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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

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

For the Fiscal Year Ended December 31, 2001

Commission File Number: 000-26223

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TUMBLEWEED COMMUNICATIONS CORP.(Exact name of registrant as specified in its charter)

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

700 Saginaw Drive

Redwood City, CA 94063

(Address of principal executive offices, including zip code)

Registrant's
telephone number, including area code(650) 216-2000

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of 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.        o

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 February 15, 2002 was approximately $91,945,732 (based on the closing price for shares of the Registrant's Common Stock as
reported on the Nasdaq National Market of $4.09 on that date). 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, 2002 was 30,631,382.

DOCUMENTS INCORPORATED BY REFERENCE

Certain
parts of the Tumbleweed Communications Corp. Proxy Statement relating to the annual meeting of stockholders to be held on May 30, 2002 (the "Proxy Statement") are incorporated by
reference into Part III of this Annual Report on Form 10-K.

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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, including, but not limited to, implementing our business strategy; attracting and retaining customers; obtaining and expanding market acceptance of the products and
services we offer; forecasts of Internet usage and the size and growth of relevant markets; rapid technological changes in our industry and relevant markets; and competition in our market. Discussions
containing such forward-looking statements may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations." In some cases, forward-looking statements can be
identified by terminology such as "may," "will," "should," "could," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," and similar
expressions. These forward-looking statements are based on current beliefs, expectations and assumptions and involve certain risks and uncertainties that could cause actual results, levels of
activity, performance, achievements and events to differ materially from those implied by such forward-looking statements. Factors that could cause or contribute to such differences include those
discussed under the caption "Risks and Uncertainties" contained herein, as well as those discussed elsewhere herein. These forward-looking statements are made as of the date of this Annual Report on
Form 10-K. We disclaim any obligation to update these forward-looking statements or to explain the reasons why actual results may differ. We reserve the right to update these
statements for any reason, including the occurrence of material events.

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TUMBLEWEED COMMUNICATIONS CORP.
2001 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

|        |  |                                                                                       |  | Page
|------- |  | ------------------------------------------------------------------------------------- |  | ----
|        |  | PART I                                                                                |  |     
|Item 1  |  | Business                                                                              |  | 4   
|Item 2  |  | Properties and Facilities                                                             |  | 14  
|Item 3  |  | Legal Proceedings                                                                     |  | 14  
|Item 4  |  | Submission of Matters to a Vote of Security Holders                                   |  | 26  
|        |  | PART II                                                                               |  |     
|Item 5  |  | Market for the Registrant's Common Equity and Related Stockholder Matters             |  | 27  
|Item 6  |  | Selected Financial Data                                                               |  | 28  
|Item 7  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 31  
|Item 7a |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 38  
|Item 7b |  | Critical Accounting Policies and Estimates                                            |  | 38  
|Item 8  |  | Financial Statements and Supplementary Data                                           |  | 41  
|Item 9  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 67  
|        |  | PART III                                                                              |  |     
|Item 10 |  | Directors and Executive Officers                                                      |  | 68  
|Item 11 |  | Executive Compensation                                                                |  | 68  
|Item 12 |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 68  
|Item 13 |  | Certain Relationships and Related Transactions                                        |  | 68  
|        |  | PART IV                                                                               |  |     
|Item 14 |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                       |  | 69  

TRADEMARKS

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

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PART I

Item 1Business.

Overview

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

Tumbleweed
Secure Guardian augments and extends traditional, network-focused security solutions by adding a critical layer of content-focused security management. Secure Guardian is a
server-level software framework that sits between an organization's internal applications and a corporate firewall, and provides centralized security for both incoming and outgoing communications
crossing the firewall. Security is provided by intelligently analyzing and managing three critical and interrelated factors: the content that travels over the network; the identities of senders and
receivers; and the business processes that direct the proper flow of information across the extended enterprise.

Industry Background

The use of groupware applications, customer service applications and web services has grown as enterprises are increasingly relying on these applications to
communicate with their customers, business partners and suppliers. Enterprises are looking for communications applications that can integrate and
migrate business processes and associated data with groupware and web applications and transform how they communicate and conduct business with their partners and customers. The volume of groupware
communications and web-based email has grown significantly over the past several years in both the business and consumer markets. According to recent IDC research, worldwide Internet
traffic will increase 93-fold from 2000 to 2005.

To
fully leverage the power of communicating using the Internet and email, businesses must first address the issues of security, centralized management, automation, legacy integration
and end-user behavior, as well as potential adoption issues. The use of policies and management protocols that were traditionally applied to paper or voice-based processes within a company
in many cases can and should be applied to communications conducted over the Internet and email. The adoption of these policies and protocols is critical to establish adherence to regulatory
requirements that face each industry and to provide enterprises with the same protection of audit trail and confidentiality that paper processes supply. In addition, recent studies from Gartner Group
indicate that consumers are hesitant about doing business online unless they can have confidence that the security and the privacy of their information is protected. End-users are also
interested in easily accessible online services and communications from the companies with which they do business.

With
comprehensive security solutions, businesses can deploy policies enterprise-wide, provide critical management of communications, and leverage the investment they have
made in their existing systems in order to fully maximize business conducted on the Internet.

Tumbleweed's Security Solutions and Services

We offer a comprehensive family of communications solutions built on the Tumbleweed Secure Guardian framework that enable enterprises to safely leverage the
cost-efficiencies and productivity of Internet communications. In addition, all Tumbleweed solutions are designed to integrate with existing business systems and groupware applications
requiring no significant change in existing firewall or system infrastructures. Our application and protocol-specific solutions can be purchased independently

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or together to create a powerful and complete communications solution for businesses. All of our solutions offer multi-level security using industry standards, universal access, and proven
scalability for high volume message traffic.

All
of our solutions are built on the Tumbleweed Secure Guardian framework, an enterprise-wide security framework made up of a platform, the Tumbleweed Secure Policy Gateway,
and a multitude of protocol enablers that allow virtually any system to connect to Tumbleweed Secure Guardian. Tumbleweed Secure Guardian offers software solutions and product suites to both protect
and extend commercial and governmental enterprise networks.

Tumbleweed Secure GuardianSolutions to Protect Enterprises

Our protection solutions enable companies to centrally control, manage and monitor their Internet communications stream. By controlling and monitoring groupware
and browser-based communications, as well as employee Internet usage, our customers can better comply with their own internal corporate policies as well as government regulations. Tumbleweed solutions
combine not only all of the elements required to establish and manage communications policies but also allow for virus and spam protection, archival of critical communications and regulatory
compliance.

Every
day, high volumes of email messages flow in and out of businesses carrying intellectual property assets (such as business plans, technology and engineering specifications, and
contracts), personal communications, and harmful content such as viruses and spam. By neglecting to monitor and manage this communications stream, businesses risk:



Businesses
need to monitor and manage their communications so that groupware applications can continue to be a tool for fast, cost-effective communications. They need to
centrally manage and globally enforce communications policies. They need a solution that complements, rather than replaces, their groupware infrastructure. They also need a solution that enforces
communication controls automatically, without relying on the initiative or costly re-training of individual users within their organization.

By
integrating our protection solutions with existing groupware networks, a business can take control of its online communications and set policies to apply content control, filtering,
encryption, access control, attachment management, virus scanning and digital signatures to groupware traffic. Because our solutions allow policies to be administered centrally and enforced
universally across an enterprise, our server-based protection solutions offer several advantages over desktop solutions, including:



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Our
Secure Guardian protection solutions include Tumbleweed Secure Mail, Tumbleweed Secure Archive, and Tumbleweed Secure Web:



Tumbleweed Secure GuardianSolutions to Extend Enterprise Networks

Our extension solutions allow businesses and organizations to establish secure Internet communications channels with partners, suppliers and customers. All of
Tumbleweed's extension solutions are server-based and integrate with existing groupware networks, enterprise systems, or legacy applications in order to secure communications automatically before it
crosses the corporate firewall. Without retraining users or changing desktop software, our extension solutions enable businesses to take advantage of moving their business communications online and
ensure that those communications are encrypted, auditable and controlled so that access is granted only to appropriate recipients.

Our
extension solutions include Tumbleweed Secure Public Network (SPN), Tumbleweed Secure Redirect, Tumbleweed Secure Messenger, Tumbleweed Secure CRM and Tumbleweed Secure Statements.



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Tumbleweed Professional Services

Our professional services organization provides consulting, integration engineering, custom application development, training and educational services and support
used to build online communication systems based on our products.

The
following are examples of the professional services we offer:

Custom application development,which extends the functionality of our solutions with custom engineering used to create unique online
communication solutions that can be deployed to precisely meet a company's business needs.

Integration consulting,which allows our customers to integrate our solutions with existing technology infrastructure, including legacy
systems, customer databases, support systems, and billing systems.

Data center design and installation,which assists customers in designing communication services based on our products, including
determining hardware requirements, backup and redundancy processes, and physically implementing our solution in the customer's data center. Our professional services organization may also provide
ongoing support of the customer's data center.

Technical training,which provides the customer with formal training in the administration and operation of our products and use of
Tumbleweed application programming interfaces, or APIs.

Support, which assists customers in managing Tumbleweed products they have deployed.

Our
products are generally deployed in business-critical environments, where highly responsive customer support is critical to the continuing success of the deployed solution. We
maintain a centralized technical support group that is responsible for first-line and second-line customer support as
well as distribution of products and documentation updates. This group works closely with our professional services and product development 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 negotiated
separately and is in addition to our standard 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 provide a comprehensive family of solutions to leverage the Internet for businesses worldwide. Key elements of our strategy are:

Establish Tumbleweed as a leading provider of Internet security software solutions that offer customers increased productivity, lowered costs and reduced liability.

We intend to establish Tumbleweed Secure Guardian as the leading foundation upon which to build mission-critical business communications. Our focus is on offering
solutions that allow our customers to rapidly recoup their original investment and earn a significant return on that investment. Our customers use our solutions to increase their productivity,
efficiency and reduce costs. By moving business processes online and extending online communications to include a number of different applications, our software solutions can eliminate costs
associated with traditional paper, fax or voice-based business processes. Our solutions enable our customers to define and implement multi-layer security policies, ensuring the safe and efficient use
of corporate email systems and the privacy of confidential information. Through a direct sales force and a reseller channel, we are pursuing

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customers in the healthcare, pharmaceutical, banking, brokerage, insurance, telecommunications, technology and manufacturing industries.

Focus on providing solutions in markets where we have solid market traction and which represent the largest opportunities for us.

Our strategy is to offer solutions with a number of key characteristics. We offer solutions that have a horizontal application across a number of vertical
industries with market drivers thereby reducing our exposure to any single specific vertical market. We focus on solutions that have a relatively short deployment time, and therefore a lower services
loadreducing the cost of running our professional services organization and changing the mix of services revenue in our revenue stream. Our strategy is intended to ultimately help us
improve our overall gross margins and serve our customers better. In addition, our strategy is to target geographic markets where Internet usage has matured and where we have reached critical mass in
product sales, such as the United States, Japan, Germany, and the United Kingdom.

Cultivate a channel of resellers to augment our direct sales effort and educate the market about Tumbleweed.

We intend to promote and leverage our channel of resellers, including value-added resellers, to expand the sales of our solutions in strategic vertical and
geographic markets. By choosing best-of-breed partners and customers to offer our solutions to the marketplace, we can better capture the opportunity of a growing market and
leverage the brand recognition and extensive sales and marketing resources of leading technology providers and consultants. Our Tumbleweed Channel Alliance partners focus on
small-to-mid-sized enterprises while our direct sales force focuses on large enterprises.

Provide comprehensive professional and/or outsourcing services through systems integrators or through our in-house team.

We offer a full suite of professional and consulting services that are end-to-end and designed to help customers implement our solutions
as rapidly as possible. The services include business-specific applications consulting, software development, training and complete technical support. In addition, services and outsourcing can also be
provided through our best-of-breed systems integrators.

Customers and Target Markets

Enterprise customers use Tumbleweed solutions to secure online communications and other business delivery processes originating within their own enterprise. These
communications and processes reach customers, business partners, suppliers and employees. Examples of Tumbleweed customers include: American Century Services Corp., American Express Travel Related
Services Company, Inc., Amgen Inc., Beckman Coulter, Inc., Best Buy Co., Inc., Broadcom Corp., Diners Club International Ltd., the U.S. Food & Drug Administration,
Gap Inc., JP Morgan Chase & Co., Merck & Co., Inc., National Semiconductor Corp., Northern Trust Corp., Phoenix Home Life Insurance Co., Salomon Smith Barney
Inc., Siebel Systems, Inc., Skandaniska Enskilda Banken AB, Union Miniere Oxyde (UK) Ltd., Verizon Communications, Wachovia Securities, Inc., and Wells Fargo & Co. Over 100 of the
Fortune 500 use various Tumbleweed solutions today.

