreement during the three months ended June 30, 2006, with no comparable transactions in 2007.

Cost of Revenue. Cost of revenue is comprised of costs for product revenue, service costs, provision for excess inventory, and the
amortization of intangible assets for core/developed technology and maintenance agreements relating to corporate acquisitions. Cost of product revenue is primarily comprised of royalties paid to third parties for software licensed by us for
inclusion in our products, and the cost of our products sold on appliances including related shipping and warranty costs. Service costs are comprised primarily of employee and employee-related costs, including stock-based compensation expense, for
customer support, consulting and training, and contract development projects with third parties. Provision for excess inventory is comprised of costs associated with excess inventory resulting from our transitions to new appliance manufacturers.
Total cost of revenue increased to $14.5 million in 2007 (or 25% of total 2007 revenue) from $13.5 million in 2006 (or 22% of total 2006 revenue), primarily due to a $1.4 million increase in our cost of product revenue, a $922,000 increase in our
service costs, partially offset by a $769,000 decrease in our provision for excess inventory and a $531,000 decrease in our amortization of intangible assets.

Cost of product revenue increased to $5.7 million in 2007 (or 10% of total 2007 revenue) from $4.3 million in 2006 (or 7% of total 2006 revenue) due primarily to an increase in appliance costs and royalty costs.
Appliance costs increased by $1.1 million during 2007 due to an increase in the number of appliances shipped to our customers as customer adoption of our appliance products increased relative to 2006. Royalties paid to third parties for software
licensed by us for inclusion in our products increased by $619,000 during 2007, due to an increase in revenue from our anti-virus products and the increase in the number of appliance units shipped to our customers, both of which require third-party
licenses for which we pay royalties. We expect cost of product revenue to increase during 2008 due to an expected increase in the number of appliance products to be shipped.

Provision for excess inventory of $164,000 in 2007 (or less than 1% of total 2007 revenue) and $933,000 in 2006 (or 2% of total 2006 revenue) was the
estimated loss for excess inventory and purchase commitments associated with transitioning our hardware products to new appliance manufacturers.

Cost of service revenue increased to $7.7 million in 2007 (or 13% of total 2007 revenue) from $6.8 million in 2006 (or 11% of total 2006 revenue) due primarily to an $851,000 increase in employee-related costs. Employee-related costs
increased due to an increase in average services headcount and an increase in incentive compensation as professional services revenue increased in 2007 as compared to 2006. Average services headcount increased to 77



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employees in 2007 from 65 employees in 2006 primarily due to transitioning from a partial utilization of third parties in our support function towards a full
employee-based support model and due to the need for greater personnel resources to fulfill our customer service requirements due to our increased service revenues.

Amortization of intangible assets included in cost of revenue decreased to $936,000 in 2007 (or 2% of total 2007 revenue) from $1.5 million in 2006 (or 2% of total 2006 revenue) due to the amortization in full during
the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired during the acquisition of Valicert. Intangible assets, amortization for which is included in cost of revenue, will
be amortized in full in the three months ended March 31, 2008.

Research and Development Expenses. Research and
development expenses are primarily comprised of employee and employee-related costs, including stock-based compensation expense and other costs required for the development and quality assurance of our products. Research and development expenses
increased to $15.1 million in 2007 (or 26% of total 2007 revenue) from $14.8 million in 2006 (or 24% of total 2006 revenue), primarily due to a $226,000 increase in consulting costs. Consulting costs increased due to a greater utilization of
third-parties to assist in our research and development processes.

Sales and Marketing Expenses. Sales and marketing expenses
are primarily comprised of employee and employee-related costs, including stock-based compensation expense, travel expenses, and costs associated with marketing program costs. Sales and marketing expenses increased to $28.6 million in 2007 (or 50%
of total 2007 revenue) from $28.0 million in 2006 (or 45% of total 2006 revenue) primarily due to a $636,000 increase in stock-based compensation expense. Stock-based compensation expense increased primarily due to the expense associated with the
terminations of certain employees and a greater number of stock options vesting over 2007 as compared to 2006.

General and
Administrative Expenses. General and administrative expenses consist primarily of employee and employee-related costs, including stock-based compensation expense, for our administrative, finance, legal, and human resources departments, as
well as public reporting costs and professional fees including intellectual property enforcement and protection costs. General and administrative expenses decreased to $10.2 million in 2007 (or 18% of total 2007 revenue) from $10.6 million in 2006
(or 17% of total 2006 revenue). The decrease in general and administrative expense was primarily due to a $418,000 decrease in stock-based compensation expense. Stock-based compensation expense decreased due to recognition of expense related to a
large stock-based award, a portion of which vested immediately upon the grant in January 2006 with no comparable expense in 2007.

Amortization of intangible assets.Amortization of intangible assets included in operating expenses consists of the amortization of intangible assets for customer base and reseller agreements and trademarks and tradenames recorded as
a result of the Valicert, Incubator Limited, and Corvigo, Inc. acquisitions. Amortization of intangible assets included in operating expenses decreased to $305,000 in 2007 (or 1% of total 2007 revenue) from $1.0 million in 2006 (or 2% of total 2006
revenue). The decrease in the amortization of intangible assets included in operating expenses was due to the amortization in full during the three months ended June 30, 2006 of the customer base and reseller agreements acquired during the
Valicert acquisition. Intangible assets, amortization for which is included in operating expenses, will be amortized in full in the three months ended March 31, 2008.

Restructuring costs.Restructuring costs of $930,000 for 2007 were comprised of severance costs to terminated employees and associated legal
expenses. During the fourth quarter of 2007, an expense reduction program was implemented that included the termination of approximately 40 employees. As of December 31, 2007, the remaining liability related to these costs is $520,000. There
were no restructuring costs in 2006.

Other income, net. Other income, net, is generally comprised of interest income earned on
investment securities. Other income, net, increased to $1.3 million in 2007 from $1.2 million in 2006. The increase in other income, net, was primarily due to increase in interest income driven by an increase in interest rates.



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Years ended December 31, 2006 and 2005

Revenue. Total revenue increased to $62.0 million in 2006 from $50.0 million in 2005. The increase in total revenue was primarily due to a
$7.7 million increase in product revenue, a $3.6 million increase in support and maintenance revenue, and a $694,000 increase in patent license revenue.

Product revenue increased to $28.7 million in 2006 from $20.9 million in 2005. The increase in product revenue was due to an increase in license revenue of $8.2 million, partially offset by decreases in
subscription-based license revenue and transaction-based license revenue of $363,000 and $97,000, respectively. The increase in license revenue was primarily due to an increased volume of contracts with customers along with revenue growth in the
financial services and government industries. The decreases in subscription-based license revenue and transaction-based license revenue were due to our continued transition away from those selling models and towards selling perpetual licenses with
associated support and maintenance contracts.

Service revenue increased to $29.7 million in 2006 from $26.1 million in 2005. The increase
in service revenue was primarily due to a $3.6 million increase in support and maintenance revenue. The increase in support and maintenance revenue was due to revenue growth in our installed customer base, an increase in sales of our anti-spam
service which is sold on a subscription fee basis, and an expansion of our customer base.

Intellectual property revenue increased to $3.6
million in 2006 from $3.0 million in 2005. The increase in intellectual property revenue was due to an increase in patent license revenue.

Cost of Revenue. Total cost of revenue increased to $13.5 million in 2006 (or 22% of total 2006 revenue) from $10.4 million in 2005 (or 21% of total 2005 revenue), primarily due to a $1.7 million increase in product costs, a
$1.3 million increase in service costs, and a $610,000 increase in provision for excess inventory, partially offset by a decrease in amortization of intangible assets of $573,000.

Cost of product revenue increased to $4.3 million in 2006 (or 7% of total 2006 revenue) from $2.6 million in 2005 (or 5% of total 2005 revenue) due
primarily to an increase in appliance costs and royalty costs. Appliance costs increased by $709,000 during 2006 due to an increase in the number of appliance products shipped, resulting from higher sales of our products sold on appliances.
Royalties paid to third parties for software licensed by us for inclusion in our products increased by $889,000 during 2006, due to an increase in our product revenues and the addition of new software licenses from third parties included in our
products.

Provision for excess inventory of $933,000 in 2006 (or 2% of total 2006 revenue) is the estimated loss for excess inventory and
purchase commitments associated with transitioning our hardware products to a new appliance manufacturer and from a proprietary design to a standard product offering. Provision for excess inventory of $323,000 in 2005 (or 1% of total 2005 revenue)
is the expense incurred for obsolete inventory associated with our transition to a new appliance manufacturer.

Cost of service revenue
increased to $6.8 million in 2006 (or 11% of total 2006 revenue) from $5.4 million in 2005 (or 11% of total 2005 revenue), primarily due to an increase in employee and employee-related costs, including stock-based compensation expense, an increase
in consulting costs, an increase in travel expenses, and an increase in allocated overhead charges. Employee and employee-related costs increased by $632,000 during 2006 due to an increase in average services headcount and a $140,000 increase in
stock-based compensation expense due to our adoption of SFAS 123R during 2006. Average services headcount increased to 65 employees in 2006 from 48 employees in 2005 primarily due to transitioning from a partial utilization of third parties in our
support function towards a full employee-based support model and due to the need for greater personnel resources to fulfill our customer service requirements due to our increased service revenues. Consulting costs increased by $168,000 during 2006
due to a greater utilization of third parties to assist with providing service to our customers. Travel expenses increased by $211,000 during 2006 due to increased travel related to customer projects. Allocated overhead charges increased by $189,000
during 2006 due to an increase in our allocable cost base caused by higher information technology costs including an upgrade to our computer network infrastructure performed during 2006.



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Amortization of intangible assets included in cost of revenue decreased to $1.5 million in 2006 (or 2% of
total 2006 revenue) from $2.0 million in 2005 (or 4% of total 2005 revenue) due to the amortization in full during the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired
during the acquisition of Valicert.

Research and Development Expenses. Research and development expenses increased to $14.8
million in 2006 (or 24% of total 2006 revenue) from $12.1 million in 2005 (or 24% of total 2005 revenue), primarily due to a $2.6 million increase in employee and employee-related costs. Employee and employee-related costs increased primarily due to
an increase in stock-based compensation expense of $1.0 million resulting from our adoption of SFAS 123R during 2006 as well as salary increases and growth in average research and development headcount. Average research and development headcount
increased to 155 in 2006 from 149 in 2005 driven by our efforts to broaden and upgrade our products.

Sales and Marketing
Expenses. Sales and marketing expenses increased to $28.0 million in 2006 (or 45% of total 2006 revenue) from $25.2 million in 2005 (or 50% of total 2005 revenue) primarily due to a $2.7 million increase in employee and employee-related
costs. Employee and employee-related costs increased due to an increase in commissions of $1.0 million, an increase in stock-based compensation expenses of $401,000 resulting from our adoption of SFAS 123R during 2006, salary increases, growth in
average sales and marketing headcount, and expenses related to changes in sales and marketing management. Commissions increased as a result of increased sales in 2006. Average sales and marketing headcount increased to 89 in 2006 from 84 in 2005 due
to our efforts to expand our capabilities in this area.

General and Administrative Expenses.General and administrative expenses
increased to $10.6 million in 2006 (or 17% of total 2006 revenue) from $6.0 million in 2005 (or 12% of total 2005 revenue). The increase in general and administrative expense was primarily due to an increase in employee and employee-related costs,
legal expenses, and consulting costs. Employee and employee-related costs increased by $4.0 million during 2006. Employee and employee-related costs increased due to an increase in stock-based compensation expenses of $2.5 million during 2006, due
to our adoption of SFAS 123R, as well as an increase in salary expenses due to growth in average general and administrative headcount and salary increases. Average general and administrative headcount increased to 38 in 2006 from 23 in 2005, largely
due to a realignment of resources into our general and administrative function from other functions during 2006. Legal expenses increased by $357,000 during 2006 due to various legal matters. Consulting costs increased by $216,000 during 2006 due to
a greater utilization of third parties to assist us with projects associated with our growth as a company.

Amortization of intangible
assets.Amortization of intangible assets included in operating expenses decreased to $1.0 million in 2006 (or 2% of total 2006 revenue) from $1.3 million in 2005 (or 3% of total 2005 revenue). The decrease in the amortization of intangible
assets included in operating expenses was due to the amortization in full during the three months ended June 30, 2006 of the customer base and reseller agreements acquired during the Valicert acquisition.

Merger-related and other credit. There were no merger-related and other credit in 2006. Merger-related and other costs of a net credit of
$96,000 for 2005 consist of a $296,000 credit related to the termination of an operating lease in Slough, United Kingdom and a $200,000 severance cost associated with the resignation of our former Chief Executive Officer. The combined cost of the
final lease settlement payments, commissions, brokerage fees, and legal fees related to the termination of the Slough lease was less than the existing accrual for the loss on the lease, resulting in the expense credit.

Other income, net.Other income, net, increased to $1.2 million in 2006 from $982,000 in 2005. The increase in other income, net, was primarily
due to increase in interest income driven by an increase in interest rates and a larger cash balance.



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Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the issuance of equity securities. As of December 31, 2007, we had approximately $26.3 million in cash and cash equivalents.

Net cash used in operating activities in 2007 was $4.2 million, which was primarily the result of our net loss of $10.8 million, offset by non-cash
charges of $4.5 million for stock-based compensation expense and $2.6 million for depreciation and amortization expenses.

Net cash used in
operating activities for 2007 was $4.2 million compared to net cash provided by operating activities for 2006 of $3.8 million. This was primarily the result of a $5.9 million increase in our net loss and a $992,000 decrease in depreciation and
amortization expense in 2007 compared to 2006.

Net cash used in investing activities decreased to $1.5 million in 2007 from $1.6 million
in 2006. Net cash used in investing activities for both 2007 and 2006 was comprised of purchases of property and equipment. Net cash used in investing activities decreased in 2007 as compared to 2006 due to the timing of payments.