Tumbleweed
solutions and related services are sold directly to enterprises across a number of vertical industries. Our target markets include: healthcare, banking, brokerage, insurance,
pharmaceutical, government, manufacturing, technology and telecommunications. In addition, our solutions are offered through the service providers such as those listed above that offer their customers
secure, reliable and trackable communication services for a fee. Tumbleweed's distribution strategy

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addresses the requirements of small companies and large enterprises alike. The primary geographic markets we are focused on are the United States, Japan, Germany and the United Kingdom. We have a
Tumbleweed Channel Alliance program to target small and mid-sized business customers and gain market visibility.

Sales

We maintain a direct sales force that focuses on signing key enterprise customers as well as further penetrating existing accounts by selling them new
applications. Our sales force is comprised of domestic and international sales groups consisting of a total of 80 employees as of December 31, 2001. Offices in the U.S. currently include
Redwood City, California; Ann Arbor, Michigan; Brentwood, California; Cedar Park, Texas; Charlotte, North Carolina; Chicago, Illinois; Denver, Colorado; Irvine, California; Irving, Texas; New York,
New York; Reston, Virginia; and San Ramon, California. Our offices outside the U.S. currently include Germany, Hong Kong, Japan, the Netherlands, Switzerland, and the United Kingdom. Our sales force
includes field sales engineers and inside sales personnel who support the account executives. Field sales engineers assist our account executives with technical presentations, customer requirements
analysis and initial solution designs. Our inside sales personnel assist the account executives in managing their customer relationships. Our sales effort is augmented by the sales forces of our
channel partners. The sales force also works with Tumbleweed Channel Alliance Partners to sell Tumbleweed products. The typical sales cycle can range from several weeks to six months, but may be
significantly longer for large sales.

Marketing

Our marketing efforts are organized around three primary areas: product marketing, product management and corporate marketing. Product marketing identifies target
markets and customer opportunities, then develops the positioning, programs and materials to reach customers and support sales activities.

Product
management translates customer and market requirements into product plans and works with engineering to ensure completion. Product management also trains salespeople on product
information. Corporate marketing drives lead generation activities to support Tumbleweed sales, as well as overall market awareness of us and our products through media, analyst and investor
relations, events, and speaking engagements. Corporate marketing is also responsible for branding, corporate identity, and the Tumbleweed website. Both product marketing and corporate marketing work
closely with direct sales and channel sales partners to focus programs more effectively and guide product research and development.

Governmental Regulation

We are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, and
laws or regulations directly applicable to access to online commerce. However, due to the increasing popularity and use of the Internet and other online services, it is possible that a number of laws
and regulations may be adopted with respect to the Internet or other online services covering issues such as user privacy, Internet transaction taxation, pricing, content, copyrights, distribution and
characteristics and quality of products and services. Furthermore, the growth and development of the market for online commerce may prompt calls for more stringent consumer protection laws that may
impose additional burdens on those companies conducting business online. For example, the Federal Communications Commission could determine through one of its ongoing proceedings that the Internet is
subject to regulation. Among other possible courses of action, the FCC may determine that Internet service providers are subject to certain access charges or fees for carrying Internet traffic over
the public switched telephone network. The adoption of any additional laws or regulations may decrease the growth of the Internet or other

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online services, which could, in turn, decrease the demand for our products and services and increase our cost of doing business, or otherwise have a material adverse effect on our business,
financial condition and results of operations.

Permits
or licenses may be required from federal, state, local or foreign governmental authorities to operate or to sell some products on the Internet. We may not be able to obtain these
permits or licenses. We may be required to comply with future national and/or international legislation and statutes regarding conducting commerce on the Internet in all or specific countries
throughout the world. It may not be possible to comply with this legislation or these statutes on a commercially reasonable basis, if at all.

In
addition, our products rely on encryption and authentication technology from third parties to provide the security and authentication necessary to achieve secure transmission of
confidential information. Exports of software products utilizing encryption technology are generally restricted by the U.S. and various foreign governments. We have obtained approval to export
products using up to 255-bit symmetric encryption and 2048-bit public key encryption, including the products formerly known as IME Server, IME Desktop, IME Receive Applet, IME
Remote API using OmniORB with SSL, and MMS Worldwide/255. We are not exporting other hardware, software or technology that is subject to export control under U.S. law. However, the list of countries
and products for which exports are
restricted and the related regulatory policies could be revised in the future, and we may not be able to obtain required government approvals.

Intellectual Property

To date, the U.S. Patent and Trademark Office has issued us six U.S. patentsfive utility patents and one design patent related to the user interface
of our products. We have filed an additional twenty-two utility patent applications that are now pending in the U.S. Patent and Trademark Office. We also have twenty-three patent
applications now pending in foreign jurisdictions, including three pending applications filed under the Patent Cooperation Treaty. In addition, we currently have nine registered trademarks worldwide,
including the mark Tumbleweed, and are pursuing other key trademarks and service marks in the U.S. and internationally.

We
regard our patents, trademarks and other intellectual property as critical to our success. We rely on patent and trademark law together with confidentiality and/or license agreements
with our employees, customers, partners and others to protect our proprietary rights. Despite these precautions, we may not be successful in protecting our rights. For example, it may be possible for
unauthorized third parties to copy particular portions of our products or reverse engineer or obtain and use information that we regard as proprietary. Some end-user license provisions
protecting against unauthorized use, copying transfer and disclosure of the licensed program may be unenforceable under the laws of some jurisdictions and foreign countries. In addition, the laws of
some foreign countries do not protect proprietary rights, particularly software based patents, to the same extent as do the laws of the U.S. Our means of protecting our proprietary rights in the U.S.
or abroad may not be adequate and competing companies may independently develop similar technology. In particular, we are currently engaged in litigation to enforce our intellectual property rights,
which may not be successful and in any event will result in substantial expenditures of resources to pursue.

The
status of U.S. patent protection in the software industry is not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents and as the Federal
Courts further interpret software-based inventions. The status of foreign protection in the software industry is also evolving and not well-defined. Our patent applications may not be
issued with the scope of the claims sought by us, if at all. Our products may infringe patents issued to third parties. In addition, because foreign patent applications are not published until
18 months after filing and patent applications in the

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U.S. are not publicly disclosed until the patent is issued, U.S. and/or foreign applications may have been filed by third parties that relate to our software products.

Third
parties could claim infringement by us with respect to current or future products or services. 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. We aggressively seek to enforce our patent and other intellectual property rights,
which may further increase the risk of adverse claims. Any of these claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention and resources, limit use of our services or require us to enter into royalty or license agreements. A successful claim
of product infringement against us could harm our business and prospects.

Competition

The markets in which we compete are intensely competitive and rapidly changing. We believe there is no single competitor that offers the complete package of
secure content management software that Tumbleweed sells. We are aware of competitors that exist for each of our product lines and for combined components of our solution sets.

Our
principal competition for our Tumbleweed Secure Guardian protection solutions are companies that offer various Internet content security, web security, messaging policy management,
and enterprise relationship management products. Companies that sell products that compete with some of the features within our products include: Kana Communications, Inc., Clearswift
Technologies, Symantec Corp., and Trend Micro Incorporated.

Our
principal competition in the secure document delivery and statement presentment market area comes from other online communication or information security service providers, some of
which have services or products that are intended to compete directly with our products or that could be used as alternatives to our products. Examples of some of these providers are Automatic Data
Processing, Inc., DST Systems, Inc., New River Systems, and PostX Corporation. Our solutions can be an alternative to traditional mail and courier delivery services such as those offered
by Federal Express Corporation, UPS, or the U.S. Postal Service, and to general purpose e-mail applications and services. In addition, companies with which we do not presently directly
compete may become competitors in the future, either through the expansion of our products or through their product development in the area of secure online communication services. These companies
include International Business Machines Corporation/Lotus Development Corporation and Microsoft Corporation.

The
principal competitive factors in our industry include price, product functionality, product integration, platform coverage and ability to scale, worldwide sales infrastructure and
global technical support. Some of our competitors have greater financial, technical, sales, marketing and other resources than we do, as well as greater name recognition and a larger installed
customer base. Additionally, some of these competitors have research and development capabilities that may allow them to develop new or improved products that may compete with product lines we market
and distribute. We expect that the market for mission-critical messaging software, which has been fragmented historically, will become more consolidated with larger companies being better positioned
to compete in such an environment in the long term. As this market continues to develop, a number of companies with greater resources than ours could attempt to increase their presence in this market
by acquiring or forming strategic alliances with our competitors or business partners. Our success will depend on our ability to adapt to these competing forces, to develop more advanced products more
rapidly and less expensively than our competitors, and to educate potential customers as to the benefits of licensing our products rather than developing their own products. Competitors could
introduce products with
superior features, scalability and functionality at lower prices than our products and could also bundle existing or new products with other more established products in order to compete with us. In
addition,

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because there are relatively low barriers to entry for the software market, we expect additional competition from other established and emerging companies. Increased competition is likely to result
in price reductions, reduced gross margins and loss of market share, any of which could harm our business.

Employees

As of December 31, 2001, we employed 231 people worldwide, including 60 in engineering, 80 in sales, 50 in professional services, 11 in marketing, and 30
combined in corporate management, finance, human resources, information technology, 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.

Item 2Properties and Facilities.

We lease approximately 40,000 square feet for our corporate headquarters located in Redwood City, California under a lease with a term of five years commencing
June 8, 1999. We also maintain domestic sales offices in Ann Arbor, Michigan; Brentwood, California; Cedar Park, Texas; Charlotte, North Carolina; Chicago, Illinois; Denver, Colorado; Irvine,
California; Irving, Texas; New York, New York; Reston, Virginia; and San Ramon, California. Further, we maintain sales offices in various locations overseas, including Germany, Hong Kong, Japan, the
Netherlands, Switzerland, and the United Kingdom.

Item 3Legal Proceedings.

On March 3, 1999, we sued the docSpace Company, Inc. in the United States District Court for the Northern District of California alleging infringement of
our U.S. Patent No. 5,790,790. In its answer, docSpace raised counterclaims alleging, among other things, antitrust violations and unfair competition. On March 9, 2000, Critical Path,
Inc. acquired docSpace. On July 31, 2001, we entered into an agreement with Critical Path whereby they acknowledged the validity and enforceability of the two patents at issue, and licensed
those patents from us in exchange for a royalty bearing license fee. We have agreed to dismiss both lawsuits.

On
July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface Systems, Inc., a company we
acquired in 2000, and various additional
defendants, including Interface's prior president and chief executive officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the Southern
District of New York. The three cases contain substantially similar allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock price. The
complaints seek relief under the federal securities laws on behalf of purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of action. On
September 27, 2000, we filed (i) a motion to strike or dismiss for failure to meet the certification requirements of the Private Securities Litigation Reform Act, (ii) a motion to
dismiss for failure to state a claim, and (iii) a motion to dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern District of Michigan. On
July 27, 2001, the Court granted our motion to transfer the lawsuits to the Eastern District of Michigan, and left the decision on the pending motions to dismiss to the transferee Court. The
United States District Court for the Eastern District of Michigan held a status conference on the cases on October 23, 2001 without resolving either of our pending motions. On March 8,
2002, the Court ordered the parties to appear for a status and scheduling conference on April 4, 2002. On March 26, 2002, we received from plaintiffs' Michigan counsel a draft amended
complaint through which plaintiffs propose to (i) consolidate the separate actions into one action; (ii) add certain new plaintiffs; (iii) add Tumbleweed Communications Corp. as a
defendant; (iv) drop the claims under the Federal securities laws; and (v) add claims for breach of

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fiduciary duty and negligent misrepresentation. Plaintiffs have not yet filed a motion to amend the pending complaints, nor has the court authorized such an amendment. In the meantime, the motion to
dismiss and the motion to strike, discussed above, remain before the court with respect to the pending complaints.

Although
we believe these lawsuits are without merit, no assurance can be given about their outcome, and an adverse outcome could significantly harm our business and operating results.
Moreover, the costs in defending these complaints could harm future operating results.

Risks and Uncertainties

Because we are in an early stage of development and have a history of losses, it is difficult to evaluate our business and we may face expenses, delays and difficulties.

We have only a limited operating history upon which an evaluation can be based. Accordingly, our prospects must be considered in light of the risks, expenses,
delays and difficulties frequently encountered by companies in a similarly early stage of development, particularly companies engaged in new and rapidly evolving markets like ours. We incurred net
losses of $114.2 million, $69.8 million, and $24.2 million in the years ended December 31, 2001, 2000, and 1999, respectively. As of December 31, 2001, we had
incurred cumulative net losses of $249.2 million.

We anticipate continued losses.

Our success may depend in large part upon our ability to generate sufficient revenue to achieve profitability and to effectively maintain existing relationships
and develop new relationships with customers and strategic partners. If we do not succeed, our revenue may not increase, and we may not achieve or maintain profitability on a timely basis or at all.
In particular, we intend to expend significant financial and management resources on product development, sales and marketing, strategic relationships, technology and operating infrastructure. As a
result, we expect to incur additional losses and continued negative cash flow from operations for the foreseeable future.

Our quarterly financial results are subject to significant fluctuations.

As a result of our limited operating history and the emerging nature of the markets in which we compete, we may not be able to accurately forecast our revenue or
expenses. Our success is dependent upon our ability to enter into and maintain profitable relationships with customers and to develop and maintain profitable usage of our products by our customers and
their end-users.

Our
revenue has fluctuated and our quarterly operating results will continue to fluctuate based on the timing of the execution and termination of customer agreements in a given quarter.
Under the traditional software licensing model, license revenue is comprised of initial license and distribution fees. As a result, we typically recognize initial license fees as revenue in the same
quarter an agreement was signed. To the extent that customers purchase our product under the subscription-based pricing model, however, we account for and report our contracted revenue over the life
of the agreement.

Our
services revenue historically has been comprised largely of implementation, customization and consulting fees as well as customer support contracts. Our ability to receive revenue
from services is subject to multiple risks, including the risk that we may not be able to meet increasing customer demand because of a lack of adequately trained personnel, and the risk that customers
may not timely accept the services provided and delay payment for such services.

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In
addition, we have experienced, and expect to continue to experience, fluctuations in revenue and operating results from quarter to quarter for other reasons, including, but not
limited to:



As
a result of these factors we believe that quarter-to-quarter comparisons of our revenue and operating results are not necessarily meaningful, and that these
comparisons may not be accurate indicators of future performance. Quarterly financials for 2001 that include revenue accounted for under the both the subscription-based pricing model and the
traditional software pricing model will not be comparable with historical quarters that used our previous licensing model. Because our staffing and operating expenses are based on anticipated revenue
levels, and because a high percentage of our costs are fixed, small variations in the timing of the recognition of specific revenue could cause significant variations in operating results from quarter
to quarter. In addition, many of our customers delay purchases of our products until the end of each quarter. If we are unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall, any significant revenue shortfall would likely have an immediate negative effect on our operating results. Moreover, we believe the difficulties outlined above with respect to
financial forecasts also apply to securities analysts that may publish estimates of our financial results. Our operating results in one or more future quarters may fail to meet the expectations of
securities analysts or investors due to any of a wide variety of factors, including fluctuations in financial ratios or other metrics used to measure our performance. If this occurs, we would expect
to experience an immediate and significant decline in the trading price of our stock.

In
addition, the terrorist acts of September 11, 2001 in New York City, Washington D.C. and Pennsylvania, as well as the response, military and otherwise, by the United States,
have created an uncertain economic environment and we cannot predict the impact of these events, any subsequent terrorist acts or of any related military action, on our customers or business. We
believe that, in light of these events, some businesses may curtail spending on information technology, which could also affect our quarterly results or financial condition in the future.

Restructuring of operations and other cost reducing measures we have implemented may not achieve the results we intend and even may harm our business.

In January 2001, we announced a restructuring of our business, which included a reduction in force and the closure of three international locations. Since
that time we have engaged in other ongoing measures
to reduce expenses and establish an enterprise that is appropriate for our expected revenue levels. The planning and implementation of this effort has placed, and may continue to place, a significant
strain on our managerial, operational, financial and other resources. Additionally, the actions undertaken to restructure the business may negatively affect our employee turnover, recruiting and
retention of important employees. If we are unable to implement our restructuring effectively or if we experience difficulties in carrying out the restructuring, our expenses could increase more
quickly than we expect. If we find that the actions taken to date did not sufficiently decrease the growth of our expenses, we may find it necessary to implement further streamlining of our expenses,
to perform additional reductions in our headcount or to undertake additional restructurings of our business.

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

As of December 31, 2001, we had cash and cash equivalents of $43.2 million and incurred cumulative net losses of $249.2 million. Our current
cash reserves may be insufficient in the face of either lower than expected revenues or extraordinary or unexpected cash expenses. As a result, we may be required to raise funds through public or
private financings, strategic relationships, or other arrangements. Funding, if needed, however, 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.

A limited number of customers account for a high percentage of our revenue and the failure to maintain or expand these relationships could harm our business.

The loss of one or more of our major customers, the failure to attract new customers on a timely basis or a reduction in usage and revenue associated with the
existing or proposed customers would harm our business and prospects. Five customers comprised approximately 17%, 20%, and 36% of our revenue in 2001, 2000, and 1999, respectively.

If we do not secure key relationships with enterprise customers, our access to broader markets will be limited.

Our enterprise customers, which use or intend to use our products to intelligently manage the incoming and outgoing online communications of their enterprises,
are a significant source of our revenue. A key aspect of our strategy is to access target markets prior to adoption of alternative solutions by the larger participants in these markets. The failure to
secure key relationships with new enterprise customers in targeted markets could limit or effectively preclude our entry into these target markets, which would harm our business and prospects.

Customers in a preliminary phase of implementing our product may not proceed on a timely basis or at all.

Some of our customers are currently in a pre-production or pre-launch stage of implementing our products and may encounter delays or other
problems in introducing them. A customer's decision not to do so or a delay in implementation could result in a delay or loss in related revenue or otherwise harm our businesses and prospects. We
cannot predict when any customer that is currently in a pilot or preliminary phase will implement broader use of our services.

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

To date, we have generated a significant amount of Tumbleweed Secure Messenger revenue from contracts with a limited number of service provider customers, which
use or intend to use our products for the communication of third-party documents and data. If these customers do not effectively promote the use of Secure Messenger to their end-users or
cease to offer Secure Messenger to their end-users, the adoption of our services and the recognition of associated revenue could be limited. Because our contracts with our service provider
customers are non-exclusive, these customers could elect to offer competing secure online communication services to their customers through our existing or future competitors. The service
provider customers also may compete with our secure online communication services through their traditional physical delivery channels.

The markets for enhanced online content management services generally, and for our products specifically, are new and may not develop.

The market for our products and services is new and evolving rapidly. If the market for our products and services fails to develop and grow, or if our products
and services do not gain broad market acceptance, our business and prospects will be harmed. In particular, our success will depend

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upon the adoption and use by current and potential customers and their end-users of secure content management services. Our success will also depend upon acceptance of our technology as
the standard for providing these services. The adoption and use of our products and services will involve changes in the manner in which businesses have traditionally exchanged information. In some
cases, our customers have little experience with products, services and technology like those offered by us. Our ability to influence usage of our products and services by customers and
end-users is limited. For example, the usage of Secure Messenger by the end-users of our service provider customers has been limited to date. We have spent, and intend to
continue to spend, considerable resources educating potential customers and their end-users about the value of our products and services. It is difficult to assess, or to predict with any
assurance, the present and future size of the potential market for our products and services, or our growth rate, if any. Moreover, we cannot predict whether our products and services will achieve any
market acceptance. Our ability to achieve our goals also depends upon rapid market acceptance of future enhancements of our products and our ability to identify new markets as they emerge. Any
enhancement that is not favorably received by customers and end-users may not be profitable and, furthermore, could damage our reputation or brand name. Any failure to identify and address
new market opportunities could harm our business and prospects.

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

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

The markets we address are highly competitive and rapidly changing, and we may not be able to compete successfully.

We may not be able to compete successfully against current and future competitors, and the multiple competitive pressures we face could harm our business and
prospects. The markets in which we compete are intensely competitive and rapidly changing.

Our
principal competition for our Tumbleweed Secure Guardian protection solutions are companies that offer various Internet content security, web security, messaging policy management,
and enterprise relationship management products. Companies that sell products that compete with some of the features within our products include Kana Communications, Inc., Clearswift
Technologies, Symantec Corp., and Trend Micro Incorporated.

Our
principal competition in the secure document delivery and statement presentment market area comes from other online communication or information security service providers, some of
which have services or products that are intended to compete directly with our products or that could be used as alternatives to our products. Examples of some of these providers are Automatic Data
Processing, Inc., DST Systems, Inc., New River Systems, and PostX Corporation. Our solutions can be an alternative to traditional mail and courier delivery services such as those offered
by Federal Express Corporation, UPS, or the U.S. Postal Service, and to general purpose e-mail applications and services. In addition, companies with which we do not presently directly
compete may become competitors in the future, either through the expansion of our products or through their product development in the area of secure online communication services. These companies
include International Business Machines Corporation/Lotus Development Corporation, and Microsoft Corporation.

The
principal competitive factors in our industry include price, product functionality, product integration, platform coverage and ability to scale, worldwide sales infrastructure and
global technical

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support. Some of our competitors have greater financial, technical, sales, marketing and other resources than we do, as well as greater name recognition and a larger installed customer base.
Additionally, some of these competitors have research and development capabilities that may allow them to develop new or improved products that may compete with product lines we market and distribute.
We expect that the market for secure content management software will become more consolidated with larger companies being better positioned to compete in such an environment in the long term. As this
market continues to develop, a number of companies with greater resources than ours could attempt to increase their presence in this market by acquiring or forming strategic alliances with our
competitors or business partners. Our success will depend on our ability to adapt to these competing forces, to develop more advanced products more rapidly and less expensively than our competitors,
and to educate potential customers as to the benefits of licensing our products rather than developing their own products. Competitors could introduce products with superior features, scalability and
functionality at lower prices than our products and could also bundle existing or new products with other more established products in order to compete with us. In addition, because there are
relatively low barriers to entry for the software market, we expect additional competition from other established and emerging companies. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could harm our business.

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

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

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

We restructured our business in 2001, which has placed, and continues to place, a significant strain on managerial, informational, administrative and operational
resources. Our current systems, procedures and controls may not be adequate to achieve the rapid execution necessary to effectively operate within the market for our products and services. We need to
continue to enhance and improve our managerial capacity, and improve or replace our existing operational, customer service and financial systems, procedures and controls. Any failure to properly
manage these systems and procedural transitions could impair our ability to attract and service customers, and could cause us to incur higher operating costs and delays in the execution of our
business plan. Despite our restructuring, we expect that we may need to continue the expansion of our employee base. Our management may not be able to hire, train, retain, motivate and manage required
personnel. In addition, our management may not be able to
successfully identify, manage and exploit existing and potential market opportunities. If we cannot manage growth effectively, our business and operating results could suffer. Finally, we may have
operational, customer service and financial systems that are not appropriate for our current estimated size. Moving to more appropriate office systems may also place a strain on our current systems
and require financial expenditures to end the commitments on other systems.

We have a lengthy sales and implementation cycle which could harm our business.

If we are unable to license our services to new customers on a timely basis or if our existing and proposed customers and their end-users suffer
delays in the implementation and adoption of our services, our revenue may be limited and business and prospects may be harmed. Our customers must evaluate our technology and integrate our products
and services into the products and services they

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provide. In addition, our customers may need to adopt a comprehensive sales, marketing and training program in order to effectively implement some of our products. Finally, we must coordinate with
our customers using our product for third-party communications in order to assist end-users in the adoption of our products. For these and other reasons, the cycle associated with
establishing licenses and implementing our products can be lengthy. This cycle is also subject to a number of significant delays over which we have little or no control. Forecasts about license
revenue may be inaccurate as a result of any or all of these factors, and inaccurate forecasts may cause our business, or market valuation, to suffer.

A failure to protect our intellectual property may significantly harm our business.

We currently rely on a combination of patents, trade secrets, copyrights, trademarks and licenses, together with non-disclosure and confidentiality
agreements to establish and protect our proprietary rights in our products. We hold certain patent rights with respect to some of our products. We have filed, and expect in the future to file,
additional patent applications. Our existing patents or trademarks, as well as any future patents or trademarks obtained by us, may be challenged, invalidated or circumvented, or our competitors may
independently develop or patent technologies that are substantially equivalent or superior to our technology. Further patent or trademark protection may not be obtained, in the United States or
elsewhere, for our existing or new products, applications or services. In addition, further protection, if obtained, may not be effective. In some countries, meaningful patent or trademark protection
is not available.

To
date, we have not received any material claims of infringement upon the proprietary rights of third parties. However, third parties could assert infringement claims against us in the
future, and the cost of responding to such assertions, regardless of their validity, could be significant. 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. We aggressively seek to enforce our patent and other intellectual property rights, which
may further increase the risk of adverse claims. Any of these claims, with or without merit, could be time consuming to defend, result in costly
litigation, divert management's attention and resources, limit use of our services or require us to enter into royalty or license agreements. In addition, such claims may be found to be valid and
could result in awards against us, which could harm our business.