Net cash provided by financing activities was $1.4 million in 2007 and 2006, respectively. Net cash provided by financing activities for both 2007 and
2006 was comprised of proceeds from the issuance of our common stock.

As of December 31, 2007, our principal commitments consisted of
obligations related to outstanding operating leases and unconditional purchase obligations. We do not anticipate a substantial increase in operating lease obligations in the immediate future.

Our capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and services, and
the resources devoted to the development of our products and services and to sales and marketing and other operating activities. We believe that our existing capital resources should enable us to maintain our current and planned operations for at
least the next twelve months. Our current cash reserves, however, may be insufficient if we experience either lower than expected revenues or extraordinary or unexpected cash expenses, or for other reasons. Funding, if pursued, may not be available
on acceptable terms or at all. If adequate funds are not available, we may be required to curtail significantly or defer one or more of our operating goals or programs, or take other steps that could harm our business or future operating results. We
may consider future financing alternatives, which may include the incurrence of debt, additional public or private equity offerings or an equity investment by a strategic partner.

Off-Balance Sheet Arrangements

At December 31, 2007, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

Tabular Disclosure of Contractual Obligations

Future cash payments for contractual obligations and commercial commitments as of December 31, 2007, are as follows (in thousands):



|                                   |  |                 |       |            |   |            |  |                  |     |       |   |   |  |   |      
|---------------------------------- |  | --------------- | ----- | ---------- | - | ---------- |  | ---------------- | --- | ----- | - | - |  | - | -----
|                                   |  | Less than1 Year |       | 1  3Years |   | 3  5Years |  | More than5 Years |     | Total
|Operating leases                   |  | $               | 1,221 |            | $ | 838        |  | $                | 791 |       | $ |  |  | $ | 2,850
|Unconditional purchase obligations |  |                 | 1,870 |            |   | 1,579      |  |                  |    |       |   |  |  |   | 3,449
|                                   |  |                 |       |            |   |            |  |                  |     |       |   |   |  |   |      
|Total                              |  | $               | 3,091 |            | $ | 2,417      |  | $                | 791 |       | $ |  |  | $ | 6,299
|                                   |  |                 |       |            |   |            |  |                  |     |       |   |   |  |   |      



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Indemnifications

In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify the third-party to such arrangement from any losses incurred relating to the services they perform on
behalf of us or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss
clauses. Historically, payments we have made related to these indemnifications have been immaterial.

Recent Accounting Pronouncements

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

As of January 1,
2007, we did not have any federal, state, and foreign unrecognized tax benefits. Upon the adoption of FIN 48, we adopted an accounting policy to classify interest and penalties on unrecognized tax benefits as income tax expense. For the years
prior to adoption of FIN 48, we did not have interest or penalties on unrecognized tax benefits and therefore, had no established accounting policy. As of January 1, 2007, we had no interest or penalties accrued on unrecognized tax benefits. We
file income tax returns in the U.S. federal jurisdiction, various states, and foreign jurisdictions. Due to our net operating losses, we are subject to examinations by U.S. federal and state income tax authorities for all our historical periods. As
of December 31, 2007, we did not have and do not expect to have any material changes to unrecognized tax benefits within the next twelve months.

In June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue 06-03, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented
in the Income Statement (EITF 06-03). EITF 06-03 provides guidance on an entitys disclosure of its accounting policy regarding the gross or net presentation of certain taxes and provides that if taxes included in gross
revenues are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual periods). Taxes within the scope of EITF 06-03 are those that are imposed on and
concurrent with a specific revenue-producing transaction. The guidance is effective for interim and annual periods beginning after December 15, 2006. We did not have and do not expect to have any material impact of EITF 06-03 on our financial
position and results of operations.

In June 2006, the FASB ratified the EITF consensus on Issue 06-02, Accounting for Sabbatical
Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-02). EITF 06-02 requires that the costs associated with unrestricted sabbaticals and other similar benefit
arrangements be recognized over the service period during which the employee earns the benefit. The provisions of EITF 06-02 are effective for fiscal years beginning after December 15, 2006. We applied the provisions of EITF 06-02 through a
cumulative effect adjustment that resulted in increases of $117,000 each to our accumulated deficit and accrued liabilities balances, respectively. The changes in accumulated deficit for 2007 are as follows:



|                                |  |                |          |  
|------------------------------- |  | -------------- | -------- | -
|                                |  | (In thousands) |         
|Balance as of December 31, 2006 |  | $              | (295,812 | )
|Net loss                        |  |                | (10,765  | )
|Adoption effect of EITF 06-02   |  |                | (117     | )
|                                |  |                |          |  
|Balance as of December 31, 2007 |  | $              | (306,694 | )
|                                |  |                |          |  



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In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and
does not expand the use of fair value in any new circumstances. SFAS 157 is generally effective for financial statements issued for fiscal years beginning after November 15, 2007 and for nonfinancial assets and liabilities that are not
remeasured at fair value on a recurring basis for fiscal years beginning after December 31, 2008. We do not expect SFAS 157 to have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), which establishes
principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree in a business combination. SFAS 141R also
establishes principles around how goodwill acquired in a business combination or a gain from a bargain purchase should be recognized and measured, as well as provides guidelines on the disclosure requirements on the nature and financial impact of
the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008 and will be adopted by us beginning in the first quarter of 2010. Although we will continue to evaluate the application of SFAS No. 141R,
we do not currently believe adoption will have a material impact on our financial condition or operating results.

In December 2007, the
FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research
Bulletin No. 51 (SFAS 160). SFAS 141R changes how business acquisitions are accounted for and impacts financial statements both on the acquisition date and in subsequent periods. SFAS 160 changes the accounting and
reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 are effective for fiscal years beginning after December 15, 2008 and will be adopted by
us beginning in the first quarter of 2009. Although we will continue to evaluate the application of SFAS 141R and SFAS 160, we do not currently believe adoption will have a material impact on our financial condition or operating results.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

We derive our revenue from three sources: (i) product revenue, which includes license fees and appliance fees (for products that are delivered on an appliance platform), and subscription-based license fees;
(ii) service revenue, which consists of support and maintenance fees, consulting fees, and training fees; and (iii) intellectual property revenue, which consists of patent license agreement fees. As described below, significant management
judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period based on the judgments and estimates made by our
management.



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We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue
Recognition (SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions (SOP 98-9). We make significant judgments related to
revenue recognition. Specifically, as set forth in paragraph 8 of SOP 97-2 in connection with each transaction involving our products, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred,
(iii) the fee is fixed or determinable, and (iv) collectibility is probable. We apply these criteria as discussed below.



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



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



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



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

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

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



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

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

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

We typically grant our customers a warranty which guarantees that our products will substantially conform to our current specifications for 90 days from
the delivery date pursuant to the terms of the arrangement. We account for the estimated cost of product and service warranties in accordance with SFAS 5, Accounting for Contingencies, provided that it is probable that a liability exists, and
provided the cost to repair or otherwise satisfy the claim can be reasonably estimated. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims were $231,000, $278,000, and
$0 in 2007, 2006, and 2005, respectively.

Stock-based Compensation Expense

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



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amounts will be recorded as a cumulative adjustment in the period estimates are revised. Actual results, and future changes in estimates, may differ
substantially from our current estimates and our results of operations could be materially impacted.

Prior to January 1, 2006, we
accounted for our stock-based compensation arrangements for employees and non-employees using the intrinsic-value method pursuant to Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (APB25).
Accordingly, stock-based compensation expense was generally recorded for fixed plan stock options on the date of grant only when either options were granted to non-employees or the fair value of the underlying common stock exceeded the exercise
price for stock options granted.

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

On July 19, 2005, our Board of Directors approved the acceleration of vesting of certain unvested stock options with
exercise prices equal to or greater than $3.82 per share previously awarded to our employees (including our executive officers) and our Directors under our stock option plans. The acceleration of vesting was effective for stock options outstanding
as of July 19, 2005. Options to purchase approximately 1.7 million shares of common stock were accelerated. All of the options accelerated had exercise prices greater than our common stock price of $3.24 on the date of acceleration. The
weighted-average exercise price of the options accelerated was $5.00. In accordance with the provisions of APB25, no stock-based compensation expense was recognized as a result of the acceleration since the exercise price of all the accelerated
options exceeded our common stock price on the date of acceleration. The purpose of the acceleration was to enable us to avoid recognizing compensation expense associated with these options in future periods in our consolidated statement of
operations upon our adoption of SFAS 123R.

Valuation of Allowance for Doubtful Accounts

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

Valuation of Long-Lived Assets and Goodwill

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



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



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



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



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



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

We evaluate whether goodwill is impaired on at least an annual basis in accordance with SFAS 142, Goodwill and Other Intangible Assets(SFAS 142) or more frequently if certain indicators are
present. If this evaluation indicates that the value of the goodwill may be impaired, we make an assessment of the impairment of the goodwill using the two-step method prescribed by SFAS 142. Any such impairment charge could be significant and have
a material adverse effect on our reported financial statements. We completed our annual assessment of goodwill in the three months ended June 30, 2007, 2006, and 2005, respectively, and no impairment of goodwill was determined as a result of
these assessments. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes. As of December 31, 2007, we had goodwill of $48.1 million.

Accrual for Anticipated Operating Lease Losses

We assess anticipated operating lease losses whenever we determine that our usage of our facility space will be impacted by business conditions and subsequently reevaluate anticipated losses each time a sublease is entered into or exited.
Changing market conditions make anticipated operating lease losses difficult to determine. During 2003 we recognized a charge of $996,000 related to potential losses on an operating lease in Slough, United Kingdom that was included in our
consolidated statement of operations as Merger-related and other costs. The charge was estimated to include contractually required repairs, remaining lease liabilities, and brokerage fees, offset by estimated sublease income. During 2004 we
recognized a charge of $168,000 on an operating lease in Slough, United Kingdom, that was included in our consolidated statement of operations as Merger-related and other costs due to a revised estimate of the term of expected subleases on the
building which required an increase to the existing liability recorded for the anticipated lease loss on this lease. During 2005, we recognized a $296,000 credit related to this same lease that was included in our consolidated statement of
operations as Merger-related and other costs due to the combined cost of the final lease settlement payments, commissions, brokerage fees, and legal fees related to the termination of this lease being less than the existing accrual for the loss on
the lease. Estimates related to sublease costs and income are based on assumptions regarding the period required to locate and contract with a sublessee, sublease rates, and brokerage fees. Each reporting period we review these estimates, and to the
extent that our assumptions change and/or actual charges are incurred, the ultimate charge for the loss on this operating lease could vary from our current estimates.

Item 7AQuantitative and Qualitative Disclosures about Market Risk

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

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

Interest Rate Sensitivity

The primary objective of
our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk.
This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate. For example, if we hold a security that was issued with a fixed rate equal to the then-prevailing interest rate and the prevailing
interest rate later rises, the fair value of our investment will decline. To minimize this risk, we maintain our portfolio of cash equivalents in commercial paper and money market funds. In general, our investments are not subject to market risk
because the interest paid on these funds fluctuates with the prevailing interest rate. As of December 31, 2007, none of our cash equivalents were subject to market risk.



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Item 8Financial Statements and Supplementary Data

TUMBLEWEED COMMUNICATIONS CORP.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                                       |  |     
|---------------------------------------------------------------------- |  | ----
|                                                                       |  | Page
|Report of Independent Registered Public Accounting Firm                |  | 44  
|Consolidated Balance Sheets                                            |  | 45  
|Consolidated Statements of Operations                                  |  | 46  
|Consolidated Statements of Stockholders Equity and Comprehensive Loss |  | 47  
|Consolidated Statements of Cash Flows                                  |  | 48  
|Notes to Consolidated Financial Statements                             |  | 49  



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R
EPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and
Stockholders

Tumbleweed Communications Corp.:

We have audited the accompanying consolidated balance sheets of Tumbleweed Communications Corp. and subsidiaries (the Company) as of December 31,
2007 and 2006, and the related consolidated statements of operations, stockholders equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the
Companys internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Managements Report on Internal Control Over Financial Reporting appearing under item 9A(c). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the
Companys internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such
other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.

A
companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our
opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/    KPMG LLP

Mountain View, California

March 14, 2008



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T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)



|                                                                                                                                                           |  |              |          |   |      |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                           |  | December 31, |         
|                                                                                                                                                           |  | 2007         |          |   | 2006 |  
|ASSETS                                                                                                                                                     |  |              |          |   |      |  
|Current assets:                                                                                                                                            |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                  |  | $            | 26,299   |   |      | $ | 30,511   |  
|Accounts receivable, net of allowance for doubtful accounts of $368 and $431 as of December 31, 2007 and 2006,
respectively                                |  |              | 13,074   |   |      |   | 12,506   |  
|Other current assets                                                                                                                                       |  |              | 1,733    |   |      |   | 1,938    |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                       |  |              | 41,106   |   |      |   | 44,955   |  
|Property and equipment, net                                                                                                                                |  |              | 2,038    |   |      |   | 1,820    |  
|Goodwill                                                                                                                                                   |  |              | 48,074   |   |      |   | 48,074   |  
|Intangible assets, net                                                                                                                                     |  |              | 233      |   |      |   | 1,470    |  
|Other assets                                                                                                                                               |  |              | 385      |   |      |   | 612      |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                               |  | $            | 91,836   |   |      | $ | 96,931   |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|                                                                                                                                                           |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                       |  |              |          |   |      |  
|Current liabilities:                                                                                                                                       |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                           |  | $            | 820      |   |      | $ | 1,808    |  
|Accrued liabilities                                                                                                                                        |  |              | 6,795    |   |      |   | 7,522    |  
|Accrued merger-related and other costs                                                                                                                     |  |              |         |   |      |   | 97       |  
|Deferred revenue                                                                                                                                           |  |              | 20,996   |   |      |   | 20,003   |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                  |  |              | 28,611   |   |      |   | 29,430   |  
|Deferred revenue, excluding current portion                                                                                                                |  |              | 5,401    |   |      |   | 4,728    |  
|Other long-term liabilities                                                                                                                                |  |              | 13       |   |      |   | 63       |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total liabilities                                                                                                                                          |  |              | 34,025   |   |      |   | 34,221   |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Stockholders equity:                                                                                                                                      |  |              |          |   |      |   |          |  
|Preferred stock, $0.001 par value; 10,000,000 shares authorized, zero shares outstanding as of December 31, 2007 and 2006, respectively                    |  |              |         |   |      |   |         |  
|Common stock, $0.001 par value; 100,000,000 shares authorized, 51,129,313 and 50,427,209 shares outstanding as of December 31, 2007 and
2006, respectively |  |              | 52       |   |      |   | 51       |  
|Additional paid-in capital                                                                                                                                 |  |              | 365,155  |   |      |   | 359,238  |  
|Treasury stock (717,500 shares as of December 31, 2007 and 2006, respectively)                                                                             |  |              | (796     | ) |      |   | (796     | )
|Accumulated other comprehensive income                                                                                                                     |  |              | 94       |   |      |   | 29       |  
|Accumulated deficit                                                                                                                                        |  |              | (306,694 | ) |      |   | (295,812 | )
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                 |  |              | 57,811   |   |      |   | 62,710   |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                                 |  | $            | 91,836   |   |      | $ | 96,931   |  
|                                                                                                                                                           |  |              |          |   |      |   |          |  

See accompanying notes to consolidated financial statements.