We
also rely, to some extent, on unpatented trade secrets and other unpatented proprietary information. Our policy is to have employees sign confidentiality agreements, to have selected
parties sign non-competition agreements and to have third parties sign non-disclosure agreements. Although we take precautionary measures to maintain our unpatented proprietary
information, others may acquire equivalent information or otherwise gain access to or disclose our proprietary information and we may be unable to meaningfully protect our rights to our proprietary
information.

Profitable expansion in international markets may be difficult.

We invested significant financial and managerial resources to expand our sales and marketing operations in international markets and have opened sales offices in
Germany, Hong Kong, Japan, the Netherlands, Switzerland, and the United Kingdom. For the years ended December 31, 2001, 2000, and 1999 we derived 24%, 32% and 41%, respectively, of our revenue
from international operations. However, to date, we have limited experience in international operations and may not be able to compete effectively in international markets. A key component of our
long-term strategy is to further expand into international markets, and we must continue to devote substantial resources to our international operations in order to succeed in these
markets. In this regard, we may encounter difficulties such as:



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In
addition, our expansion into international markets will increasingly subject us to fluctuations in currency exchange rates. In the future, an increasing number of our contracts may be
denominated in currencies other than U.S. dollars. We do not presently engage in hedging or similar transactions to protect us from currency fluctuations. Any of the foregoing difficulties of
conducting business internationally could harm our international operations and, consequently, our business and prospects.

If we do not provide adequate support services to our customers to implement our products, our business may suffer.

Our professional services organization assists our customers in implementing our products through software installation, integration with existing customer
systems, contract engineering, consulting and training. If the professional services organization does not adequately assess customer requirements or address technical problems, customers may seek to
discontinue their relationships with us due to dissatisfaction with the product or our customer support. Furthermore, these customers may realize lower usage than they could have otherwise achieved
because they did not fully capitalize on the product in ways that could have been addressed by our professional services organization. Our products must be integrated with existing hardware and
complex software products of our customers or other third parties, and our customers may not have significant experience with the implementation of products similar to our own. In addition, profitably
providing contract engineering and integration services is an increasingly important aspect of our strategy to strengthen customer loyalty to our product and company. Therefore, our business and
future prospects significantly depend on the strength of our professional services organization and our ability to leverage this organization by augmenting our reach through trained and qualified
systems integrators. If our professional services organization does not adequately meet these multiple challenges, our business and prospects could suffer.

Product performance problems, system failures, and internet problems could severely damage our business.

The ability of our customers to use Tumbleweed-based services depends on stable product performance, and the efficient and uninterrupted operation of the computer
and communications hardware as well as the software and Internet network systems that they maintain. Although our ability to manage the effects of system failures which occur in computer hardware,
software and network systems is limited, the occurrences of these failures could harm our reputation, business and prospects. The Internet has experienced a variety of outages and other delays as a
result of damage to portions of our infrastructure, and the Internet could face similar outages and delays in the future. In addition, an increasing number of our customers require us to provide
computer and communications hardware, software and Internet networking systems to them as an outsourced data center service. All data

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centers, whether hosted by us, our customers or by an independent third party to which it outsources this function, are vulnerable to damage or interruption from fire, flood, earthquake, power loss,
telecommunications failure or other similar events.

If our software contains errors, we may lose customers or experience reduced market acceptance of our products.

Our software products are inherently complex and may contain defects and errors that are detected only when the products are in use. In addition, some of our
customers require or may require enhanced customization of our software for their specific needs, and these modifications may increase the likelihood of undetected defects or errors. Further, we often
render implementation, consulting and other technical services, the performance of which typically involves working with sophisticated software, computing and networking systems, and we could fail to
meet customer expectations as a result of any defects or errors. As a result, we may lose customers, customers may fail to implement our products more broadly within their organization and we may
experience reduced market acceptance of our products. Some of our products are designed to facilitate the secure transmission of sensitive business information to specified parties outside the
business over the Internet. As a result, the reputation of our software products for providing good security is vital to their acceptance by customers. Our products may be vulnerable to
break-ins, theft or other improper activity that could jeopardize the security of information for which we are responsible. Problems caused by product defects, failure to meet project
milestones for services or security breaches could result in loss of or delay in revenue, loss of market share, failure to achieve market acceptance, diversion of research and development resources,
harm to our reputation, or increased insurance, service and warranty costs. To address these problems, we may need to expend significant capital resources that may not have been budgeted.

We may be unable to recruit, retain and motivate qualified personnel, which could harm our business, including product development.

We must continue to identify, recruit, hire, train, retain and motivate highly skilled technical, managerial, sales, marketing and customer service personnel.
Competition for these personnel is intense, and we may not be able to successfully recruit, assimilate or retain sufficiently qualified personnel. In particular, we may encounter difficulties in
recruiting a sufficient number of qualified software developers and sales personnel, and we may not be able to retain these employees. The failure to recruit and retain necessary technical,
managerial, sales, merchandising, marketing and customer service personnel could harm our business and our ability to obtain new customers and develop new products. Although we have used and continue
to use stock options as a retention tool, many of our employees hold stock options that are "underwater" (i.e., the market price of our stock is below their option exercise price) and these options
may be ineffective as a retention tool. Our employee turnover may increase if outstanding stock options continue to remain underwater and we do not adjust the option exercise prices. Any adjustment of
stock option exercise prices may result in dilution to our stockholders and depress our stock price.

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

We are substantially dependent on the continued services and performance of our executive officers and other key personnel. The loss of the services of any of our
executive officers or other key employees could significantly delay or prevent the achievement of our development and strategic objectives. We do not have long-term employment agreements
with any of our key personnel. The loss of services of any of our executive officers or other key personnel could significantly harm our business and prospects.

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Our efforts to establish, maintain and strengthen our brands will require significant expenditures and may not be successful.

If the marketplace does not associate our brands with high quality Internet communication services, it may be more difficult for us to attract new customers or
introduce future products and services. The market for our services is new. Therefore, our failure to establish brand recognition at this stage could harm our ability to compete in the future with
other companies that successfully establish a brand name for their services. We must succeed in our marketing efforts, provide high quality services and increase our user base in order to build our
brand awareness and differentiate our products from those of our competitors. These efforts have required significant expenditures to date. Moreover, we believe that these efforts will require
substantial commitments of resources in the future as our brands become increasingly important to our overall strategy and as the market for our services grows.

Because our products utilize the Internet, if use of the Internet does not increase, or the architecture of the Internet is altered, the level of use of our products will
suffer.

If the Internet and other products and services necessary for the utilization of our products are not sufficiently developed, fewer customers and
end-users will use our products and our business will be harmed. In particular, the success of our products and services will depend on the development and maintenance of adequate Internet
infrastructure, such as a reliable network backbone with the necessary speed, data capacity and other features demanded by users. Moreover, our success will also depend on the timely development of
complementary products or services such as high-speed Internet connections for providing reliable access and services and this may not occur. Moreover, changes in the architecture of the
Internet may limit the success of our products. Because the online exchange of information is new and evolving, the Internet may not prove to be a viable platform for secure online communication
services in the long term. The Internet has experienced, and is expected to continue to experience, significant growth in the numbers of users and amount of traffic. As the Internet continues to
experience increased numbers of users and frequency of use, or if its users require increasingly more resources, the Internet infrastructure may not be able to support the demands placed on it. As a
result, the performance or reliability of the Internet may be harmed. This in turn could decrease the level of Internet usage and also the level of utilization of our products and services.

Government regulation relating to the Internet may increase costs of doing business or require changes in our business model.

We are subject to regulations applicable to businesses generally and laws or regulations directly applicable to companies utilizing the Internet. Although at
present there are relatively few specific laws and regulations directly applicable to the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet.
These laws could cover issues like user privacy, pricing, content, intellectual property, distribution, taxation, antitrust, legal liability and characteristics and quality of products and services.
The adoption of any additional laws or regulations could decrease the demand for our products and services and increase our cost of doing business or otherwise harm our business or prospects. Delays
in the enactment of expected regulations may result in delayed software purchasing by our customers who are subject to such regulations, which in turn may harm our business.

Moreover,
the applicability to the Internet of existing laws in various jurisdictions governing issues like property ownership, sales and other taxes, libel and personal privacy is
uncertain and may take years to resolve. For example, tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in online commerce. New state tax
regulations may subject us to additional state sales and income taxes. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply
to our business, or the application of existing laws and regulations to the Internet and commercial online services could harm our ability to conduct business and harm operating results.

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Our products are subject to export controls, and we may be unable to obtain necessary export approvals.

Exports of software products utilizing encryption technology are generally restricted by the U.S. and various foreign governments. All cryptographic products
require export licenses from certain U.S. government agencies. We have obtained approval to export products using up to 128-bit symmetric encryption and 1024-bit public key
encryption, including the products formerly named IME Server, IME Desktop, IME Receive Applet, IME Remote API using OmniORB with SSL, MMS WorldWide/56 and MMS Strong WorldWide/128. We are not
exporting other products and services that are subject to export control under U.S. law. However, the list of products and countries for which export approval is required, and the related regulatory
policies, could be revised, and we may not be able to obtain necessary approval for the export of future products. The inability to obtain required approvals under these regulations could limit our
ability to make international sales. Furthermore, competitors may also seek to obtain approvals to export products that could increase the amount of competition we face. Additionally, countries
outside of the U.S. could impose regulatory restrictions impairing our ability to import our products into those countries.

Costs of communicating via the Internet could increase if access fees are imposed.

Certain local telephone carriers have asserted that the increasing popularity and use of the Internet has burdened the existing telecommunications infrastructure,
and that many areas with high Internet use have begun to experience interruptions in telephone service. These carriers have petitioned the Federal Communications Commission to impose access fees on
Internet service providers and online service providers. If these access fees are imposed, the costs of communicating on the Internet could increase substantially, potentially slowing the increasing
use of the Internet. This could in turn decrease demand for our services or increase the costs of doing business.

We may have liability for Internet content.

As a provider of Internet communication products and services, we face potential liability for defamation, negligence, copyright, patent or trademark infringement
and other claims based on the nature and content of the materials transmitted online. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance
coverage, could be costly and could require us to implement measures to reduce exposure to this liability. This may require us to expend substantial resources or to discontinue selected service or
product offerings.

We
do not and cannot screen all of the content generated by users of our product but may be exposed to liability with respect to this content. Furthermore, certain foreign governments,
such as Germany, have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the U.S. Other countries, such as China,
regulate or prohibit the
transport of telephonic data in their territories. Failure to comply with regulations in a particular jurisdiction could result in fines or criminal penalties or the termination of service in one or
more jurisdictions. Moreover, the increased attention focused on liability issues as a result of lawsuits and legislative proposals could impact the growth of Internet use. Liability insurance may not
cover claims of these types, or may not be adequate to indemnify against all liability that may be imposed.

Interface Systems, Inc., a Tumbleweed subsidiary, is a defendant in several purported securities class action lawsuits.

On July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface and various
additional defendants, including Interface's President and Chief Executive Officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the Southern
District of New York. The three cases contain substantially similar allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock price. The
complaints seek relief under the federal securities laws on behalf of

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purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of action. On September 27, 2000, we filed (i) a motion to strike or
dismiss for failure to meet the certification requirements of the Private Securities Litigation Reform Act, (ii) a motion to dismiss for failure to state a claim, and (iii) a motion to
dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern District of Michigan. On July 27, 2001, the Court granted our motion to transfer the
lawsuits to the Eastern District of Michigan, and left the decision on the pending motions to dismiss to the transferee Court. The United States District Court for the Eastern District of Michigan
held a status conference on the cases on October 23, 2001 without resolving either of our pending motions. On March 8, 2002, the court ordered the parties to appear for a status and
scheduling conference on April 4, 2002. On March 26, 2002, we received from plaintiffs' Michigan counsel a draft amended complaint through which plaintiffs propose to
(i) consolidate the separate actions into one action; (ii) add certain new plaintiffs; (iii) add Tumbleweed Communications Corp. as a defendant; (iv) drop the claims under
the Federal securities laws; and (v) add claims for breach of fiduciary duty and negligent misrepresentation. Plaintiffs have not yet filed a motion to amend the pending complaints, nor has the
court authorized such an amendment. In the meantime, the motion to dismiss and the motion to strike, discussed above, remain before the court with respect to the pending complaints.

Although
we believe these lawsuits are without merit, no assurance can be given about their outcome, and an adverse outcome could significantly harm our business and operating results.
Moreover, the costs in defending these complaints could harm future operating results.