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T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                              |  | Years Ended December 31, |        
|                                                              |  | 2007                     |         |   | 2006 |   |        | 2005 | 
|Revenue:                                                      |  |                          |         |   |      |   |        |      |  |   |        |  
|Product revenue                                               |  | $                        | 22,529  |   |      | $ | 28,683 |      |  | $ | 20,945 |  
|Service revenue                                               |  |                          | 33,559  |   |      |   | 29,664 |      |  |   | 26,103 |  
|Intellectual property revenue                                 |  |                          | 1,367   |   |      |   | 3,647  |      |  |   | 2,953  |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Total revenue                                                 |  |                          | 57,455  |   |      |   | 61,994 |      |  |   | 50,001 |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of revenue:                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of product revenue(1)                                    |  |                          | 5,694   |   |      |   | 4,316  |      |  |   | 2,597  |  
|Provision for excess inventory                                |  |                          | 164     |   |      |   | 933    |      |  |   | 323    |  
|Cost of service revenue(1)                                    |  |                          | 7,672   |   |      |   | 6,750  |      |  |   | 5,407  |  
|Amortization of intangible assets                             |  |                          | 936     |   |      |   | 1,467  |      |  |   | 2,040  |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Total cost of revenue                                         |  |                          | 14,466  |   |      |   | 13,466 |      |  |   | 10,367 |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Gross profit                                                  |  |                          | 42,989  |   |      |   | 48,528 |      |  |   | 39,634 |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Operating expenses:                                           |  |                          |         |   |      |   |        |      |  |   |        |  
|Research and development(1)                                   |  |                          | 15,107  |   |      |   | 14,836 |      |  |   | 12,107 |  
|Sales and marketing(1)                                        |  |                          | 28,575  |   |      |   | 28,002 |      |  |   | 25,194 |  
|General and administrative(1)                                 |  |                          | 10,157  |   |      |   | 10,622 |      |  |   | 6,013  |  
|Amortization of intangible assets                             |  |                          | 305     |   |      |   | 1,041  |      |  |   | 1,284  |  
|Merger-related and other credit                               |  |                          |        |   |      |   |       |      |  |   | (96    | )
|Restructuring costs                                           |  |                          | 930     |   |      |   |       |      |  |   |       |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Total operating expenses                                      |  |                          | 55,074  |   |      |   | 54,501 |      |  |   | 44,502 |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Operating loss                                                |  |                          | (12,085 | ) |      |   | (5,973 | )    |  |   | (4,868 | )
|Other income, net                                             |  |                          | 1,336   |   |      |   | 1,206  |      |  |   | 982    |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Loss before provision for income taxes                        |  |                          | (10,749 | ) |      |   | (4,767 | )    |  |   | (3,886 | )
|Provision for income taxes                                    |  |                          | 16      |   |      |   | 115    |      |  |   | 23     |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Net loss                                                      |  | $                        | (10,765 | ) |      | $ | (4,882 | )    |  | $ | (3,909 | )
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Net loss per sharebasic and diluted                          |  | $                        | (0.21   | ) |      | $ | (0.10  | )    |  | $ | (0.08  | )
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Weighted-average sharesbasic and diluted                     |  |                          | 51,028  |   |      |   | 50,007 |      |  |   | 48,627 |  
|                                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|(1)    Including stock-based compensation expense as follows: |  |                          |         |   |      |   |        |      |  |   |        |  
|Cost of product revenue                                       |  | $                        |        |   |      | $ | 9      |      |  | $ |       |  
|Cost of service revenue                                       |  |                          | 142     |   |      |   | 142    |      |  |   | 2      |  
|Research and development                                      |  |                          | 946     |   |      |   | 1,256  |      |  |   | 219    |  
|Sales and marketing                                           |  |                          | 1,205   |   |      |   | 569    |      |  |   | 168    |  
|General and administrative                                    |  |                          | 2,211   |   |      |   | 2,629  |      |  |   | 121    |  

See accompanying notes to consolidated financial statements.



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T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE LOSS

Years Ended December 31, 2007, 2006 and 2005

(in thousands, except share data)



|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------- |  | ----------------- |  | ----------------- | -- | ------------------------ | - | ------- | ------------- |  | - | ------------------------------- | - |  | ------------------------------------------ | ---- | - | ----------------- | - | ---- | ------------------ |  | - | ------------------------ | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                         |  | CommonStockShares |  | CommonStockAmount |    | AdditionalPaid-InCapital |   |         | TreasuryStock |  |   | DeferredStock-BasedCompensation |   |  | AccumulatedOtherComprehensiveIncome (Loss) |      |   | ComprehensiveLoss |   |      | AccumulatedDeficit |  |   | TotalStockholdersEquity |  
|BALANCES, DECEMBER 31, 2004                                                                              |  | 48,154,581        |  | $                 | 48 |                          | $ | 351,122 |               |  | $ | (796                            | ) |  | $                                          | (525 | ) |                   | $ | (651 | )                  |  |   |                          |   |  | $ | (286,794 | ) |  | $ | 62,404  |  
|Net loss                                                                                                 |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   | (3,909                   | ) |  |   | (3,909   | ) |  |   | (3,909  | )
|Foreign currency translation adjustment                                                                  |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   | 58   |                    |  |   | 58                       |   |  |   |         |   |  |   | 58      |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                 |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  | $ | (3,851                   | ) |  |   |          |   |  |   |         |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Issuance of common stock upon exercise of stock options                                                  |  | 1,338,379         |  |                   | 2  |                          |   | 2,152   |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 2,154   |  
|Amortization of deferred stock-based compensation expense                                                |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            | 446  |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 446     |  
|Credit to deferred stock-based compensation related to terminated employees                              |  |                  |  |                   |   |                          |   | (172    | )             |  |   |                                |   |  |                                            | 92   |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | (80     | )
|Deferred stock-based compensation expense related to severance agreements                                |  |                  |  |                   |   |                          |   | 144     |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 144     |  
|Deferred stock-based compensation expense related to stock options granted to non-employees              |  |                  |  |                   |   |                          |   | 178     |               |  |   |                                |   |  |                                            | (178 | ) |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   |        |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|BALANCES, DECEMBER 31, 2005                                                                              |  | 49,492,960        |  | $                 | 50 |                          | $ | 353,424 |               |  | $ | (796                            | ) |  | $                                          | (165 | ) |                   | $ | (593 | )                  |  |   |                          |   |  | $ | (290,703 | ) |  | $ | 61,217  |  
|Cumulative effect of adjustments from the adoption of SAB No. 108                                        |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   | 624  |                    |  |   |                          |   |  |   | (227     | ) |  |   | 397     |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|ADJUSTED BALANCES, DECEMBER 31, 2005                                                                     |  | 49,492,960        |  | $                 | 50 |                          | $ | 353,424 |               |  | $ | (796                            | ) |  | $                                          | (165 | ) |                   | $ | 31   |                    |  |   |                          |   |  | $ | (290,930 | ) |  | $ | 61,614  |  
|Net loss                                                                                                 |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   | (4,882                   | ) |  |   | (4,882   | ) |  |   | (4,882  | )
|Foreign currency translation adjustment                                                                  |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   | (2   | )                  |  |   | (2                       | ) |  |   |         |   |  |   | (2      | )
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                 |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  | $ | (4,884                   | ) |  |   |          |   |  |   |         |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Issuance of common stock upon exercise of stock options                                                  |  | 934,249           |  |                   | 1  |                          |   | 1,356   |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 1,357   |  
|Additional paid in capital from stock-based compensation expense                                         |  |                  |  |                   |   |                          |   | 4,605   |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 4,605   |  
|Reduction in deferred stock-based compensation and additional paid in capital upon adoption of SFAS 123R |  |                  |  |                   |   |                          |   | (165    | )             |  |   |                                |   |  |                                            | 165  |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   |        |  
|Tax benefit from employee stock options                                                                  |  |                  |  |                   |   |                          |   | 18      |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 18      |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|BALANCES, DECEMBER 31, 2006                                                                              |  | 50,427,209        |  | $                 | 51 |                          | $ | 359,238 |               |  | $ | (796                            | ) |  | $                                          |     |   |                   | $ | 29   |                    |  |   |                          |   |  | $ | (295,812 | ) |  | $ | 62,710  |  
|Net loss                                                                                                 |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   | (10,765                  | ) |  |   | (10,765  | ) |  |   | (10,765 | )
|Foreign currency translation adjustment                                                                  |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   | 65   |                    |  |   | 65                       |   |  |   |         |   |  |   | 65      |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                                                 |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  | $ | (10,700                  | ) |  |   |          |   |  |   |         |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|Issuance of common stock upon exercise of stock options                                                  |  | 702,104           |  |                   | 1  |                          |   | 1,413   |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 1,414   |  
|Additional paid in capital from stock-based compensation expense                                         |  |                  |  |                   |   |                          |   | 4,504   |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   |         |   |  |   | 4,504   |  
|Adoption effect of EITF 06-02                                                                            |  |                  |  |                   |   |                          |   |        |               |  |   |                                |   |  |                                            |     |   |                   |   |     |                    |  |   |                          |   |  |   | (117     | ) |  |   | (117    | )
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  
|BALANCES, DECEMBER 31, 2007                                                                              |  | 51,129,313        |  | $                 | 52 |                          | $ | 365,155 |               |  | $ | (796                            | ) |  | $                                          |     |   |                   | $ | 94   |                    |  |   |                          |   |  | $ | (306,694 | ) |  | $ | 57,811  |  
|                                                                                                         |  |                   |  |                   |    |                          |   |         |               |  |   |                                 |   |  |                                            |      |   |                   |   |      |                    |  |   |                          |   |  |   |          |   |  |   |         |  

See accompanying notes to consolidated financial statements.



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T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                          |  | Years Ended December 31, |        
|                                                                                          |  | 2007                     |         |   | 2006 |   |        | 2005 | 
|Cash flows provided by (used in) operating activities:                                    |  |                          |         |   |      |   |        |      |  |   |        |  
|Net loss                                                                                  |  | $                        | (10,765 | ) |      | $ | (4,882 | )    |  | $ | (3,909 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                          |         |   |      |   |        |      |  |   |        |  
|Stock-based compensation expense                                                          |  |                          | 4,504   |   |      |   | 4,605  |      |  |   | 510    |  
|Depreciation and amortization expense                                                     |  |                          | 2,641   |   |      |   | 3,633  |      |  |   | 4,471  |  
|Bad debt expense                                                                          |  |                          | 22      |   |      |   | 55     |      |  |   |       |  
|Loss (gain) on disposal of property and equipment                                         |  |                          | (163    | ) |      |   | 44     |      |  |   | 45     |  
|Changes in operating assets and liabilities:                                              |  |                          |         |   |      |   |        |      |  |   |        |  
|Accounts receivable                                                                       |  |                          | (590    | ) |      |   | (3,493 | )    |  |   | (1,609 | )
|Other current assets and other assets                                                     |  |                          | 432     |   |      |   | (594   | )    |  |   | 177    |  
|Accounts payable, accrued liabilities, and other long-term liabilities                    |  |                          | (1,819  | ) |      |   | 2,800  |      |  |   | 1,214  |  
|Accrued merger-related and other costs                                                    |  |                          | (97     | ) |      |   | (136   | )    |  |   | (972   | )
|Deferred revenue                                                                          |  |                          | 1,666   |   |      |   | 1,785  |      |  |   | 4,783  |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) operating activities                                       |  |                          | (4,169  | ) |      |   | 3,817  |      |  |   | 4,710  |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Cash flows used in investing activitiespurchase of property and equipment                |  |                          | (1,522  | ) |      |   | (1,631 | )    |  |   | (938   | )
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Cash flows from financing activities:                                                     |  |                          |         |   |      |   |        |      |  |   |        |  
|Repayments of borrowings                                                                  |  |                          |        |   |      |   |       |      |  |   | (467   | )
|Proceeds from issuance of common stock                                                    |  |                          | 1,414   |   |      |   | 1,357  |      |  |   | 2,154  |  
|Tax benefit from employee stock option plans                                              |  |                          |        |   |      |   | 18     |      |  |   |       |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                                                 |  |                          | 1,414   |   |      |   | 1,375  |      |  |   | 1,687  |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Effect of exchange rate fluctuations                                                      |  |                          | 65      |   |      |   | (2     | )    |  |   | 58     |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                          | (4,212  | ) |      |   | 3,559  |      |  |   | 5,517  |  
|Cash and cash equivalents, beginning of year                                              |  |                          | 30,511  |   |      |   | 26,952 |      |  |   | 21,435 |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents, end of year                                                    |  | $                        | 26,299  |   |      | $ | 30,511 |      |  | $ | 26,952 |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Supplemental disclosures of cash flow information:                                        |  |                          |         |   |      |   |        |      |  |   |        |  
|Cash paid during the year for interest                                                    |  | $                        |        |   |      | $ |       |      |  | $ | 20     |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  
|Cash paid during the year for taxes                                                       |  | $                        | 80      |   |      | $ | 13     |      |  | $ | 11     |  
|                                                                                          |  |                          |         |   |      |   |        |      |  |   |        |  

See accompanying notes to consolidated financial statements.