Internet related and technology stock prices are especially volatile and this volatility may depress our stock price.

The stock market has experienced significant price and volume fluctuations and the market prices of securities of technology companies, particularly
Internet-related companies, have been highly volatile. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been
instituted against companies. The institution of this type of litigation against us could result in substantial costs and a diversion of our management's attention and resources, which could harm our
business and prospects.

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

Our certificate of incorporation and bylaws may inhibit changes of control that are not approved by our Board of Directors. These provisions could limit the price
that investors might be willing to pay in the future for shares of our common stock. In particular, our certificate of incorporation provides for a classified Board of Directors and prohibits
stockholder action by written consent. These provisions require advance notice for nomination of directors and stockholders' proposals. In addition, as a Delaware corporation, we are subject to
Section 203 of the Delaware General Corporation Law. In general, this law prevents a person who becomes the owner of 15% or more of the corporation's outstanding voting stock from engaging in
specified business combinations for three years unless specified conditions are satisfied. In addition, our certificate of incorporation allows our Board of Directors to issue preferred stock without
further stockholder approval. This could have the effect of delaying, deferring or preventing a change in control. The issuance of preferred stock also could effectively limit the voting power of the
holders of Tumbleweed common stock. The provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, may discourage or prevent an acquisition or disposition of our
business.

Future sales of common stock by our stockholders could depress our stock price.

We cannot predict if future sales of our common stock, or the availability of our common stock for sale, will depress the market price for our common stock or our
ability to raise capital by offering

25

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equity securities. Sales of substantial amounts of common stock, or the perception that these sales could occur, may depress prevailing market prices for the common stock

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

No matters were submitted to a vote of our stockholders during the fourth quarter of 2001.

Our Executive Officers

Listed below are our executive officers as of March 29, 2002. 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 earlier resignation or removal.

|NAME                |  | TITLE                                                     |  | AGE
|------------------- |  | --------------------------------------------------------- |  | ---
|Jeffrey C. Smith    |  | Chairman and Chief Executive Officer                      |  | 35 
|Douglas A. Sabella  |  | President and Chief Operating Officer                     |  | 43 
|Elizabeth D. Jordan |  | Senior Vice PresidentFinance and Chief Financial Officer |  | 38 

Jeffrey C. Smith, Chairman of the Board of Directors and Chief Executive Officer, focusing on strategic planning and partnership
development. Before founding Tumbleweed in 1993, Mr. Smith held various senior positions in research and development with the following firms: Frame Technology from 1991 to 1993; Aeon Corp.
from 1990 to 1991; Hewlett Packard from 1988 to 1989; and IBM Scientific Research Center in Palo Alto from 1987 to 1988. Mr. Smith served as a lecturer in Software Engineering at Stanford
University in 1988 and 1989. Mr. Smith holds a B.S. in Computer Science from Stanford University.

Douglas A. Sabella, President and Chief Operating Officer, is responsible for worldwide operations, including research and development,
sales, professional services, and marketing. Prior to joining Tumbleweed in 2001, Mr. Sabella was the president and chief executive officer of Citadon, previously Bidcom, Inc., from 2000
to 2001. Prior to Bidcom, Mr. Sabella spent 15 years at Lucent Technologies from 1985 to 2000. His most recent position at Lucent was president of Lucent's Communications
Applications Group, where he led the messaging, CRM solutions, conferencing and collaboration, and the IP solutions businesses. Mr. Sabella was also COO for Lucent's Octel Messaging division,
where he was responsible for the worldwide operations and served as vice president of Lucent's Communications Software business. Prior to Lucent, Mr. Sabella held various senior management
positions at AT&T and Paramount Pictures. Mr. Sabella holds a B.B.A. in Business Administration from Hofstra University.

Elizabeth D. Jordan, Senior Vice PresidentFinance and Chief Financial Officer, is responsible for finance and administration.
Prior to joining Tumbleweed in 2001, Ms. Jordan was Senior Vice President and CFO of Catapulse, Inc., which was sold to Rational Software Corporation in February of 2001, from 2000 to
2001. At Catapulse, Ms. Jordan was responsible for all finance and administration, as well as business plan development. Prior to Catapulse, Ms. Jordan served as Executive Vice President
and CFO and other senior finance roles at Sanmina Corporation from 1997 to 2000. Prior to Sanmina, Ms. Jordan held a variety of positions in finance for Network General Corporation from 1992 to
1997. Ms Jordan holds a B.A. in Business Systems from the University of Texas and an M.B.A. in finance from the University of North Texas.

26

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PART II

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

Tumbleweed's common stock is traded on the Nasdaq National Market under the symbol "TMWD." The table below sets forth, during the periods indicated, the closing
price per share for Tumbleweed's common stock as reported on the Nasdaq National Market.

|                             |  | Price Range
|---------------------------- |  | -----------
|
|Year ended December 31, 2000 |  | $          
|First Quarter                |  | $          
|Second Quarter               |  | $          
|Third Quarter                |  | $          
|Fourth Quarter               |  | $          
|Year ended December 31, 2001 |  | $          
|First Quarter                |  | $          
|Second Quarter               |  | $          
|Third Quarter                |  | $          
|Fourth Quarter               |  | $          

As
of March 15, 2002, there were approximately 920 holders of record of our common stock. This does not include the number of persons whose stock is in nominee or "street name"
accounts through brokers.

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.

Offerings of Securities

On August 11, 1999, we completed an initial public offering of our common stock, $0.001 par value, at a price of $12.00 per share. The shares of common
stock sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (No. 333-79687). The Registration
Statement was declared effective by the Securities and Exchange Commission on August 5, 1999. To date, we have used the proceeds for working capital and other general corporate purposes, and we
expect to continue to use the proceeds for such purposes. In addition, we may use a portion of the proceeds to acquire complementary products, technologies or businesses.

On
August 1, 2000, we completed a primary and secondary public offering of 3,000,000 shares of our common stock at a price of $56.00 per share. Of the 3,000,000 shares of common
stock, 1,500,000 primary shares were sold by us and 1,500,000 secondary shares were sold by our stockholders. Tumbleweed did not receive any of the proceeds from shares sold by its stockholders. Net
proceeds of $77.9 million were received by us from the offering of primary shares. To date, we have used the proceeds for working capital and other general corporate purposes, and we expect to
continue to use
the proceeds for such purposes. In addition, we may use a portion of the proceeds to acquire complementary products, technologies or businesses.

27

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Item 6Selected Financial Data.

Selected Financial Information

The following selected financial information should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial
statements and management's discussion and analysis of financial condition and results of operations included elsewhere in this report. All necessary adjustments, which consisted only of normal
recurring adjustments, have been included in the amounts stated below.

|                                                                                                                                |  | Year Ended December 31, |         
|------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | --------
|
|
|Consolidated Statements of Operations Data:                                                                                     |  |                         |         
|Revenue from continuing product lines                                                                                           |  | $                       | 29,048  
|Revenue from discontinued product lines                                                                                         |  |                         |        
|Gross profit (1), (2)                                                                                                           |  |                         | 16,773  
|Operating expenses (3)                                                                                                          |  |                         | 129,475 
|Operating loss before amortization and impairment of goodwill and intangible assets, restructuring, and merger-related expenses |  |                         | (44,825 
|Operating loss                                                                                                                  |  |                         | (112,702
|Net loss                                                                                                                        |  |                         | (114,165
|Net loss per sharebasic and diluted                                                                                            |  | $                       | (3.78   
|Shares used in calculating basic and diluted loss per share                                                                     |  |                         | 30,171  

|                                               |  | December 31,
|---------------------------------------------- |  | ------------
|
|
|Consolidated Balance Sheet Data:               |  |             
|Cash and cash equivalents                      |  | $           
|Total assets                                   |  |             
|Long-term debt, excluding current installments |  |             
|Total stockholders' equity                     |  |             

---

28

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Selected Quarterly Financial Data (Unaudited)

All necessary adjustments, which consisted only of normal recurring 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                    |       
|----------------------------------------- | ----------------------------------------------------------------------------- | --------------------------------- | ------
|
|
|Fiscal 2001                               |                                                                               |                                   |       
|Revenue:                                  |                                                                               |                                   |       
|                                          | Product and IP revenue                                                        |                                   | $     
|                                          | Service revenue                                                               |                                   |       
|                                          |                                                                               |                                   |       
|                                          |                                                                               | Total revenue                     |       
|Cost of revenue (1)                       |                                                                               |                                   | 2,808 
|                                          |                                                                               |                                   |       
|Gross profit                              |                                                                               |                                   | 6,389 
|Operating expenses:                       |                                                                               |                                   |       
|                                          | Research and development (2)                                                  |                                   |       
|                                          | Sales and marketing (3)                                                       |                                   |       
|                                          | General and administrative (4)                                                |                                   |       
|                                          | Stock compensation                                                            |                                   |       
|                                          | Amortization of goodwill, intangibles and in-process research and development |                                   |       
|                                          | Impairments, merger-related, and restructuring expenses (5)                   |                                   |       
|                                          |                                                                               |                                   |       
|                                          |                                                                               | Total operating expenses          |       
|                                          |                                                                               |                                   |       
|Operating loss                            |                                                                               |                                   | (3,546
|                                          | Impairment of investments                                                     |                                   |       
|                                          | Other income                                                                  |                                   |       
|                                          |                                                                               |                                   |       
|                                          |                                                                               | Total other income (expense), net |       
|                                          |                                                                               |                                   |       
|Loss before taxes                         |                                                                               |                                   | (6,920
|                                          | Provision for taxes                                                           |                                   |       
|                                          |                                                                               |                                   |       
|Net loss                                  |                                                                               |                                   | (7,016
|                                          | Other comprehensive income (loss)translation loss                            |                                   |       
|                                          |                                                                               |                                   |       
|Comprehensive loss                        |                                                                               | $                                 | (7,208
|                                          |                                                                               |                                   |       
|Net loss per sharebasic and diluted      |                                                                               | $                                 | (0.23 
|                                          |                                                                               |                                   |       
|Weighted average sharesbasic and diluted |                                                                               |                                   | 30,461
|                                          |                                                                               |                                   |       

---

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|                                          |                                                                               | Quarters Ended           |        
|----------------------------------------- | ----------------------------------------------------------------------------- | ------------------------ | -------
|
|
|Fiscal 2000                               |                                                                               |                          |        
|Revenue:                                  |                                                                               |                          |        
|                                          | Product and IP revenue                                                        |                          | $      
|                                          | Services revenue                                                              |                          |        
|                                          |                                                                               |                          |        
|                                          |                                                                               | Total Revenue            |        
|Cost of revenue (1)                       |                                                                               |                          | 3,984  
|                                          |                                                                               |                          |        
|Gross profit                              |                                                                               |                          | 4,220  
|Operating expenses:                       |                                                                               |                          |        
|                                          | Research & development (2)                                                    |                          |        
|                                          | Sales & marketing (3)                                                         |                          |        
|                                          | General & administrative (4)                                                  |                          |        
|                                          | Stock compensation                                                            |                          |        
|                                          | Amortization of goodwill, intangibles and in-process research and development |                          |        
|                                          | Impairments, merger-related, and restructuring expenses (5)                   |                          |        
|                                          |                                                                               |                          |        
|                                          |                                                                               | Total operating expenses |        
|Operating loss                            |                                                                               |                          | (27,546
|                                          | Other income, net                                                             |                          |        
|                                          |                                                                               |                          |        
|Loss before taxes                         |                                                                               |                          | (26,296
|                                          | Provision for taxes                                                           |                          |        
|                                          |                                                                               |                          |        
|Net loss                                  |                                                                               |                          | (26,338
|                                          | Other comprehensive income (loss)translation loss                            |                          |        
|                                          |                                                                               |                          |        
|Comprehensive loss                        |                                                                               | $                        | (26,126
|                                          |                                                                               |                          |        
|Net loss per sharesbasic and diluted     |                                                                               | $                        | (0.89  
|                                          |                                                                               |                          |        
|Weighted average sharesbasic and diluted |                                                                               |                          | 29,457 
|                                          |                                                                               |                          |        

---

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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 the related notes. The following
discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors
that could cause or contribute to these differences include, but are not limited to, those discussed below and those listed under "Risks and Uncertainties".