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T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2007, 2006, and 2005

(1)    Organization

Tumbleweed Communications Corp. (Tumbleweed) is a recognized expert in
providing managed file transfer, email security, and identity validation products for enterprise and government customers of all sizes. With Tumbleweeds products, organizations can block security threats, protect information, confidently
conduct business online, and reduce their cost of doing business. Tumbleweed provides comprehensive solutions for secure file transfer, email threat protection, email encryption, and identity validation that allow organizations to safely and
confidently conduct business over the Internet.

(2)    Summary of Significant Accounting Policies

Basis of Presentation and Consolidation Policy

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

Reclassifications

Certain
reclassifications have been made to prior years amounts to properly state cash capital expenditures in the consolidated financial statement of cash flows and to conform to the current year presentation. The effects of these reclassifications were
immaterial to operating and investing cash flows in 2006 and 2005.

Cash and Cash Equivalents

Tumbleweed considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.

Concentrations of Credit Risk

Financial instruments, which potentially subject Tumbleweed to concentrations of credit risk, consist primarily of cash equivalents and accounts receivable. Tumbleweeds cash equivalents generally consist of money market funds with
qualified financial institutions. To analyze accounts receivable, Tumbleweed performs periodic evaluations of its customers financial condition and, when necessary, records bad debt expense. No single customer comprised 10% or more of
Tumbleweeds accounts receivable balance, net of allowance for doubtful accounts, at December 31, 2007. One customer comprised 27% of Tumbleweed accounts receivable balance, net of allowance for doubtful accounts, at December 31,
2006. This balance was collected in full during the three months ended March 31, 2007. For 2007 and 2005, respectively, no single customer comprised 10% or more of Tumbleweeds revenue. For 2006, one customer comprised 13% of revenue.

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful life of the asset, generally 2 to 5 years for computers, software, furniture, and equipment; and
the shorter of the estimated useful life of the asset or the remaining lease term for leasehold improvements. Tumbleweed recorded depreciation expense of $1.4 million, $1.1 million, and $1.1 million for 2007, 2006, and 2005, respectively.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Maintenance and repairs are expensed as incurred. Renewals and betterments that materially extend the
lives of assets are capitalized and depreciated. Upon disposal, the assets cost and accumulated depreciation are removed from the balance sheet and any resulting gain or loss is recorded in the consolidated statement of operations.

Capitalized Software

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, capitalized
costs for software development have not been material. The period between the achievement of technological feasibility and the general release of Tumbleweeds products has typically been of a short duration.

Restricted Cash and Letters of Credit

Tumbleweed had restricted cash in the amounts of $0 and $26,000 included as a part of Other current assets on its consolidated balance sheets as of December 31, 2007 and 2006, respectively. Tumbleweed had restricted cash in the amounts
of $369,000 and $571,000 included as a part of Other assets on its consolidated balance sheets as of December 31, 2007 and 2006, respectively. The restricted cash primarily relates to letters of credit held by the lessors of Tumbleweeds
Redwood City, California and Sofia, Bulgaria offices and its former office in Palo Alto, California.

Goodwill and Intangible Assets

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



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



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



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



| |  |  | significant decline in Tumbleweeds stock price for a sustained period; and
| | - |  | ---------------------------------------------------------------------------



| |  |  | Tumbleweeds market capitalization relative to its net book value.
| | - |  | ------------------------------------------------------------------

Recoverability of intangible assets held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows
expected to be generated by the asset. 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 assets exceeds the fair value of the assets, generally estimated using
discounted net cash flows. Assets to be disposed of are reported at the lower of their carrying amount or fair value less cost to sell.

As
of December 31, 2007, in connection with the acquisitions of Corvigo inc. (Corvigo), Incubator Limited (Incubator), and Valicert, Inc. (Valicert) on March 18, 2004, March 15, 2004, and
June 23, 2003, respectively, Tumbleweed recognized $33.4 million, $1.4 million, and $13.3 million of goodwill, respectively, representing the excess of the respective purchase prices over the fair values of the acquired net tangible and
identified intangible assets. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, (SFAS 142), the goodwill acquired in the Corvigo,
Incubator, and Valicert acquisitions is not amortized, but instead, the goodwill balances will be tested for impairment at least annually and more frequently if certain indicators are present. Any future impairment loss related to the goodwill
recorded in connection with the acquisitions of Corvigo, Incubator, and Valicert will not be deductible by Tumbleweed for federal income tax purposes.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Revenue Recognition

Tumbleweed derives its revenue from three sources: (i) product revenue, which includes license fees and appliance fees (for products that are
delivered on an appliance platform), and subscription-based license fees; (ii) service revenue, which consists of support and maintenance fees, consulting fees, and training fees; and (iii) intellectual property revenue, which consists of
patent license agreement fees. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of
Tumbleweeds revenue for any period based on the judgments and estimates made by its management.

Tumbleweed recognizes revenue in
accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain
Transactions (SOP 98-9). Tumbleweed makes significant judgments related to revenue recognition. Specifically, as set forth in paragraph 8 of SOP 97-2 in connection with each transaction involving our products, Tumbleweed must
evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv) collectibility is probable. Tumbleweed applies these criteria as discussed below.



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



| |  |  | Delivery has occurred.    Tumbleweed delivers software to its customers physically or electronically. For physical deliveries,
Tumbleweeds transfer terms are typically free on board, or FOB, shipping point. For electronic deliveries, delivery occurs when Tumbleweed provides the customer access codes or keys that allow the customer to take immediate
possession of the software.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The fee is fixed or determinable.Tumbleweeds determination that an arrangement fee is fixed or determinable depends principally
on the arrangements payment terms. Tumbleweeds standard payment terms require the arrangement fee to be due within a maximum of 90 days. Where these terms apply, Tumbleweed regards the fee as fixed or determinable and recognizes revenue
upon delivery pursuant to the terms of the arrangement, assuming all other revenue recognition criteria are met. If the payment terms do not meet this standard, which Tumbleweed refers to as extended payment terms, Tumbleweed does not
consider the fee to be fixed or determinable and generally recognizes revenue when customer installments are due and payable.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Collectibility is probable.    To recognize revenue, Tumbleweed must judge collectibility of the arrangement fees, which it does on a
customer-by-customer basis pursuant to its credit review policy. Tumbleweed typically sells to customers with whom it has a history of successful collection. For new customers, Tumbleweed evaluates their financial position and ability to pay. If
Tumbleweed determines that collectibility is not probable based upon its credit review process or its customers payment history, Tumbleweed recognizes revenue when payment is received.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Tumbleweed allocates revenue on software transactions (referred to as arrangements in the accounting literature) involving multiple elements
to each undelivered element based on their respective fair values. Specifically, in a multi-element arrangement Tumbleweed allocates revenue first to undelivered elements such as support and maintenance, consulting services, and training based on
each elements fair value and the residual is allocated to the product license as product revenue. The fair value of support and maintenance fees is recognized ratably over the contractual term of the maintenance, typically one year. The
fair value of services not considered essential to the functionality of the product or technology delivered is initially deferred and recognized as



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



revenue as the services are performed. Tumbleweeds determination of the fair value of each element in multiple element arrangements is based on
vendor-specific objective evidence (VSOE). Tumbleweed limits its assessment of the VSOE of fair value for each element to the price charged when that element is sold separately.

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

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

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

Tumbleweed recognizes revenue from indirect
channels such as resellers using the same criteria as are used for arrangements obtained through its direct sales team.

Tumbleweed
typically grants its customers a warranty which guarantees that its products will substantially conform to its current specifications for 90 days from the delivery date pursuant to the terms of the arrangement. Tumbleweed accounts for the estimated
cost of product and service warranties in accordance with SFAS 5, Accounting for Contingencies, provided that it is probable that a liability exists, and provided the cost to repair or otherwise satisfy the claim can be reasonably estimated.
The amount of the accrual recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims were $231,000, $278,000, and $0 in 2007, 2006, and 2005, respectively.

Advertising

Tumbleweed expenses
advertising costs as incurred. Total advertising expense was $552,000, $236,000, and $111,000, for 2007, 2006, and 2005, respectively.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Stock-Based Compensation

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

Tumbleweed recognizes stock-based compensation expense for the unvested portion of stock-based compensation awards granted prior to, but not yet vested, as of January 1, 2006 on an accelerated basis over the vesting period of the
individual award consistent with its methodology prior to the adoption of SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R) and consistent with the method described in Financial Accounting Standards Board
Interpretation 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date
fair value estimated in accordance with the provisions of SFAS 123R and compensation cost for these awards is recognized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term.

Prior to January 1, 2006, Tumbleweed accounted for its stock-based compensation arrangements for employees and non-employees using
the intrinsic-value method pursuant to Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (APB25). Accordingly, stock-based compensation expense was generally recorded for fixed plan stock options on
the date of grant only when either options were granted to non-employees or the fair value of the underlying common stock exceeded the exercise price for stock options granted.

Had stock-based compensation expense for Tumbleweeds stock-based compensation plans been determined consistent with the fair value approach set
forth in SFAS 123, Tumbleweeds net losses for 2005 would have been as follows (in thousands, except per share amounts):



|                                                                                             |  |      |         |  
|-------------------------------------------------------------------------------------------- |  | ---- | ------- | -
|                                                                                             |  | 2005 |        
|Net loss as reported                                                                         |  | $    | (3,909  | )
|Add: Stock-based compensation expense included in net loss                                   |  |      | 510     |  
|Less: Total stock-based compensation determined under fair value based method for all awards |  |      | (10,650 | )
|                                                                                             |  |      |         |  
|Net loss pro forma                                                                           |  | $    | (14,049 | )
|                                                                                             |  |      |         |  
|Basic and diluted net loss per share as reported                                             |  | $    | (0.08   | )
|                                                                                             |  |      |         |  
|Basic and diluted net loss per share pro forma                                               |  | $    | (0.29   | )
|                                                                                             |  |      |         |  



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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

On July 19, 2005, Tumbleweed Board of Directors approved the acceleration of vesting of
certain unvested stock options with exercise prices equal to or greater than $3.82 per share previously awarded to its employees (including executive officers) and Directors under Tumbleweed stock option plans. The acceleration of vesting was
effective for stock options outstanding as of July 19, 2005. Options to purchase approximately 1.7 million shares of common stock were accelerated. All of the options accelerated had exercise prices greater than our common stock price of
$3.24 on the date of acceleration. The weighted-average exercise price of the options accelerated was $5.00. In accordance with the provisions of APB25, no stock-based compensation expense was recognized as a result of the acceleration since the
exercise price of all the accelerated options exceeded our common stock price on the date of acceleration. The purpose of the acceleration was to enable Tumbleweed to avoid recognizing compensation expense associated with these options in future
periods in its consolidated statement of operations upon its adoption of SFAS 123R.

Tumbleweed estimates the fair value of stock options
granted using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table. The expected life of the options is based on the weighted-average period of time that options granted are expected to be outstanding,
giving consideration to vesting schedules and Tumbleweeds historical exercise patterns. Tumbleweeds expected volatility is based on the daily historical volatility of Tumbleweeds common stock, over the expected life of the option.
The risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of the option. When the expected term of Tumbleweeds stock-based awards
does not correspond with the terms for which interest rates are quoted, Tumbleweed performs a straight-line interpolation to determine the rate from the available term maturities. Tumbleweed has not historically paid dividends, thus the expected
dividend yield is zero. Tumbleweed issues new shares of common stock upon the exercise of stock options. The assumptions for 2007, 2006, and 2005, respectively, are as follows:



|                                      |  |      |           |   |      |   |           |      |  |   |           |  
|------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                      |  | 2007 |           |   | 2006 |   |           | 2005 | 
|Stock options:                        |  |      |           |   |      |   |           |      |  |   |           |  
|Weighted-average fair value of grants |  | $    | 1.65      |   |      | $ | 1.86      |      |  | $ | 2.16      |  
|Expected life                         |  |      | 4.5 years |   |      |   | 4.5 years |      |  |   | 4.0 years |  
|Expected volatility                   |  |      | 69        | % |      |   | 81        | %    |  |   | 89        | %
|Risk-free interest rate               |  |      | 4.40      | % |      |   | 4.75      | %    |  |   | 3.99      | %
|Dividend yield                        |  |      | 0         | % |      |   | 0         | %    |  |   | 0         | %
|                                      |  |      |           |   |      |   |           |      |  |   |           |  

The cost of restricted stock awards is determined using the fair value of Tumbleweeds common
stock on the date of the grant, and compensation expense is recognized over the vesting period. Vesting periods are determined by Tumbleweed Board of Directors. Generally, restricted stock awards are subject to the employees continuing service
to Tumbleweed. The weighted-average grant date fair value of restricted stock granted during 2007 was $2.62.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Total stock-based compensation expense for 2007, 2006, and 2005 was as follows:



|                                       |  |                          |       |      |   |       |  |   |    
|-------------------------------------- |  | ------------------------ | ----- | ---- | - | ----- |  | - | ---
|                                       |  | Years Ended December 31,
|                                       |  | 2007                     |       | 2006 |   | 2005 
|Cost of product revenue                |  | $                        |      |      | $ | 9     |  | $ |   
|Cost of service revenue                |  |                          | 142   |      |   | 142   |  |   | 2  
|Research and development               |  |                          | 946   |      |   | 1,256 |  |   | 219
|Sales and marketing                    |  |                          | 1,205 |      |   | 569   |  |   | 168
|General and administrative             |  |                          | 2,211 |      |   | 2,629 |  |   | 121
|                                       |  |                          |       |      |   |       |  |   |    
|Total stock-based compensation expense |  | $                        | 4,504 |      | $ | 4,605 |  | $ | 510
|                                       |  |                          |       |      |   |       |  |   |    