OVERVIEW

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

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

Additionally,
Tumbleweed Secure Guardian enables a broad spectrum of network extension solutions that help companies leverage the business efficiencies and benefits of the business
Internet, including secure communications between trading partners, moving paper-based processessuch as statement presentmentonline, and delivery and storage of aggregated
enterprise communications into a single, branded secure inbox. Tumbleweed is trusted by 1,000 blue-chip customers including American Century
Services Corp., American Express Travel Related Services Company, Inc., Amgen Inc., Beckman Coulter, Inc., Best Buy Co., Inc., Broadcom Corp., Diners Club International Ltd., the U.S.
Food & Drug Administration, Gap, Inc., JP Morgan Chase & Co., Merck, National Semiconductor Corp., Northern Trust, Phoenix Home Life Insurance Co., Salomon Smith Barney Inc.,
Siebel Systems, Inc., Skandaniska Enskilda Banken AB, Union Minere Oxyde (U.K.) Ltd., Verizon Communications, Wachovia Securities, Inc., and Wells Fargo & Co. Over 100 of the Fortune 500
use various Tumbleweed solutions today.

Revenue,
which consists of both product and intellectual property (IP) revenue and services revenue, results from new contracts and backlog. We define backlog as contractual commitments
that are not due and payable as of the balance sheet date and deferred revenue. Product and IP revenue consists of license fees and transaction revenue. We typically offer our software products under
a perpetual license. Under a perpetual license our customers pay a one-time license fee for the right to use our software. Perpetual license revenue is typically recognized upon software
shipment. We enter into patent license agreements whereby licensees gain access to our patented technology for the duration of the patent in exchange for a licensing fee. We recognize revenue from IP
upon execution of the patent license agreement and when billable. Transaction revenue is based on actual volume of transactions or contractual minimum volumes, and the related revenue is recognized
based on payment schedules or transaction reports from our customers. Services revenue consists of consulting fees and

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support and maintenance fees. Consulting fees related to installation or customization are recognized upon client acceptance or percentage of completion. Support and maintenance fees are paid for
ongoing customer support and in some instances for the right to receive future upgrades of our products during the term of the maintenance agreement. Revenue from support and maintenance is recognized
ratably over the period the support is provided. Revenue from the reseller channel is recognized upon the execution of a distribution agreement and receipt of substantive identification of the
end-user customer.

A
portion of our revenue relates to international customers or operations. Most of our international contracts are denominated in foreign currencies. We currently do not have hedging or
similar arrangements to protect us against foreign currency fluctuations. Therefore, we increasingly may be subject to currency fluctuations, which could harm our operating results in future periods.

Our
future net income and cash flow may be adversely affected by limitations on our ability to apply net operating losses for federal income tax reporting purposes against taxable income
in future periods, including limitations due to ownership changes, as defined in Section 382 of the Internal Revenue Code, arising from issuance of stock.

On
January 31, 2000, we completed the acquisition of Worldtalk Communications Corporation (Worldtalk), a leading provider of Internet security and policy management solutions that
enable organizations to define and manage e-mail and web security usage policies to manage the risks and liabilities associated with Internet communications. The business combination has
been accounted for as a pooling of interests and, accordingly, our historical financial statements have been restated to include the accounts and results of operations of Worldtalk. Except as
otherwise indicated, the terms
"Tumbleweed," "we" and "our" refer to Tumbleweed and its subsidiaries, including Worldtalk, in this discussion.

On
May 15, 2000, we repurchased from Hikari Tsushin 5% of the outstanding stock of Tumbleweed KK, or TKK, for a price of approximately $645,000. As a result of this transaction,
we own a controlling interest of the Japanese subsidiary and began accounting for the Japanese subsidiary under the consolidation method effective April 1, 2000. On August 29, 2000, we
repurchased an additional 25% of the outstanding shares of the jointly owned Japanese subsidiary, increasing our ownership position to 80%.

On
August 1, 2000, we completed a primary and secondary public offering of 3,000,000 shares of our common stock at a price of $56.00 per share. Of the 3,000,000 shares of common
stock, 1,500,000 primary shares were sold by us and 1,500,000 secondary shares were sold by our stockholders. Tumbleweed did not receive any of the proceeds from shares sold by its stockholders. Net
proceeds of $77.9 million from the offering of primary shares have been and will be used for working capital and other general corporate purposes. In addition, we may use a portion of the net
proceeds to acquire complementary products, technologies or businesses.

On
September 1, 2000, we completed the acquisition of Interface Systems, Inc. (Interface). Interface's Legacy to Internet, or L2i, products and services simplify the
process of transforming and using data found in legacy computer systems into electronic content that is easy to distribute and use online. The L2i products adapt legacy print streams and other data
types to the Internet and intelligently convert them into formats such as Portable Document Format, HyperText Markup Language or eXtensible Markup Language for use online. The combination of L2i with
Tumbleweed IME gives our customers a comprehensive, end-to-end solution for secure electronic statement presentment known as Tumbleweed Secure Statements. We divested the
Interface businesses other than L2i.

The
acquisition was accounted for using the purchase method of accounting and accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their
estimated fair

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values on the acquisition date. Since September 1, 2000, Interface's results of operations have been included in our consolidated statements of operations. The fair value of the intangible
assets was determined based upon a valuation using a combination of methods, including a cost approach for the assembled workforce, and an income approach for the core technology.

The
purchase price of approximately $77.1 million consisted of an exchange of 1,249,210 shares of our common stock with a fair value of approximately $64.2 million, assumed
stock options with a fair value of approximately $7.9 million, cash paid of $2.0 million, and other acquisition related expenses of approximately $2.9 million consisting primarily
of payments for financial advisor and other professional fees.

During
the three months ended March 31, 2001, we performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the acquisition of
Interface. The assessment was performed primarily due to changes in the economy, the overall decline in the industry growth rates, and our lower actual and projected operating results including that
of the business acquired from Interface. Our assessment is supported by the significant sustained decline in our stock price since the valuation date of the shares issued in the Interface acquisition,
which resulted in the net book value of our assets prior to the impairment charge significantly exceeding our market capitalization. As a result of our review, we recorded a $51.0 million
impairment charge to reduce goodwill and other intangible assets. The charge was determined based upon our estimated discounted cash flows over the remaining estimated useful life of the goodwill
using a discount rate of 15%. The assumptions supporting the cash flows including the discount rate were determined using our estimates as of March 31, 2001. The remaining intangible assets
were amortized in full over their remaining useful life in 2001.

In
January 2001, our Board of Directors approved a restructuring program. This restructuring program is intended to align our cost structures with our company-wide
focus on customer service, sales and research and development. The restructuring involved consolidating our facilities in the U.S. and closing and sales offices in Paris, France; Chatsworth,
Australia; and Stockholm, Sweden, realigning our professional services organization, and reducing headcount in most areas of our business. The reduction in force involved approximately 100 employees
and total charges incurred as a result of the restructuring were $4.7 million during 2001, which includes charges related to vacating leased facilities domestically and abroad.

Years ended December 31, 2001 and 2000

Revenue.Revenue is comprised of product and IP revenue and services revenue. Total revenue decreased to $29.0 million
in 2001 from $37.3 million in 2000 due to weaker global macroeconomic conditions in 2001 and the closure of offices in Australia, France, and Sweden associated with our 2001 restructuring.

Product
and IP revenue decreased to $18.4 million in 2001 from $29.2 million in 2000 due to weaker global macroeconomic conditions in 2001, a change in focus to enterprise
sales, and the closure of offices in Australia, France, and Sweden associated with our 2001 restructuring. Services revenue increased to $10.7 million in 2001 from $8.2 million in 2000
due to an increase in contract development work by our professional services organization and increases in maintenance fees from our installed customer base.

Cost of Revenue.Cost of revenue is comprised of product and IP costs and services costs. Product license cost is primarily
comprised of royalties paid to third parties for software licensed by us for inclusion in our products and bandwidth costs associated with hosting servers for those customers who
use our hosting services. Services costs are comprised primarily of personnel and overhead costs related to customer support and contract development projects. Total cost of revenue decreased to
$12.3 million in 2001 from $13.1 million for 2000. The decrease in total cost of revenue was due to a

33

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decrease in service costs and a reduction in product costs that were tied to our revenues, as our revenues decreased.

Research and Development Expenses.Research and development expenses are comprised of engineering and related costs
associated with the development of our applications, quality assurance and testing. Research and development expenses increased to $15.9 million in 2001 from $15.7 million in 2000. The
increase in research and development expenses was due to increased engineering costs resulting from the acquisition of Interface in September 2000.

Sales and Marketing Expenses.Sales and marketing expenses are comprised of salaries, commissions, travel expenses and costs
associated with trade shows, lead generation, advertising and other marketing efforts. Sales and marketing expenses decreased to $36.4 million in 2001 from $44.8 million in 2000. The
decrease in sales and marketing expenses was primarily due to decreased personnel costs as a result of the 2001 restructuring and other cost savings from our closure of offices in Australia, France,
and Sweden.

General and Administrative Expenses.General and administrative expenses consist primarily of personnel and support costs for
our finance, legal, information systems and human resources departments as well as professional fees. General and administrative expenses decreased to $9.3 million in 2001 from
$12.0 million in 2000. The decrease in general and administrative expenses was due to decreased personnel costs as a result of the 2001 restructuring and lower legal costs as the prior year
included expenses resulting from our patent infringement lawsuit against the docSpace Company, Inc.

Stock Compensation Expense.Stock compensation expense was recorded in connection with the amortization of deferred stock
compensation recorded as a result of grants of stock options to non-employees and employees at exercise prices less than the deemed fair value on the grant date, the vesting acceleration
of stock options approved for certain employees, and warrants granted to non-employees in exchange for services performed, net of a credit related to stock options granted to employees who
were later terminated. The credit resulted from the reversal of stock compensation expense previously recorded for options cancelled that had not vested. Stock compensation expense is included in our
cost of revenues and operating expenses in our statement of operations. This expense is being amortized over the vesting period of the options, which is generally four years. Stock compensation
expense decreased to $3.1 million in 2001 from $6.0 million in 2000. The decrease was the result of the termination of certain employees during the 2001 restructuring whose options had
not yet vested.

Amortization of Goodwill and Intangible Assets.Amortization of goodwill and intangible assets decreased to
$12.2 million in 2001 from $13.8 million in 2000. The decrease in expense in 2001 is due to
the $51.0 million impairment charge recorded in the first quarter of 2001. The goodwill and other intangible assets resulted from the Interface purchase and, to a lesser extent, our increase in
ownership of Tumbleweed KK from 50% to 80% during 2000. Goodwill and intangible assets are amortized over their respective lives, generally one to five years. In July 2001, the FASB issued
SFAS 142,Goodwill and Other Intangible Assets. SFAS 142 will require that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 will also require that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. We are required to adopt the provisions of SFAS 142 effective January 1, 2002.

Impairments, Merger-Related, and Restructuring Expenses.During the first quarter of 2001, our Board of Directors approved a
restructuring program. This restructuring program focuses our efforts on aligning our cost structures with our company-wide focus on customer service, sales and research and

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development. The restructuring involved consolidating facilities in the U.S. and closing international sales office locations in Paris, France; Chatsworth, Australia; and Stockholm, Sweden,
realigning our professional services organization, and reducing headcount in most areas of our business. The reduction in work force involved approximately 100 employees and total charges incurred as
a result of the restructuring were $4.7 million during 2001, which includes charges related to vacating leased facilities domestically and abroad. Merger related and restructuring expenses of
$10.8 for 2000 were recorded in connection with the acquisition of Worldtalk, and were primarily comprised of investment banker's fees, legal fees, severance payments and accounting and printer fees.

During
the three months ended March 31, 2001, we performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the acquisition of
Interface. The assessment was performed primarily due to changes in the economy, the overall decline in the industry growth rates, and our lower actual and projected operating results including that
of the business acquired from Interface. Our assessment is supported by the significant sustained decline in our stock price since the valuation date of the shares issued in the Interface acquisition,
which resulted in the net book value of our assets prior to the impairment charge significantly exceeding our market capitalization. As a result of our review, we recorded a $51.0 million
impairment charge to reduce goodwill and other intangible assets. The charge was determined based upon our estimated discounted cash flows over the remaining estimated useful life of the goodwill
using a discount rate of 15%. The assumptions supporting the cash flows including the discount rate were determined using our estimates as of March 31, 2001. The remaining intangible assets
were amortized in full over their remaining useful life in 2001.

Impairment of Investments.During 2000, we made investments in two non-public companies of $977,000 and
$3.0 million. The investments are carried at cost as we hold less than 20% of the voting equity and do not have the ability to exercise significant influence, and are included in other assets
in the accompanying balance sheet. We monitor these investments for impairment and make appropriate reductions in carrying values when necessary. During 2001 we recorded a $3.4 million expense
to recognize an other-than-temporary impairment in the value of these investments.

Other Income, Net.Other income, net, is primarily comprised of interest income earned on investment securities. Other
income, net decreased to $2.1 million in 2001 from $3.4 million in 2000. The decrease in other income, net, is due to the decline in interest rates and a reduction in our cash balances
relative to the year-earlier period when we received proceeds from the issuance of securities in August 2000.