Tumbleweed issues new shares of common stock upon the exercise of stock options. The following is
a summary of activity for Tumbleweeds stock option plans for 2007:



|                                                 |  |                 |   |  |                                |      |                                          |      |                                       |   |    
|------------------------------------------------ |  | --------------- | - |  | ------------------------------ | ---- | ---------------------------------------- | ---- | ------------------------------------- | - | ---
|Options                                          |  | Number ofShares |   |  | Weighted-averageExercise Price |      | Weighted-averageRemainingContractualTerm |      | AggregateIntrinsicValue (inthousands)
|Outstanding at January 1, 2007                   |  | 13,919,751      |   |  | $                              | 3.63 |                                          |      |                                       |   |    
|Granted                                          |  | 4,455,450       |   |  |                                | 2.69 |                                          |      |                                       |   |    
|Exercised                                        |  | (714,586        | ) |  |                                | 2.90 |                                          |      |                                       |   |    
|Forfeited, cancelled, and expired                |  | (2,736,934      | ) |  |                                | 4.84 |                                          |      |                                       |   |    
|                                                 |  |                 |   |  |                                |      |                                          |      |                                       |   |    
|Outstanding at December 31, 2007                 |  | 14,923,681      |   |  | $                              | 3.21 |                                          | 7.30 |                                       | $ | 663
|                                                 |  |                 |   |  |                                |      |                                          |      |                                       |   |    
|Vested and expected to vest at December 31, 2007 |  | 12,912,618      |   |  | $                              | 2.59 |                                          | 7.01 |                                       | $ | 655
|                                                 |  |                 |   |  |                                |      |                                          |      |                                       |   |    
|Exercisable at December 31, 2007                 |  | 9,225,997       |   |  | $                              | 3.53 |                                          | 6.23 |                                       | $ | 640
|                                                 |  |                 |   |  |                                |      |                                          |      |                                       |   |    

The aggregate intrinsic value of options exercised under Tumbleweeds stock option plans for
2007 was $700,000, determined as of the date of option exercise. During 2006, the aggregate intrinsic value of options exercised under Tumbleweeds stock option plans was $1.3 million, determined as of the date of option exercise.

As of December 31, 2007 there was $6.3 million of total unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested
stock options. That cost is expected to be recognized over a weighted-average period of 2.9 years. As of December 31, 2006 there was $5.3 million of total unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested
stock options. That cost is expected to be recognized over a weighted-average period of 2.1 years.

Non-vested restricted stock awards as
of December 31, 2007 and 2006 were as follows:



|                                |  |                 |  |                                      |     
|------------------------------- |  | --------------- |  | ------------------------------------ | ----
|Options                         |  | Number ofShares |  | Weighted-averageGrant Date FairValue
|Non-vested at December 31, 2006 |  |                |  | $                                    |    
|Granted                         |  | 83,000          |  |                                      | 2.62
|                                |  |                 |  |                                      |     
|Non-vested at December 31, 2007 |  | 83,000          |  | $                                    | 2.62
|                                |  |                 |  |                                      |     



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



As of December 31, 2007, there was $116,000 of total unrecognized compensation cost, adjusted
for estimated forfeitures, related to non-vested restricted stock awards. That cost is expected to be recognized over a weighted-average period of 2.4 years.

At December 31, 2007, Tumbleweed has the following stock option plans as described below:

1999
Employee Stock Purchase Plan

The 1999 Employee Stock Purchase Plan (the Purchase Plan) was approved by Tumbleweeds
stockholders on August 3, 1999, which allows eligible employees to purchase common stock at a discount from fair market value. A total of 500,000 shares of common stock has been reserved for issuance under the Purchase Plan for each fiscal year
occurring during the term of the Purchase Plan, which will terminate in 2009. Tumbleweed suspended the Purchase Plan in 2002.

1993
Stock Option Plan

On September 30, 1993, Tumbleweed adopted the 1993 Stock Option Plan (the Plan). In 1999,
Tumbleweeds Board of Directors approved an amendment to the plan to increase the number of shares authorized for issuance by 650,000 shares to a total of 3,768,500 authorized shares. In August 1999, Tumbleweed ceased granting further options
under the Plan. Under the Plan, the exercise price for incentive options is at least 100% of the fair market value on the date of grant. The exercise price for nonqualified stock options is at least 85% of the fair market value on the date of grant.
Options generally expire in ten years. Vesting periods are determined by Tumbleweeds Board of Directors and generally provide for 25% of the options to vest on the first anniversary date of the grant with the remaining options vesting monthly
over the following 36 months.

1999 Omnibus Stock Incentive Plan

The 1999 Omnibus Stock Incentive Plan (the Incentive Plan) was approved by Tumbleweeds stockholders on August 3, 1999, for the
benefit of Tumbleweeds officers, directors, key employees, advisors and consultants. An aggregate of 16,882,858 shares of common stock is reserved for issuance under the Incentive Plan, which provides for the issuance of stock-based incentive
awards, including stock options, stock appreciation rights, limited stock appreciation rights, restricted stock, deferred stock, and performance shares. Options generally expire in ten years. The Incentive Plan provides for an automatic annual
increase in the number of stock options available for grant of the lesser of 2,000,000 shares or 5% of the number of Tumbleweeds outstanding shares on the last day of the immediately preceding fiscal year.

2000 NSO Incentive Stock Plan

The
2000 NSO Incentive Stock Plan (the NSO Incentive Plan) was adopted by Tumbleweeds Board of Directors on July 10, 2000. The NSO Incentive Plan qualifies as a broadly based plan and is for the benefit of
Tumbleweeds officers, directors, employees, advisors, and consultants. It provides for the issuance of stock-based incentive awards, including stock options, stock appreciation rights, restricted stock, deferred stock, and performance shares
or any combination of such. The options granted under the NSO Incentive Plan are not intended to qualify as incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986. An aggregate of 4,181,500
shares of common stock are reserved for issuance under the NSO Incentive Plan, which will terminate on July 10, 2010.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Under the terms of the NSO Incentive Plan, the exercise price for stock options is determined by the
Board of Directors, Compensation Committee, or Administrators, generally 100% of the fair market value on the date of grant. The option term is determined by the Board of Directors, Compensation Committee, or Administrators, generally no longer than
ten years. Vesting periods are determined by the Board of Directors, Compensation Committee, or Administrators and generally provide for 25% of the options to vest on the first anniversary date of the grant with the remaining options vesting monthly
over the following 36 months.

Interface Stock Option Plans

On September 1, 2000, Tumbleweed assumed the Interface 1992 Stock Option Plan (the 1992 Plan) in connection with the Interface, Inc.
(Interface) acquisition. The 1992 Plan provided for the grant of both incentive stock options and non-qualified options to officers and key employees at not less than market price on the date of grant as determined by the Board of
Directors. Under the 1992 Plan, options generally vest at the rate of 33% per year after one year from the date of grant and have a term of ten years.

Valicert Stock Option Plans

On June 23, 2003, Tumbleweed assumed the Valicert 1998 Stock Option
Plan, the 2001 Non-Statutory Stock Plan, the 1996 Equity Incentive Plan, and the Receipt.com Plan in connection with the acquisition of Valicert. These stock plans provide for the grant of options and restricted stock to employees, consultants and
directors. Incentive stock options are granted at fair market value on the date of grant. Non-statutory options may be offered at not less than 85% of the fair market value on the date of the grant. Options generally vest over four years, and have a
maximum term of ten years. The number of stock options available for grant automatically increases on the first day of each fiscal year by the lesser of 1,413,912 shares or 5% of the number of Tumbleweeds outstanding shares on the last day of
the preceding year. An aggregate of 8,959,813 shares of common stock is reserved for issuance under the Valicert stock option plans.

Valicert stock option plans assumed by Tumbleweed were amended to conform with Tumbleweed stock option plans. This provides Tumbleweed with the flexibility to issue additional options as needed and promotes uniformity in new options issued
to ex-Valicert and Tumbleweed employees. Specifically, the 2001 Non-Statutory Stock Plan, the 1998 Stock Option Plan and the 1996 Equity Incentive Plan, were amended, including the forms of option agreements under each such plan, to conform the
terms and conditions applicable to options granted under such plans to the terms and conditions applicable to options granted under Tumbleweeds 1999 Omnibus Incentive Plan, including the form of option agreement under such plan.

In addition to conforming the terms of the Valicert stock option plans assumed by Tumbleweed to Tumbleweeds stock option plan, the 1998 Stock
Option Plan was further amended prior to the closing of the merger to provide the following:



| |  |  | the number of shares of Valicert common stock available for grant under the 1998 Stock Option Plan immediately following the close of the merger was no less than
1.5 million shares of Valicert common stock; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the provision of the 1998 Stock Option Plan that provides for a 5% annual increase in the number of stock options available for grant under such plan shall be
calculated as a percentage of the number of Tumbleweed shares issued and outstanding rather than the number of Valicert shares issued and outstanding.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Corvigo Stock Option Plan

On March 18, 2004, Tumbleweed assumed the Corvigo 2002 Stock Option Plan in connection with the acquisition of Corvigo. This plan provides for the
grant of options to employees, consultants and directors. Incentive stock options are granted at fair market value on the date of grant. Non-statutory options may be offered at not less than 85% of the fair market value on the date of the grant.
Generally, 25% of the options vest on the first anniversary date of the grant with the remaining options vesting monthly over the following 36 months. Options have a maximum term of ten years. An aggregate of 884,678 shares of common stock is
reserved for issuance under the Corvigo 2002 Stock Option Plan, which will not grant new options after November 15, 2012.

The
following table summarizes information about stock options outstanding as of December 31, 2007:



|                         |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      
|------------------------ |  | ------------------- |  | ---------------------------- | ----- | --------------------------------------- | --- | ----------------- | --------- | ---------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable         
|Range of Exercise Prices |  | NumberOutstanding   |  | WeightedAverageExercisePrice |       | AverageRemainingContractualLife (Years) |     | NumberExercisable |           | WeightedAverageExercisePrice
|$0.00$0.99              |  | 704,624             |  | $                            | 0.91  |                                         | 4.7 |                   | 704,624   |                              | $ | 0.91 
|1.002.52                |  | 2,715,626           |  |                              | 2.03  |                                         | 8.4 |                   | 1,025,339 |                              |   | 2.06 
|2.532.99                |  | 6,336,491           |  |                              | 2.73  |                                         | 7.8 |                   | 4,087,185 |                              |   | 2.71 
|3.004.59                |  | 3,938,019           |  |                              | 3.32  |                                         | 6.8 |                   | 2,179,928 |                              |   | 3.39 
|4.805.99                |  | 668,434             |  |                              | 4.83  |                                         | 6.3 |                   | 668,434   |                              |   | 4.83 
|6.009.99                |  | 215,390             |  |                              | 6.84  |                                         | 5.4 |                   | 215,390   |                              |   | 6.84 
|10.0017.99              |  | 208,780             |  |                              | 13.83 |                                         | 2.1 |                   | 208,780   |                              |   | 13.83
|20.00118.99             |  | 136,317             |  |                              | 27.47 |                                         | 2.4 |                   | 136,317   |                              |   | 27.47
|                         |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      
|$0.05$118.44            |  | 14,923,681          |  | $                            | 3.21  |                                         | 7.3 |                   | 9,225,997 |                              | $ | 3.53 
|                         |  |                     |  |                              |       |                                         |     |                   |           |                              |   |      

In conjunction with various financing arrangements and employment recruitment services provided to
us in 1998, 1999, and 2001, we issued warrants to purchase an aggregate of approximately 583,113 shares of common stock. Additional warrants to purchase an aggregate of 289,789 shares of common stock were assumed in 2003 as a result of the merger
with Valicert, none of which remained outstanding at December 31, 2007. As of December 31, 2007 and 2006, respectively, there were 69,015 and 72,845 warrants outstanding to purchase our common stock. Of the warrants that remain outstanding
at December 31, 2007, 21,129 expire in April 2008 with an exercise price of $4.91; 10,266 expire in April 2008 with an exercise price of $5.84; 2,566 expire in February 2010 with an exercise price of $49.09; 1,283 expire in April 2010 with an
exercise price of $49.09; and the remaining 33,771 expire in June 2011 with an exercise price of $6.66. During 2007 and 2006 no warrants were exercised.

Net Loss per Share

Basic net loss per common share has been computed using the weighted-average
number of shares of common stock outstanding during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):



|                                                                                      |  |                          |         |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                      |  | Years Ended December 31, |        
|                                                                                      |  | 2007                     |         |   | 2006 |   |        | 2005 | 
|Net loss                                                                              |  | $                        | (10,765 | ) |      | $ | (4,882 | )    |  | $ | (3,909 | )
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                          | 51,028  |   |      |   | 50,007 |      |  |   | 48,627 |  
|                                                                                      |  |                          |         |   |      |   |        |      |  |   |        |  
|Net loss per sharebasic and diluted                                                  |  | $                        | (0.21   | ) |      | $ | (0.10  | )    |  | $ | (0.08  | )
|                                                                                      |  |                          |         |   |      |   |        |      |  |   |        |  



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



|                                                                                                                                                                                                              |  |                          |  |       |  |      
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ |  | ----- |  | -----
|                                                                                                                                                                                                              |  | Years Ended December 31,
|                                                                                                                                                                                                              |  | 2007                     |  | 2006  |  | 2005 
|Warrants and options for which the exercise price was less than the average fair market value of Tumbleweeds common stock during the
period but were excluded as inclusion would decrease net loss per share |  |                         |  |      |  | 2,385
|Warrants and options excluded due to the exercise price exceeding the average fair market value of common stock during the
period                                                                             |  | 12,761                   |  | 7,725 |  | 7,082
|                                                                                                                                                                                                              |  |                          |  |       |  |      
|Total potential common shares excluded from diluted net loss per share                                                                                                                                        |  | 12,761                   |  | 7,725 |  | 9,467
|                                                                                                                                                                                                              |  |                          |  |       |  |      

Fair Value of Financial Instruments

The fair values of Tumbleweeds cash, cash equivalents, accounts receivable and accounts payable approximate their carrying values due to the short
maturity or variable-rate structure of those instruments.

Deferred Revenue and Accounts Receivable

Tumbleweed records as deferred revenue any billed amounts due from customers in excess of revenues recognized. Advance payments are also recorded as
deferred revenue until the products are shipped, services are delivered, or obligations are met. Accounts receivable includes amounts due from customers for which revenue has been recognized or amounts are legally due. Tumbleweed evaluates the
collectibility of its accounts receivable based on a combination of factors. In cases where Tumbleweed is aware of circumstances that may impair a specific customers ability to meet its financial obligations, Tumbleweed records a specific
allowance against amounts owed to it by that customer, and thereby reduces the net recognized receivable to the amount it reasonably believes will be collected. If all collection efforts have been exhausted, Tumbleweed writes off the receivable
against the allowance. In addition, Tumbleweed analyzes its accounts receivable balance in total, including review of historical bad debts, current economic trends, aging of the balances and estimated collectibility percentages for different aging
ranges, and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States
of America 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 consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period. Specifically, there are significant judgments related to the allowance for doubtful accounts, the valuation of long-term assets, accrued liabilities, accrued merger-related and other
costs, and revenue recognition. Actual results could differ from those estimates.

Foreign Currency

The functional currency for each foreign subsidiary is its respective local currency. Accordingly, all assets and liabilities related to these operations
are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income account in stockholders equity. Revenues and expenses
are translated at average exchange rates in effect during the period. Foreign currency transaction gains and losses are included in the results of operations. At December 31, 2007 and 2006, no foreign currency transactions were hedged.



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Recent Accounting Pronouncements

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

As of
January 1, 2007, Tumbleweed did not have any federal, state, and foreign unrecognized tax benefits. Upon the adoption of FIN 48, Tumbleweed adopted an accounting policy to classify interest and penalties on unrecognized tax benefits as
income tax expense. For the years prior to adoption of FIN 48, Tumbleweed did not have interest or penalties on unrecognized tax benefits and therefore, had no established accounting policy. As of January 1, 2007, Tumbleweed had no interest or
penalties accrued on unrecognized tax benefits. Tumbleweed files income tax returns in the U.S. federal jurisdiction, various states, and foreign jurisdictions. Due to its net operating losses, Tumbleweed is subject to examinations by U.S. federal
and state income tax authorities for all its historical periods. As of December 31, 2007, Tumbleweed did not have and does not expect to have any material changes to unrecognized tax benefits within the next twelve months.

In June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue 06-03, How Sales Taxes Collected from
Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (EITF 06-03). EITF 06-03 provides guidance on an entitys disclosure of its accounting policy regarding the gross or net
presentation of certain taxes and provides that if taxes included in gross revenues are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual
periods). Taxes within the scope of EITF 06-03 are those that are imposed on and concurrent with a specific revenue-producing transaction. The guidance is effective for interim and annual periods beginning after December 15, 2006. Tumbleweed
did not have and does not expect to have any material impact of EITF 06-03 on its financial position and results of operations.

In June
2006, the FASB ratified the EITF consensus on Issue 06-02, Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences (EITF 06-02). EITF 06-02
requires that the costs associated with unrestricted sabbaticals and other similar benefit arrangements be recognized over the service period during which the employee earns the benefit. The provisions of EITF 06-02 are effective for fiscal years
beginning after December 15, 2006. The provisions of EITF 06-02 were applied by Tumbleweed through a cumulative effect adjustment to its accumulated deficit that resulted in increases of $117,000 each to its accumulated deficit and accrued
liabilities balances, respectively. The changes in accumulated deficit for 2007 are as follows:



|                                |  |                |          |  
|------------------------------- |  | -------------- | -------- | -
|                                |  | (In thousands) |         
|Balance as of December 31, 2006 |  | $              | (295,812 | )
|Net loss                        |  |                | (10,765  | )
|Adoption effect of EITF 06-02   |  |                | (117     | )
|                                |  |                |          |  
|Balance as of December 31, 2007 |  | $              | (306,694 | )
|                                |  |                |          |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and
does not expand the use of fair value in any new circumstances. SFAS 157 is generally effective for financial statements issued for fiscal years beginning after November 15, 2007 and for nonfinancial assets and liabilities that are not
remesaured at fair value on a recurring basis for fiscal years beginning after December 31, 2008. Tumbleweed does not expect SFAS 157 to have a material impact on its financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), and SFAS
No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51 (SFAS 160). SFAS 141R changes how business acquisitions are accounted for and
impacts financial statements both on the acquisition date and in subsequent periods. SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of
equity. SFAS 141R and SFAS 160 are effective for fiscal years beginning after December 15, 2008 and will be adopted by Tumbleweed beginning in the first quarter of 2009. Although Tumbleweed will continue to evaluate the application of SFAS 141R
and SFAS 160, it does not currently believe adoption will have a material impact on its financial condition or operating results.

Merger-related and Other Credit

Merger-related and other costs of a net credit of $96,000 for 2005 consist of a $296,000
credit related to the termination of an operating lease in Slough, United Kingdom partially offset by a $200,000 severance cost associated with the resignation of our former Chief Executive Officer. The combined cost of the final lease settlement
payments, commissions, brokerage fees, and legal fees related to the termination of the Slough lease was less than the existing accrual for the loss on the lease, resulting in the expense credit. The Slough lease was assumed during the acquisition
of Interface in 2000 and was for a term ending in 2020 with quarterly rent payments of approximately $65,000. The final lease settlement payment for the Slough lease of approximately $113,000 was made in July 2005. There were no merger-related and
other costs in 2007 or 2006.

The following table describes accrued merger-related and other costs recorded in 2007 and 2006 (in
thousands):



|                          |  |                |     |   |                                  |   |     |       |  |   |      |  
|------------------------- |  | -------------- | --- | - | -------------------------------- | - | --- | ----- |  | - | ---- | -
|                          |  | Severancecosts |     |   | Anticipatedoperatinglease losses |   |     | Total | 
|Balance December 31, 2005 |  | $              | 149 |   |                                  | $ | 84  |       |  | $ | 233  |  
|2006 payments             |  |                | (92 | ) |                                  |   | (44 | )     |  |   | (136 | )
|                          |  |                |     |   |                                  |   |     |       |  |   |      |  
|Balance December 31, 2006 |  | $              | 57  |   |                                  | $ | 40  |       |  | $ | 97   |  
|2007 payments             |  |                | (57 | ) |                                  |   | (40 | )     |  |   | (97  | )
|                          |  |                |     |   |                                  |   |     |       |  |   |      |  
|Balance December 31, 2007 |  | $              |    |   |                                  | $ |    |       |  | $ |     |  
|                          |  |                |     |   |                                  |   |     |       |  |   |      |  

Restructuring costs

Restructuring costs of $930,000 for 2007 were comprised of severance costs to terminated employees and associated legal expenses. The restructuring
program included a targeted staff reduction of approximately 40 employees. As of December 31, 2007, the remaining liability related to these costs is $520,000. There were no restructuring costs in 2006 or 2005.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(4)    Financial Statement Components

A summary of cash and cash equivalents as of December 31, 2007 and 2006 is as follows (in thousands):



|                          |  |      |        |      |   |       
|------------------------- |  | ---- | ------ | ---- | - | ------
|                          |  | 2007 |        | 2006
|Cash                      |  | $    | 7,644  |      | $ | 5,995 
|Money market mutual funds |  |      | 18,655 |      |   | 24,516
|                          |  |      |        |      |   |       
|Cash and cash equivalents |  | $    | 26,299 |      | $ | 30,511
|                          |  |      |        |      |   |       

A summary of property and equipment as of December 31, 2007 and 2006 is as follows (in
thousands):



|                              |  |      |         |   |      |   |         |  
|----------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                              |  | 2007 |         |   | 2006 |  
|Office furniture              |  | $    | 2,068   |   |      | $ | 2,047   |  
|Computers and equipment       |  |      | 13,163  |   |      |   | 11,726  |  
|Leasehold improvements        |  |      | 1,011   |   |      |   | 1,010   |  
|                              |  |      |         |   |      |   |         |  
|                              |  |      | 16,242  |   |      |   | 14,783  |  
|Less accumulated depreciation |  |      | (14,204 | ) |      |   | (12,963 | )
|                              |  |      |         |   |      |   |         |  
|                              |  | $    | 2,038   |   |      | $ | 1,820   |  
|                              |  |      |         |   |      |   |         |  

A summary of intangible assets as of December 31, 2007 is as follows (in thousands):



|                                      |  |                              |  |                     |        |                         |   |         |     |  |   |    
|------------------------------------- |  | ---------------------------- |  | ------------------- | ------ | ----------------------- | - | ------- | --- |  | - | ---
|                                      |  | Amortizationperiod(in years) |  | Grosscarryingamount |        | Accumulatedamortization |   |         | Net
|Core/ developed technology            |  | 3 to 4                       |  | $                   | 5,850  |                         | $ | (5,675  | )   |  | $ | 175
|Customer base and reseller agreements |  | 3                            |  |                     | 3,700  |                         |   | (3,676  | )   |  |   | 24 
|Maintenance agreements                |  | 3 to 4                       |  |                     | 1,200  |                         |   | (1,174  | )   |  |   | 26 
|Trademarks and trade names            |  | 4                            |  |                     | 350    |                         |   | (342    | )   |  |   | 8  
|                                      |  |                              |  |                     |        |                         |   |         |     |  |   |    
|                                      |  |                              |  | $                   | 11,100 |                         | $ | (10,867 | )   |  | $ | 233
|                                      |  |                              |  |                     |        |                         |   |         |     |  |   |    

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



|                                      |  |                              |  |                     |        |                         |   |        |     |  |   |      
|------------------------------------- |  | ---------------------------- |  | ------------------- | ------ | ----------------------- | - | ------ | --- |  | - | -----
|                                      |  | Amortizationperiod(in years) |  | Grosscarryingamount |        | Accumulatedamortization |   |        | Net
|Core/ developed technology            |  | 3 to 4                       |  | $                   | 5,850  |                         | $ | (4,863 | )   |  | $ | 987  
|Customer base and reseller agreements |  | 3                            |  |                     | 3,700  |                         |   | (3,432 | )   |  |   | 268  
|Maintenance agreements                |  | 3 to 4                       |  |                     | 1,200  |                         |   | (1,049 | )   |  |   | 151  
|Trademarks and trade names            |  | 4                            |  |                     | 350    |                         |   | (286   | )   |  |   | 64   
|                                      |  |                              |  |                     |        |                         |   |        |     |  |   |      
|                                      |  |                              |  | $                   | 11,100 |                         | $ | (9,630 | )   |  | $ | 1,470
|                                      |  |                              |  |                     |        |                         |   |        |     |  |   |      

Intangible assets will be amortized in full in the three months ended March 31, 2008.
Expected amortization expense for 2008 is $233,000.

Goodwill represents the excess of the purchase price over the fair value of acquired
net tangible and identified intangible assets. In accordance with the provisions of SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead, is tested for impairment at least annually and more frequently if



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certain impairment conditions exist. Tumbleweed completed its annual assessment of goodwill in the three months ended June 30, 2007 and no impairment of
goodwill was determined as a result of this assessment. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes.

A summary of accrued liabilities as of December 31, 2007 and 2006 is as follows (in thousands):



|                              |  |      |       |      |   |      
|----------------------------- |  | ---- | ----- | ---- | - | -----
|                              |  | 2007 |       | 2006
|Accrued compensation          |  | $    | 2,225 |      | $ | 3,735
|Accrued restructuring charges |  |      | 520   |      |   |     
|Accrued professional fees     |  |      | 903   |      |   | 613  
|Accrued taxes                 |  |      | 307   |      |   | 456  
|Other                         |  |      | 2,840 |      |   | 2,718
|                              |  |      |       |      |   |      
|                              |  | $    | 6,795 |      | $ | 7,522
|                              |  |      |       |      |   |      

Other income, net consisted of the following (in thousands):



|                                                           |  |                          |       |   |      |   |       |      |  |   |     |  
|---------------------------------------------------------- |  | ------------------------ | ----- | - | ---- | - | ----- | ---- |  | - | --- | -
|                                                           |  | Years Ended December 31, |      
|                                                           |  | 2007                     |       |   | 2006 |   |       | 2005 | 
|Interest income                                            |  | $                        | 1,338 |   |      | $ | 1,237 |      |  | $ | 611 |  
|Interest expense                                           |  |                          |      |   |      |   |      |      |  |   | (35 | )
|Recovery of value added tax related to Valicert subsidiary |  |                          |      |   |      |   |      |      |  |   | 204 |  
|Other, net                                                 |  |                          | (2    | ) |      |   | (31   | )    |  |   | 202 |  
|                                                           |  |                          |       |   |      |   |       |      |  |   |     |  
|                                                           |  | $                        | 1,336 |   |      | $ | 1,206 |      |  | $ | 982 |  
|                                                           |  |                          |       |   |      |   |       |      |  |   |     |  

Allowance for Doubtful Accounts (in thousands):



|                                 |  |                              |     |           |    |            |      |   |                        |   |    
|-------------------------------- |  | ---------------------------- | --- | --------- | -- | ---------- | ---- | - | ---------------------- | - | ---
|Description                      |  | Balance atBeginningof Period |     | Additions |    | Reductions |      |   | Balanceat Endof Period
|                                 |  |                              |     | (a)       |    | (b)        |      |   |                       
|Allowance for doubtful accounts: |  |                              |     |           |    |            |      |   |                        |   |    
|Year Ended December 31, 2005     |  | $                            | 605 |           |   |            | (195 | ) |                        | $ | 410
|Year Ended December 31, 2006     |  | $                            | 410 |           | 55 |            | (34  | ) |                        | $ | 431
|Year Ended December 31, 2007     |  | $                            | 431 |           | 22 |            | (85  | ) |                        | $ | 368



|(a) | Additions relate to bad debt expense
|--- | ------------------------------------

|(b) | Reductions relate to write-offs of specific accounts receivable, net of recoveries.
|--- | -----------------------------------------------------------------------------------

(5)    Related Party and Other Transactions

Legal Counsel

Gregory C. Smith, a brother of Jeffrey C. Smith, a director and Tumbleweeds former Chairman and Chief Executive Officer, is a partner of the law
firm of Skadden, Arps, Slate, Meagher & Flom LLP (Skadden Arps), which began providing legal services to Tumbleweed in July 1998. Total fees paid to Skadden Arps were approximately $277,000, $430,000, and $315,000 in 2007, 2006,
and 2005, respectively, for matters relating to Tumbleweeds intellectual property and ongoing general and other litigation matters.