Years Ended December 31, 2000 and 1999

Revenue.Total revenue increased to $37.3 million in 2000 from $16.8 million in 1999 due to increased
acceptance of our solutions in the marketplace. Product and IP revenue increased to $29.2 million in 2000 from $12.3 million in 1999 due to an increase in the number of licenses sold,
additional license fees paid by existing customers, minimum transaction fees from customers due to the growth of our installed base, and an increase in the average sales price of the product line
formerly known as MMS during 2000. Services revenue increased to $8.2 million in 2000 from $3.0 million in 1999 due to an increase in contract development work by our professional
services organization, and, to a lesser extent, increases in maintenance fees. Total revenue excluding discontinued product lines increased to $37.3 million in 2000 from $15.3 million in
1999. There was no revenue from discontinued product lines in 2000.

Cost of revenue.Cost of revenue increased to $13.1 million in 2000 from $4.9 million in 1999. The increase in
cost of revenues was primarily attributable to increased service costs driven by increased personnel costs supporting our larger customer base and the acquisition of Interface in

35

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September 1, 2000. Additionally, product and IP costs increased due to increased sales of products containing software licensed from third parties.

Research and development expenses.Research and development costs increased to $15.7 million in 2000 from
$10.0 million in 1999. The increase was primarily due to increased head count in part from our Interface acquisition, increases in average salaries for development personnel, and increased
facilities-related expenses.

Sales and marketing expenses.Sales and marketing expenses increased to $44.8 million in 2000 from
$21.9 million in 1999. The increase in sales and marketing expenses was primarily due to increased sales staffing and commissions, and expanded marketing programs.

General and administrative expenses.General and administrative expenses increased to $12.0 million in 2000 from
$6.1 million in 1999. The increase in general and administrative expenses was due in part to an increase in legal fees corresponding to patent infringement lawsuit we brought against The
docSpace Company, Inc., as well as increased staffing expenses and professional fees.

Stock compensation expense.Stock compensation expense increased to $6.0 million in 2000 from $3.5 million in
1999. The increase in stock compensation expense resulted from the Interface acquisition in December 2000.

Merger related and restructuring expenses.Merger related and restructuring expenses, which were recorded in connection with
the acquisition of Worldtalk, are primarily comprised of investment banker's fees, legal fees, severance payments and accounting and printer fees. Merger related and restructuring expenses for 2000
were $10.8 million.

Amortization of goodwill and intangible assets.Amortization of goodwill and intangible assets was $13.8 million for
2000. The goodwill and other intangible assets resulted from the Interface purchase and, to a lesser extent, our increase in ownership of Tumbleweed KK from 50% to 80% during 2000.

Other income, net.Other income, net increased to $3.4 million in 2000 from $2.1 million in 1999. The increase
in other income, net, is due to increased cash balances invested in money market accounts. The increase in cash balances available for investment resulted from proceeds from the issuance of equity
securities, including common stock issued in our initial public offering completed in August 1999 and our offering completed in August 2000.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through the issuance of equity securities. As of December 31, 2001, we had $43.2 million
in cash and cash equivalents.

Net
cash used in operating activities for 2001 was $32.1 million. Cash used in operating activities was primarily the result of a net operating loss and decreases in accounts
payable and accrued liabilities, offset by certain non-cash charges, a decrease in accounts receivable and an increase in deferred revenue.

Net
cash used in investing activities for 2001 was $166,000. Net cash used in investing activities was the result of capital expenditures primarily for research and development property
and equipment, offset by the sale of our building in Ann Arbor, Michigan.

Net
cash provided by financing activities for 2001 was $444,000. Cash provided by financing activities was attributable to net proceeds from the issuance of equity securities under our
stock option and employee stock purchase plans offset by repayments of borrowings.

36

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As
of December 31, 2001, our principal commitments consisted of obligations related to outstanding operating and capital leases. Our equipment leases require payment of rental
fees to third party leasing providers. In most cases, we have no obligations to purchase the equipment at the end of the lease term. We do not anticipate a substantial increase in capital expenditures
in the immediate future. We also do not anticipate an increase in operating lease obligations.

In
June 1999, we entered into an operating lease covering approximately 40,000 square feet of office space in Redwood City, California. The lease is for a term of five years at
monthly rent of approximately $96,000. In September 2000, we leased an additional 42,000 square feet in an adjacent building with a term of five years and subleased this space. We terminated
this second lease as of December 31, 2001 and made settlement payments on this lease in the first quarter of 2002 as a part of the lease termination agreement.

In
July 1998, we entered into a debt agreement with a bank, which includes a $750,000 equipment loan facility. In June 1999, we obtained a second equipment loan facility in
the amount of $1.0 million with the same bank. The first equipment loan in the amount of $750,000 expired in December 2001 and the second equipment loan in the amount of
$1.0 million expires in December 2002. Borrowings under both equipment loan facilities bear interest at prime rate plus 0.75%, are due and payable in 36 equal monthly installments and
are secured by certain of our assets. As of December 31, 2001, total borrowings under the equipment loan facility was approximately $322,000 in the aggregate and $678,000 remained available
under the facilities. The weighted average interest rate for the equipment loans was 8.21%, 10.00%, and 8.45%, for 2001, 2000, and 1999, respectively. The loan has aggregate maturities of
approximately $322,000 in 2002.

Our
capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and services, the resources devoted to the
development of our products and services and the resources devoted to sales and marketing. We have experienced a substantial increase in capital expenditures and operating expenses since inception
consistent with relocation and the growth in operations and staffing; however, we do not anticipate continued increases in capital expenditures in the foreseeable future. We expect to experience a
seasonal reduction in sales in Europe during the summer months. In addition, many of our customers delay purchases of our products until the end of each quarter. We believe that our existing capital
resources will enable us to maintain our current and planned operations for at least the next 12 months; however, we may need to raise funds prior to that time.

We
will continue to consider future financing alternatives, which may include the incurrence of indebtedness, additional public or private equity offerings or an equity investment by a
strategic partner; however, we have no present commitments or arrangements assuring us of any future equity or debt financing. Additionally, equity or debt financing may not be available to us on
favorable terms, if at all.

37

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Contractual Obligations and Commercial Commitments

Future cash payments for contractual obligations and commercial commitments as of December 31, 2001, are as follows (in thousands):

|                                   |  | 2002 |       | 2003 |   | 2004  |  | 2005 |       | 2006 |   | After 2006 |  | Total
|---------------------------------- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ---- | - | ---------- |  | -----
|Debt                               |  | $    | 335   |      | $ |      |  | $    |      |      | $ |           |  | $    
|Capital leases                     |  |      | 59    |      |   | 9     |  |      |      |      |   |           |  |      
|Operating leases                   |  |      | 2,829 |      |   | 2,293 |  |      | 1,758 |      |   | 128        |  |      
|Lease exit costs                   |  |      | 2,335 |      |   |       |  |      |       |      |   |            |  |      
|Unconditional purchase obligations |  |      | 539   |      |   | 426   |  |      | 36    |      |   |           |  |      
|                                   |  |      |       |      |   |       |  |      |       |      |   |            |  |      
|Total                              |  | $    | 5,762 |      | $ | 2,728 |  | $    | 1,794 |      | $ | 128        |  | $    
|                                   |  |      |       |      |   |       |  |      |       |      |   |            |  |      

Item 7aQuantitative and Qualitative Disclosures About Market Risk

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

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

Interest Rate Sensitivity

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without
significantly increasing risk. Some of the securities that we have invested in may be subject to 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, 2001, none of our cash equivalents were subject to market risk.

Item 7b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 customer
arrangements, bad debts, 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.

38

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Revenue Recognition

We derive our revenue from two sources (i) product and intellectual property (IP) revenue, which includes license and transaction fees, and patent license
agreement fees, and (ii) services revenue, which includes consulting, support, and maintenance 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 if our management made different judgments or
utilized different estimates.

We
typically offer our software products under a perpetual license. Our hosting arrangements require customers to pay a one-time license fee for the right to use our
software. We enter into patent license agreements whereby licensees gain access to our patented technology for the duration of the patent in exchange for a licensing fee. Transaction fees are based on
the volume of transactions or contractual minimum volumes. Support and maintenance fees are paid, in general, for ongoing customer support during the term of the maintenance agreement.

We
apply the provisions of Statement of Position (SOP) 97-2, "Software Revenue Recognition", and SOP 98-9, "Software Revenue Recognition with Respect to Certain
Arrangements", which generally requires revenue recognized from software arrangements to be allocated to each element of the arrangement based on the relative fair values of the elements, such as
software products, consulting, training, installation, or post-contract customer support. Fair values are based upon vendor specific objective evidence. If such evidence does not exist for
delivered elements, we record revenue using the
residual method. If such evidence does not exist for undelivered elements, all revenue from the arrangement is deferred until such time that evidence of fair value does exist, or until all elements of
the arrangement are delivered, or revenue is recorded ratably if the only undelivered element is post-contract customer support.

We
recognize revenue from perpetual licenses upon shipment when the following provisions are met: (i) persuasive evidence of an arrangement exists, generally based on an executed
contract and non-binding purchase order; (ii) the product has been delivered, generally to a common carrier; (iii) the fee is fixed and determinable, and
(iv) collection of the resulting receivable is reasonably assured. We recognize revenue from IP upon execution of the patent license agreement and when billable. Transaction revenue is
recognized based on payment schedules or transaction reports from our customers. A number of our contracts include minimum transaction volume requirements. In these cases, the minimum guaranteed
revenue is recognized when fees are due and payable during those months where transaction volume does not exceed the designated minimums.

Consulting
fees related to installation or customization is recognized upon client acceptance or percentage of completion. Revenue from support and maintenance is recognized ratably over
the period the support is provided.

We
assess collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We do not request collateral from our
customers. If we determine that collection of a fee is not probable, we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon receipt of cash.

Valuation of Allowance for Doubtful Accounts

The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets, the disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. We must make estimates of the collectability of our
accounts receivables. We specifically analyze accounts receivable including review of historical bad debts, customer concentrations, customer credit-

39

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worthiness, current economic trends, aging of the balance, geographic and industry mix, and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.

Valuation of Privately-Held Investments

Our determination of impairment related to certain equity investments in privately held companies are based on the latest available valuation of such investment,
or, if unavailable, our assumptions related to projected operating results of the privately held company and potential effects of declines in market trends. Future events that adversely change the
assumptions we use to determine valuation of investments may require us to record charges for impairment of the carrying value of our investments.

Valuation of long-lived and intangible 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:



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

Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" became effective on January 1, 2002 and as a result, we will cease to
amortize approximately $6.7 million of goodwill. In lieu of amortization, we are required to perform an initial impairment
review of our goodwill in 2002 and an annual impairment review thereafter. We expect to complete our initial review during the first half of 2002.

We
currently do not expect to record an impairment charge upon completion of the initial impairment review. However, there can be no assurance that at the time the review is completed, a
material impairment charge will not be recorded.

40

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Item 8Financial Statements and Supplementary Data.

TUMBLEWEED COMMUNICATIONS CORP.        INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                |  | Page
|----------------------------------------------- |  | ----
|Report of Independent Auditors                  |  | 42  
|Consolidated Balance Sheets                     |  | 43  
|Consolidated Statements of Operations           |  | 44  
|Consolidated Statements of Stockholders' Equity |  | 45  
|Consolidated Statements of Cash Flows           |  | 46  
|Notes to Consolidated Financial Statements      |  | 47  

41

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REPORT OF INDEPENDENT AUDITORS

The
Board of Directors and Stockholders
Tumbleweed Communications Corp.:

We
have audited the accompanying consolidated balance sheets of Tumbleweed Communications Corp. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2001. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tumbleweed Communications Corp. and
subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,
2001, in conformity with accounting principles generally accepted in the United States of America.