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(6)    Debt

In the acquisition of Valicert, Tumbleweed assumed debt of $855,000 resulting from equipment leases with two financing companies. During 2003, this debt was refinanced with an $800,000 loan with a bank. This debt was
repaid in full during 2005. No debt was outstanding at either December 31, 2007 or 2006.

(7)    Income Taxes

The components of loss before income taxes attributable to domestic and foreign operations for the years ended December 31, 2007, 2006, and 2005,
respectively, are presented below (in thousands):



|                               |  |      |         |   |      |   |        |      |  |   |        |  
|------------------------------ |  | ---- | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                               |  | 2007 |         |   | 2006 |   |        | 2005 | 
|U.S.                           |  | $    | (11,267 | ) |      | $ | (5,108 | )    |  | $ | (4,146 | )
|Foreign                        |  |      | 518     |   |      |   | 341    |      |  |   | 260    |  
|                               |  |      |         |   |      |   |        |      |  |   |        |  
|Total loss before income taxes |  | $    | (10,749 | ) |      | $ | (4,767 | )    |  | $ | (3,886 | )
|                               |  |      |         |   |      |   |        |      |  |   |        |  

The federal and foreign income tax provisions for the years ended December 31, 2007, 2006,
and 2005, respectively, are presented below (in thousands):



|                           |  |      |     |   |      |   |      |  |   |   
|-------------------------- |  | ---- | --- | - | ---- | - | ---- |  | - | --
|                           |  | 2007 |     |   | 2006 |   | 2005
|U.S.                       |  | $    | (14 | ) |      | $ | 70   |  | $ |  
|Foreign                    |  |      | 30  |   |      |   | 45   |  |   | 23
|                           |  |      |     |   |      |   |      |  |   |   
|Total income tax provision |  | $    | 16  |   |      | $ | 115  |  | $ | 23
|                           |  |      |     |   |      |   |      |  |   |   

The amount of income tax expense recorded for 2007, 2006, and 2005 differed from the amounts
computed by applying the U.S. federal income tax rate of 35% to pretax income as a result of the following (in thousands):



|                                     |  |      |        |   |      |   |        |      |  |   |        |  
|------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                     |  | 2007 |        |   | 2006 |   |        | 2005 | 
|Statutory federal income tax benefit |  | $    | (3,762 | ) |      | $ | (1,668 | )    |  | $ | (1,360 | )
|State income tax expense (benefit)   |  |      |       |   |      |   | 1      |      |  |   | (121   | )
|Foreign income tax expense           |  |      |       |   |      |   |       |      |  |   | 23     |  
|Losses and credits, not utilized     |  |      | 3,396  |   |      |   | 1,586  |      |  |   | 1,798  |  
|Federal R&D credit                   |  |      | (196   | ) |      |   | (159   | )    |  |   | (400   | )
|Stock-based compensation expense     |  |      | 681    |   |      |   | 431    |      |  |   | 178    |  
|Foreign rate differential            |  |      | (129   | ) |      |   | (67    | )    |  |   | (68    | )
|Other permanent differences          |  |      | 26     |   |      |   | (9     | )    |  |   | (27    | )
|                                     |  |      |        |   |      |   |        |      |  |   |        |  
|Provision for income taxes           |  | $    | 16     |   |      | $ | 115    |      |  | $ | 23     |  
|                                     |  |      |        |   |      |   |        |      |  |   |        |  



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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The types of temporary differences that give rise to significant portions of Tumbleweeds
deferred tax assets and liabilities as of December 31, 2007 and 2006, respectively, are presented below (in thousands):



|                                                                  |  |      |          |   |      |   |          |  
|----------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                                                  |  | 2007 |          |   | 2006 |  
|Deferred tax assets:                                              |  |      |          |   |      |   |          |  
|Deferred revenue, reserves, and accruals not currently deductible |  | $    | 5,997    |   |      | $ | 4,884    |  
|Deferred research and development costs                           |  |      | 801      |   |      |   | 38       |  
|Net operating loss carryforwards                                  |  | $    | 108,768  |   |      | $ | 107,753  |  
|Tax credit carryforwards                                          |  |      | 8,108    |   |      |   | 8,327    |  
|Deferred research and development costs                           |  |      |         |   |      |   | 347      |  
|Property and equipment                                            |  |      | 516      |   |      |   | 555      |  
|                                                                  |  |      |          |   |      |   |          |  
|Gross deferred tax assets                                         |  | $    | 124,191  |   |      | $ | 121,904  |  
|Less: valuation allowance                                         |  |      | (123,601 | ) |      |   | (121,311 | )
|                                                                  |  |      |          |   |      |   |          |  
|Net deferred tax assets                                           |  |      | 590      |   |      |   | 593      |  
|Deferred tax liabilities:                                         |  |      |          |   |      |   |          |  
|Acquired intangibles                                              |  |      | (590     | ) |      |   | (593     | )
|                                                                  |  |      |          |   |      |   |          |  
|Net deferred tax assets (liabilities)                             |  | $    |         |   |      | $ |         |  
|                                                                  |  |      |          |   |      |   |          |  

A valuation allowance against Tumbleweeds net deferred tax assets has been established since
it cannot be concluded that it is more likely than not that deferred tax assets in excess of deferred tax liabilities will be realized. The valuation allowance of $121.3 million at December 31, 2006 has increased by $2.3 million to $123.6
million at December 31, 2007. The valuation allowance at December 31, 2007 includes approximately $21.0 million related to windfall stock option deductions, the benefit of which will be credited to additional paid in capital if and when
realized.

In connection with certain the acquisitions, deferred tax assets of approximately $43.2 million were recorded. A full valuation
allowance was recorded against these deferred tax assets. In the event the valuation allowance related to these acquired deferred tax assets is reduced, the tax benefits of such deferred tax assets will be applied, first, to reduce to zero any
goodwill related to this acquisition; second, to reduce to zero other non-current intangible assets related to this acquisition; and third, to reduce income tax expense.

As of December 31, 2007, Tumbleweed had net operating loss carryforwards for Federal and California income tax purposes of approximately $296.9 million and $108.3 million, respectively, available to reduce future
income subject to income taxes. The federal net operating loss carryforwards will expire in the years 2008 through 2026 and the California net operating loss carryforwards expire in the years 2008 through 2016.

As of December 31, 2007, Tumbleweed also had research and development tax credit carryforwards for Federal and California income tax return purposes
of approximately $4.3 million and $5.7 million, respectively, available to reduce future income taxes. Tumbleweed also has California Manufacturing Credit carryforwards of $262,000. The Federal research and development tax credit will expire in
years 2008 through 2027. The California research and development tax credit carries forward indefinitely.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Tumbleweeds ability to utilize the net operating losses and tax credit carryforwards in the
future may be subject to substantial restriction in the event of past or future ownership changes as defined in Section 382 of the Internal Revenue Code and similar state tax law.

(8)    Stockholders Equity

Under Tumbleweeds certificate of
incorporation, Tumbleweed is authorized to issue 100,000,000 shares of common stock, each with a par value of $0.001. As of December 31, 2007 and 2006, respectively, Tumbleweed had 51,129,313 and 50,427,209 shares outstanding. Tumbleweed is
also authorized to issue 10,000,000 shares of preferred stock, each with a par value of $0.001. Tumbleweed has zero preferred shares outstanding as of December 31, 2007 and 2006, respectively.

(9)    Employee Benefit Plan

Tumbleweed has a 401(k) plan that allows eligible employees to contribute a percentage of their compensation, limited to $15,500 ($20,500 for employees over age 50), $15,000 ($20,000 for employees over age 50), and $14,000 ($18,000 for
employees over age 50) in 2007, 2006, and 2005, respectively. Tumbleweed did not match contributions to employees 401(k) plans in 2007, 2006, or 2005.

(10)    Commitments and Contingencies

Lease Commitments

Tumbleweed leases its facilities and certain equipment under operating lease agreements. The facilities leases expire at various dates through 2012.
Tumbleweed has an operating lease covering approximately 40,000 square feet of office space in Redwood City, California. The lease expires in July 2008 with current monthly rent payments of approximately $88,000. Tumbleweed is in the process of
determining whether to renew this lease or relocate to a new leased office facility.

Future minimum lease payments for operating leases as
of December 31, 2007, are as follows (in thousands):



|                              |  |                 |      
|----------------------------- |  | --------------- | -----
|Year Ending December 31,      |  | OperatingLeases
|2008                          |  |                 | 1,221
|2009                          |  |                 | 434  
|2010                          |  |                 | 404  
|2011                          |  |                 | 404  
|2012                          |  |                 | 387  
|                              |  |                 |      
|Future minimum lease payments |  | $               | 2,850
|                              |  |                 |      

Total rent expense under operating leases for 2007, 2006, and 2005, was $1.9 million, $1.6
million, and $1.5 million, respectively.

Contingencies

In December 2001, certain plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York (the
District Court) on behalf of purchasers of the common stock of Valicert, Inc. (which was later acquired by Tumbleweed) alleging violations of federal securities laws. In re Valicert, Inc. Initial Public Offering Securities
Litigation, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offering



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Securities Litigation, No. 21 MC 92 (SAS). The operative amended complaint is brought on purported behalf of all persons who purchased Valicert
common stock from the date of its July 27, 2000 initial public offering (IPO) through December 6, 2000. It names as defendants Valicert, its former Chief Executive Officer, and its Chief Financial Officer (the Valicert
Defendants), as well as an investment banking firm that served as an underwriter for the IPO. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, on the grounds that the registration statement for the IPO did not disclose that: (1) the underwriter agreed to allow certain customers to purchase shares in the IPO in exchange for excess commissions to be paid to the underwriter; and
(2) the underwriter arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. The complaint also appears to allege that false or misleading analyst reports were issued. The complaint does not claim
any specific amount of damages. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial purposes. In February 2003, the
Court issued a ruling on all defendants motions to dismiss, denying Valicerts motion to dismiss the claims under the Securities Act of 1933, but granting Valicerts motion to dismiss the claims under the Securities Exchange Act of
1934.

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

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

Accordingly, the stay remains in place and the plaintiffs and issuers have stated that they
are prepared to discuss how the settlement might be amended or renegotiated to comply with the ruling of the Court of Appeals. Failure of the District Court to approve the settlement (or an amended or renegotiated settlement) followed by
an adverse outcome could harm Tumbleweeds business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve
for any potential loss, as Tumbleweed does not consider a loss to be probable at this time. All costs incurred as a result of this legal proceeding are charged to expense as incurred.

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



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

(11)    Indemnifications

In the ordinary course of business, Tumbleweed enters into contractual arrangements under which it may agree to indemnify the third-party to such
arrangement from any losses incurred relating to the services they perform on behalf of Tumbleweed or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to
past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments Tumbleweed has made related to these indemnifications have been immaterial.

(12)    Segment Information

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

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



|                                |  |                          |        |      |   |        |  |   |       
|------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                |  | Years Ended December 31,
|                                |  | 2007                     |        | 2006 |   | 2005  
|North America                   |  | $                        | 50,377 |      | $ | 57,666 |  | $ | 44,940
|Europe, Middle East, and Africa |  |                          | 4,901  |      |   | 2,980  |  |   | 3,742 
|Asia Pacific                    |  |                          | 2,001  |      |   | 1,024  |  |   | 1,074 
|Latin America                   |  |                          | 176    |      |   | 324    |  |   | 245   
|                                |  |                          |        |      |   |        |  |   |       
|Total revenue                   |  | $                        | 57,455 |      | $ | 61,994 |  | $ | 50,001
|                                |  |                          |        |      |   |        |  |   |       

Revenue information by product area is as follows (in thousands):



|                                         |  |                          |        |      |   |        |  |   |       
|---------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------
|                                         |  | Years Ended December 31,
|                                         |  | 2007                     |        | 2006 |   | 2005  
|Managed file transfer and email security |  | $                        | 49,033 |      | $ | 43,530 |  | $ | 39,716
|Identity validation                      |  |                          | 7,055  |      |   | 14,817 |  |   | 7,332 
|Intellectual property                    |  |                          | 1,367  |      |   | 3,647  |  |   | 2,953 
|                                         |  |                          |        |      |   |        |  |   |       
|Total revenue                            |  | $                        | 57,455 |      | $ | 61,994 |  | $ | 50,001
|                                         |  |                          |        |      |   |        |  |   |       



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



|                        |  |              |       |      |   |      
|----------------------- |  | ------------ | ----- | ---- | - | -----
|                        |  | December 31,
|                        |  | 2007         |       | 2006
|North America           |  | $            | 1,659 |      | $ | 1,403
|Bulgaria                |  |              | 361   |      |   | 388  
|Other                   |  |              | 18    |      |   | 29   
|                        |  |              |       |      |   |      
|Total long-lived assets |  | $            | 2,038 |      | $ | 1,820
|                        |  |              |       |      |   |      



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

Not
applicable.

Item 9AControls and Procedures



|(a) | Evaluation of disclosure controls and procedures.
|--- | -------------------------------------------------

Tumbleweeds management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, Tumbleweeds Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, Tumbleweeds disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Tumbleweed in the
reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by Tumbleweed in the reports that it files or submits under the Exchange Act are accumulated and communicated to its
management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.



|(b) | Changes in internal controls over financial reporting.
|--- | ------------------------------------------------------

During 2007, Tumbleweed expanded the deployment of its financial accounting system to its subsidiaries in Bulgaria and the United Kingdom. This expansion was designed to enhance Tumbleweeds financial reporting by providing more timely
and accurate financial and accounting information, and by eliminating the need to transfer financial data from one financial system to another.

Other than the change mentioned above, no other changes in Tumbleweeds internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during 2007 that have
materially affected, or are reasonably likely to materially affect, Tumbleweeds internal control over financial reporting.

Tumbleweeds management, including its Chief Executive Officer and Chief Financial Officer, does not expect that its disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within
Tumbleweed have been detected. Tumbleweeds controls and procedures are designed to provide reasonable assurance of achieving their objectives and Tumbleweeds Chief Executive Officer and Chief Financial Officer have concluded that its
controls and procedures are effective at that reasonable assurance level.



|(c) | Managements Report on Internal Control over Financial Reporting
|--- | ----------------------------------------------------------------

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our
management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission, or COSO, in Internal Control-Integrated Framework. Our management has concluded that, as of December 31, 2007, our internal control over financial reporting is effective based on these criteria. Our independent registered
public accounting firm, KPMG LLP, has audited the Companys internal control over financial reporting as of December 31, 2007 as stated in their report, included herein.

Item 9BOther Information

Not applicable.



70



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##### Table of Contents

PART III

Item 10Directors and Executive Officers of the Registrant

The information required by this item,
insofar as it relates to Tumbleweeds directors, will be contained under the captions Election of Directors and Section 16 Beneficial Ownership Reporting Compliance in the Proxy Statement and is incorporated herein by
reference. The information relating to Tumbleweeds executive officers is contained in Part I under the heading Our Executive Officers. Tumbleweed has adopted a Code of Conduct, which applies to all employees, officers and
directors, including its Chief Executive Officer, Chief Financial Officer, Vice President and Corporate Controller, and other Tumbleweed finance employees. The Code of Conduct is available on Tumbleweeds website at www.tumbleweed.com under the
caption Corporate Governance on the Investor Relations page. A copy of the Code of Conduct will be provided, without charge, to any stockholder who requests one by written request addressed to:

Tumbleweed Communications Corp.

700 Saginaw Drive, Redwood City, CA 94063

Attention: Corporate Secretary

If any substantive amendments to the Code of Conduct are made or any waivers are granted thereunder, including any implicit waiver, Tumbleweeds
Chief Executive Officer, Chief Financial Officer or other authorized officer will disclose the nature of such amendment or waiver on our website at www.tumbleweed.com or in a report on Form 8-K.

Item 11Executive Compensation

The information required by this item will be contained in the Proxy
Statement under the caption Executive Compensation and is incorporated herein by reference.

Item 12Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item will be contained in the Proxy Statement under the caption Security Ownership of Certain Beneficial Owners and Management and is incorporated herein by reference.

Item 13Certain Relationships and Related Transactions

The information required by this item will be
contained in the Proxy Statement under the caption Certain Relationships and Related Transactions and is incorporated herein by reference.

Item 14Principal Accountant Fees and Services

The information required by this item will be
contained in the Proxy Statement under the caption Audit Fees and Pre-Approval Policies and is incorporated herein by reference.



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##### Table of Contents

PART IV

Item 15Exhibits/ Financial Statement Schedules



|(a) | Documents filed as a part of this Form 10-K:
|--- | --------------------------------------------

(1) Financial Statements:



|                                                                       |  |     
|---------------------------------------------------------------------- |  | ----
|                                                                       |  | Page
|Reports of Independent Registered Public Accounting Firm               |  | 44  
|Consolidated Balance Sheets                                            |  | 45  
|Consolidated Statements of Operations                                  |  | 46  
|Consolidated Statements of Stockholders Equity and Comprehensive Loss |  | 47  
|Consolidated Statements of Cash Flows                                  |  | 48  
|Notes to Consolidated Financial Statements                             |  | 49  

(2) Financial Statement Schedules:

Financial statement schedules are omitted because they are either not applicable, not required, or the information required to be set forth therein is
included in the Financial Statements or Notes thereto.



|(b) | Exhibits:
|--- | ---------

The following exhibits are filed as part of,
or incorporated by reference into, this Form 10-K.



|              |  |                                                                                                                                                                      
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                  
|              | 
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                      
|              | 
|3.2(1)        |  | Amended and Restated Bylaws of Registrant                                                                                                                            
|              | 
|4.1(1)        |  | Specimen common stock certificate                                                                                                                                    
|              | 
|4.2           |  | Warrant to purchase shares of common stock of Valicent, Inc.                                                                                                         
|              | 
|10.1(2)       |  | 1993 Stock Option Plan                                                                                                                                               
|              | 
|10.2(3)       |  | 1999 Omnibus Stock Incentive Plan, as amended                                                                                                                        
|              | 
|10.3(2)       |  | 1999 Employee Stock Purchase Plan                                                                                                                                    
|              | 
|10.4(4)       |  | 2000 NSO Incentive Stock Plan, as amended                                                                                                                            
|              | 
|10.5(2)       |  | Form of Indemnity Agreement                                                                                                                                          
|              | 
|10.6(5)       |  | Employment agreement between James P. Scullion and Tumbleweed, dated January 23, 2006                                                                                
|              | 
|10.7(6)       |  | Employment agreement between Timothy G. Conley and Tumbleweed, dated April 28, 2006                                                                                  
|              | 
|10.8(7)       |  | Employment agreement between Taher A. Elgamal and Tumbleweed, dated October 3, 2006                                                                                  
|              | 
|10.9(8)       |  | Employment agreement between Nicholas W. Hulse and Tumbleweed, dated March 5, 2007                                                                                   
|              | 
|10.10(9)      |  | Employment agreement between Bernard J. Cassidy and Tumbleweed, dated June 15, 2007                                                                                  
|              | 
|10.11(9)      |  | Amendment to the transition agreement between Jeffrey C. Smith and Tumbleweed, dated August 2, 2007                                                                  
|              | 
|10.12         |  | Employment agreement between Jorge E. Rodriguez and Tumbleweed, dated December 6, 2007                                                                               
|              | 
|10.13         |  | 1999 Omnibus Stock Incentive Plan Restricted Stock Agreement                                                                                                         
|              | 
|10.14         |  | 1999 Omnibus Stock Incentive Plan Deferred Stock Agreement                                                                                                           
|              | 
|21.1          |  | Subsidiaries of the Registrant                                                                                                                                       
|              | 
|23.1          |  | Consent of Independent Registered Public Accounting Firm                                                                                                             
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002



72



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##### Table of Contents

|              |  |                                                                                                                                                                      
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                  
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                    
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                    



|(1) | Incorporated by reference to Tumbleweeds Registration Statement on Form S-1/A (File No. 333-79687), filed June 29, 1999.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(2) | Previously filed in Tumbleweeds Registration Statement on Form S-4 (File No. 333-92589), filed December 10, 1999, as amended and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Previously filed in Tumbleweeds Registration Statement on Form S-1 (File No. 333-41188), filed July 11, 2000, as amended and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Previously filed in Tumbleweeds Quarterly Report on Form 10-Q, filed May 15, 2001, and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to our Current Report on Form 8-K, filed January 27, 2006.
|--- | ------------------------------------------------------------------------------------

|(6) | Incorporated by reference to our Current Report on Form 8-K, filed May 2, 2006.
|--- | -------------------------------------------------------------------------------

|(7) | Incorporated by reference to our Current Report on Form 8-K, filed October 3, 2006.
|--- | -----------------------------------------------------------------------------------

|(8) | Incorporated by reference to our Current Report on Form 8-K, filed March 6, 2007.
|--- | ---------------------------------------------------------------------------------

|(9) | Incorporated by reference to our Current Report on 10-Q, filed August 7, 2007.
|--- | ------------------------------------------------------------------------------



73



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, as
amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 17th day of March, 2008.



TUMBLEWEED COMMUNICATIONS CORP.By:

/S/    JAMES P.
SCULLIONJames P. Scullion Chairman of the Board and Chief Executive Officer (Principal Executive Officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.



|                                                         |  |                                                                                                                             |  |               
|-------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                                |  | Title                                                                                                                       |  | Date          
|                                                         |  |                                                                                                                            
|/S/    JAMES P.
SCULLION James P. Scullion               |  | Chairman of the Board and Chief Executive Officer                                                                           |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    TIMOTHY G.
CONLEY Timothy G. Conley               |  | Senior Vice President of Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    TAHER
ELGAMAL Taher Elgamal                       |  | Director and Chief Technology Officer                                                                                       |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    CHRISTOPHER H.
GREENDALE Christopher H. Greendale |  | Director                                                                                                                    |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    KENNETH R.
KLEIN Kenneth R. Klein                 |  | Director                                                                                                                    |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    STANDISH H.
OGRADY Standish H. OGrady           |  | Director                                                                                                                    |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    DEBORAH D.
RIEMAN Deborah D. Rieman               |  | Director                                                                                                                    |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    JAMES A.
HEISCH James A. Heisch                   |  | Director                                                                                                                    |  | March 17, 2008
|                                                         |  |                                                                                                                            
|/S/    JEFFREY C.
SMITH Jeffrey C. Smith                 |  | Director                                                                                                                    |  | March 17, 2008



74



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##### Table of Contents

INDEX TO EXHIBITS



|              |  |                                                                                                                                                                      
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                  
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of Registrant                                                                                                      
|              | 
|3.2(1)        |  | Amended and Restated Bylaws of Registrant                                                                                                                            
|              | 
|4.1(1)        |  | Specimen common stock certificate                                                                                                                                    
|              | 
|4.2           |  | Warrant to purchase shares of common stock of Valicent, Inc.                                                                                                         
|              | 
|10.1(2)       |  | 1993 Stock Option Plan                                                                                                                                               
|              | 
|10.2(3)       |  | 1999 Omnibus Stock Incentive Plan, as amended                                                                                                                        
|              | 
|10.3(2)       |  | 1999 Employee Stock Purchase Plan                                                                                                                                    
|              | 
|10.4(4)       |  | 2000 NSO Incentive Stock Plan, as amended                                                                                                                            
|              | 
|10.5(2)       |  | Form of Indemnity Agreement                                                                                                                                          
|              | 
|10.6(5)       |  | Employment agreement between James P. Scullion and Tumbleweed, dated January 23, 2006                                                                                
|              | 
|10.7(6)       |  | Employment agreement between Timothy G. Conley and Tumbleweed, dated April 28, 2006                                                                                  
|              | 
|10.8(7)       |  | Employment agreement between Taher A. Elgamal and Tumbleweed, dated October 3, 2006                                                                                  
|              | 
|10.9(8)       |  | Employment agreement between Nicholas W. Hulse and Tumbleweed, dated March 5, 2007                                                                                   
|              | 
|10.10(9)      |  | Employment agreement between Bernard J. Cassidy and Tumbleweed, dated June 15, 2007                                                                                  
|              | 
|10.11(9)      |  | Amendment to the transition agreement between Jeffrey C. Smith and Tumbleweed, dated August 2, 2007                                                                  
|              | 
|10.12         |  | Employment agreement between Jorge E. Rodriguez and Tumbleweed, dated December 6, 2007                                                                               
|              | 
|10.13         |  | 1999 Omnibus Stock Incentive Plan Restricted Stock Agreement                                                                                                         
|              | 
|10.14         |  | 1999 Omnibus Stock Incentive Plan Deferred Stock Agreement                                                                                                           
|              | 
|21.1          |  | Subsidiaries of the Registrant                                                                                                                                       
|              | 
|23.1          |  | Consent of Independent Registered Public Accounting Firm                                                                                                             
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                    
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                    



|(1) | Incorporated by reference to Tumbleweeds Registration Statement on Form S-1/A (File No. 333-79687), filed June 29, 1999.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(2) | Previously filed in Tumbleweeds Registration Statement on Form S-4 (File No. 333-92589), filed December 10, 1999, as amended and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Previously filed in Tumbleweeds Registration Statement on Form S-1 (File No. 333-41188), filed July 11, 2000, as amended and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Previously filed in Tumbleweeds Quarterly Report on Form 10-Q, filed May 15, 2001, and incorporated herein by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to our Current Report on Form 8-K, filed January 27, 2006.
|--- | ------------------------------------------------------------------------------------

|(6) | Incorporated by reference to our Current Report on Form 8-K, filed May 2, 2006.
|--- | -------------------------------------------------------------------------------

|(7) | Incorporated by reference to our Current Report on Form 8-K, filed October 3, 2006.
|--- | -----------------------------------------------------------------------------------

|(8) | Incorporated by reference to our Current Report on Form 8-K, filed March 6, 2007.
|--- | ---------------------------------------------------------------------------------

|(9) | Incorporated by reference to our Current Report on 10-Q, filed August 7, 2007.
|--- | ------------------------------------------------------------------------------