Mountain
View, California
January 24, 2002

42

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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Consolidated Balance Sheets (in thousands, except share and per share data)

|                                               |                                                                                                                                                                      | December 31,                               |       
|---------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------
|
|Assets                                         |                                                                                                                                                                      |                                            |       
|Current assets:                                |                                                                                                                                                                      |                                            |       
|                                               | Cash and cash equivalents                                                                                                                                            |                                            | $     
|                                               | Accounts receivable, net of allowance for doubtful accounts of $1,985 and $1,125 as of December 31, 2001 and 2000, respectively                                      |                                            |       
|                                               | Other current assets                                                                                                                                                 |                                            |       
|                                               |                                                                                                                                                                      |                                            |       
|                                               |                                                                                                                                                                      | Total current assets                       |       
|                                               | Property and equipment, net                                                                                                                                          |                                            |       
|                                               | Goodwill and intangible assets, net                                                                                                                                  |                                            |       
|                                               | Other assets                                                                                                                                                         |                                            |       
|                                               |                                                                                                                                                                      |                                            |       
|                                               |                                                                                                                                                                      | Total assets                               |       
|                                               |                                                                                                                                                                      |                                            |       
|Liabilities and Stockholder' Equity            |                                                                                                                                                                      |                                            |       
|Current liabilities:                           |                                                                                                                                                                      |                                            |       
|                                               | Accounts payable                                                                                                                                                     |                                            | $     
|                                               | Current installments of long-term debt                                                                                                                               |                                            |       
|                                               | Accrued liabilities                                                                                                                                                  |                                            |       
|                                               | Accrued restructuring                                                                                                                                                |                                            |       
|                                               | Deferred revenue                                                                                                                                                     |                                            |       
|                                               |                                                                                                                                                                      |                                            |       
|                                               |                                                                                                                                                                      | Total current liabilities                  |       
|Long-term debt, excluding current installments |                                                                                                                                                                      |                                            | 9     
|Deferred revenue                               |                                                                                                                                                                      |                                            | 1,568 
|Other long-term liabilities                    |                                                                                                                                                                      |                                            | 433   
|                                               |                                                                                                                                                                      |                                            |       
|Total liabilities                              |                                                                                                                                                                      |                                            | 21,859
|                                               |                                                                                                                                                                      |                                            |       
|Commitments and contingencies                  |                                                                                                                                                                      |                                            |       
|Minority interest                              |                                                                                                                                                                      |                                            | 356   
|                                               |                                                                                                                                                                      |                                            |       
|Stockholders' equity:                          |                                                                                                                                                                      |                                            |       
|                                               | Common stock, $.001 par value; 100,000,000 shares authorized, 30,545,170 and 29,554,621 shares issued and outstanding as of December 31, 2001 and 2000, respectively |                                            |       
|                                               | Additional paid-in capital                                                                                                                                           |                                            |       
|                                               | Deferred compensation expense                                                                                                                                        |                                            |       
|                                               | Accumulated other comprehensive loss                                                                                                                                 |                                            |       
|                                               | Accumulated deficit                                                                                                                                                  |                                            |       
|                                               |                                                                                                                                                                      |                                            |       
|                                               |                                                                                                                                                                      | Total stockholders' equity                 |       
|                                               |                                                                                                                                                                      |                                            |       
|                                               |                                                                                                                                                                      | Total liabilities and stockholders' equity |       
|                                               |                                                                                                                                                                      |                                            |       

See
accompanying notes to consolidated financial statements.

43

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

|                                                         |                                                                                                                                  | Years ended December 31,              |         
|-------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------- | --------
|
|Revenue:                                                 |                                                                                                                                  |                                       |         
|                                                         | Product and IP revenue                                                                                                           |                                       | $       
|                                                         | Services                                                                                                                         |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Revenue from continuing product lines |         
|                                                         | Discontinued product line                                                                                                        |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Total revenue                         |         
|Cost of revenues:                                        |                                                                                                                                  |                                       |         
|                                                         | Product and IP                                                                                                                   |                                       |         
|                                                         | Services (inclusive of non-cash compensation of $317 and $150 in 2001 and 2000, respectively)                                    |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Total cost of revenues                |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Gross profit                          |         
|Operating expenses:                                      |                                                                                                                                  |                                       |         
|                                                         | Research and development (inclusive of non-cash compensation of $667, $828, and $1,049 in 2001, 2000, and 1999, respectively)    |                                       |         
|                                                         | Sales and marketing (inclusive of non-cash compensation of $1,812, $4,153, and $1,961 in 2001, 2000, and 1999, respectively)     |                                       |         
|                                                         | General and administrative (inclusive of non-cash compensation of $668, $429, and $526 in 2001, 2000, and 1999, respectively)    |                                       |         
|                                                         | Amortization of goodwill, intangibles, and in-process research and development                                                   |                                       |         
|                                                         | Merger-related and restructuring expenses (inclusive of non-cash compensation of ($336) and $411 in 2001 and 2000, respectively) |                                       |         
|                                                         | Impairment of goodwill and intangible assets                                                                                     |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Total operating expenses              |         
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Operating loss                        |         
|                                                         | Impairment of investments                                                                                                        |                                       |         
|                                                         | Other income, net                                                                                                                |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|Net loss before provision for taxes                      |                                                                                                                                  |                                       | (114,012
|                                                         | Provision for income taxes                                                                                                       |                                       |         
|                                                         |                                                                                                                                  |                                       |         
|Net loss                                                 |                                                                                                                                  |                                       | (114,165
|                                                         |                                                                                                                                  |                                       |         
|Other comprehensive income (loss)translation adjustment |                                                                                                                                  |                                       | (524    
|                                                         |                                                                                                                                  |                                       |         
|                                                         |                                                                                                                                  | Comprehensive loss                    |         
|                                                         |                                                                                                                                  |                                       |         
|Net loss per sharebasic and diluted                     |                                                                                                                                  | $                                     | (3.78   
|                                                         |                                                                                                                                  |                                       |         
|Weighted average sharesbasic and diluted                |                                                                                                                                  |                                       | 30,171  
|                                                         |                                                                                                                                  |                                       |         

See
accompanying notes to consolidated financial statements.

44

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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity
Years ended December 31, 2001, 2000 and 1999
(in thousands, except share data)

|                            |                                                                                   | Convertible Preferred Stock |             |   |   |     |            |            |   |    |    |   |         |        |   |        |       
|--------------------------- | --------------------------------------------------------------------------------- | --------------------------- | ----------- | - | - | --- | ---------- | ---------- | - | -- | -- | - | ------- | ------ | - | ------ | ------
|
|
|
|BALANCES, DECEMBER 31, 1998 |                                                                                   | 6,723.931                   |             | $ | 7 |     | 6,994,189  |            | $ | 7  |    | $ | 47,001  |        | $ | (1,548 | )     
|                            | Issuance of common stock upon exercise of stock options                           |                             |            |   |   |    |            | 877,893    |   |    | 1  |   |         | 1,247  |   |        |      
|                            | Issuance of Series B preferred stock in exchange for services                     |                             | 15,000      |   |   |    |            |           |   |    |   |   |         | 54     |   |        |      
|                            | Issuance of Series C preferred stock and warrants net of issuance costs of $1,337 |                             | 5,586,003   |   |   | 5   |            |           |   |    |   |   |         | 18,748 |   |        |      
|                            | Issuance of Series C preferred stock in exchange for services                     |                             | 6,500       |   |   |    |            |           |   |    |   |   |         | 23     |   |        |      
|                            | Issuance of common stock warrant                                                  |                             |            |   |   |    |            |           |   |    |   |   |         | 127    |   |        |      
|                            | Issuance of common stock upon exercise of warrants                                |                             |            |   |   |    |            | 94,610     |   |    |   |   |         | 270    |   |        |      
|                            | Purchases under Employee Stock Purchase Plan                                      |                             |            |   |   |    |            | 39,000     |   |    |   |   |         | 311    |   |        |      
|                            | Foreign currency translation adjustment                                           |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            | Deferred compensation expense on stock option grants                              |                             |            |   |   |    |            |           |   |    |   |   |         | 7,271  |   |        | (7,271
|                            | Amortization of deferred compensation expense                                     |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        | 3,536 
|                            | Conversion of preferred stock to common stock                                     |                             | (12,331,434 | ) |   | (12 | )          | 12,331,434 |   |    | 12 |   |         |       |   |        |      
|                            | Gain on sale of TKK subsidiary                                                    |                             |            |   |   |    |            |           |   |    |   |   |         | 1,491  |   |        |      
|                            | Repurchase of common stock                                                        |                             |            |   |   |    |            |           |   |    |   |   |         | (36    | ) |        |      
|                            | Issuance of common stockIPO, net of issuance costs of $4,855                     |                             |            |   |   |    |            | 4,219,592  |   |    | 5  |   |         | 45,769 |   |        |      
|                            | Issuance of common stock for equity financing                                     |                             |            |   |   |    |            | 867,000    |   |    | 1  |   |         | 9,891  |   |        |      
|                            | Net loss                                                                          |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            |                                                                                   |                             |             |   |   |     |            |            |   |    |    |   |         |        |   |        |       
|BALANCES, DECEMBER 31, 1999 |                                                                                   |                            |             |   |  |     | 25,423,718 |            |   | 26 |    |   | 132,167 |        |   | (5,283 | )     
|                            | Issuance of common stock upon exercise of stock options                           |                             |            |   |   |    |            | 1,234,033  |   |    | 1  |   |         | 6,260  |   |        |      
|                            | Purchases under Employee Stock Purchase Plan                                      |                             |            |   |   |    |            | 111,886    |   |    |   |   |         | 1,785  |   |        |      
|                            | Issuance of options in exchange for services                                      |                             |            |   |   |    |            |           |   |    |   |   |         | 616    |   |        |      
|                            | Foreign currency translation adjustment                                           |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            | Deferred compensation expense on stock option grants                              |                             |            |   |   |    |            |           |   |    |   |   |         | 4,004  |   |        | (4,004
|                            | Deferred compensation expense on vesting acceleration                             |                             |            |   |   |    |            |           |   |    |   |   |         | 275    |   |        | 136   
|                            | Amortization of deferred compensation expense                                     |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        | 4,944 
|                            | Issuance of common stock upon exercise of warrants                                |                             |            |   |   |    |            | 35,774     |   |    |   |   |         |       |   |        |      
|                            | Issuance of common stocksecond offering, net of issuance costs of $6,147         |                             |            |   |   |    |            | 1,500,000  |   |    | 2  |   |         | 77,851 |   |        |      
|                            | Issuance of common stockInterface acquisition                                    |                             |            |   |   |    |            | 1,249,210  |   |    | 1  |   |         | 72,225 |   |        | (2,254
|                            | Net loss                                                                          |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            |                                                                                   |                             |             |   |   |     |            |            |   |    |    |   |         |        |   |        |       
|BALANCES, DECEMBER 31, 2000 |                                                                                   |                            |             | $ |  |     | 29,554,621 |            | $ | 30 |    | $ | 295,183 |        | $ | (6,461 | )     
|                            | Issuance of common stock upon exercise of stock options                           |                             |            |   |   |    |            | 788,869    |   |    | 1  |   |         | 659    |   |        |      
|                            | Purchases under Employee Stock Purchase Plan                                      |                             |            |   |   |    |            | 201,680    |   |    |   |   |         | 384    |   |        |      
|                            | Issuance of options and warrants in exchange for services                         |                             |            |   |   |    |            |           |   |    |   |   |         | 341    |   |        |      
|                            | Foreign currency translation adjustment                                           |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            | Deferred compensation expense on vesting acceleration                             |                             |            |   |   |    |            |           |   |    |   |   |         | 234    |   |        | 163   
|                            | Amortization of deferred compensation expense                                     |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        | 3,123 
|                            | Credit to deferred compensation related to terminated employees                   |                             |            |   |   |    |            |           |   |    |   |   |         | (2,076 | ) |        | 1,341 
|                            | Net loss                                                                          |                             |            |   |   |    |            |           |   |    |   |   |         |       |   |        |      
|                            |                                                                                   |                             |             |   |   |     |            |            |   |    |    |   |         |        |   |        |       
|BALANCES, DECEMBER 31, 2001 |                                                                                   |                            |             | $ |  |     | 30,545,170 |            | $ | 31 |    | $ | 294,727 |        | $ | (1,834 | )     
|                            |                                                                                   |                             |             |   |   |     |            |            |   |    |    |   |         |        |   |        |       

See accompanying notes to consolidated financial statements.

45

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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Consolidated Statements of Cash Flows (in thousands)

|                                                     |                                                                                   | Years Ended December 31,                        |                                          
|---------------------------------------------------- | --------------------------------------------------------------------------------- | ----------------------------------------------- | -----------------------------------------
|
|Cash flows from operating activities:                |                                                                                   |                                                 |                                          
|                                                     | Net loss                                                                          |                                                 | $                                        
|                                                     | Adjustments to reconcile net loss to net cash used in operating activities:       |                                                 |                                          
|                                                     |                                                                                   | Stock-based compensation expense                |                                          
|                                                     |                                                                                   | Depreciation and amortization                   |                                          
|                                                     |                                                                                   | Bad debt expense                                |                                          
|                                                     |                                                                                   | Minority interest                               |                                          
|                                                     |                                                                                   | In-process research and development             |                                          
|                                                     |                                                                                   | Impairment of goodwill and intangible assets    |                                          
|                                                     |                                                                                   | Impairment of investments                       |                                          
|                                                     |                                                                                   | Loss on disposal of property and equipment, net |                                          
|Changes in operating assets and liabilities:         |                                                                                   |                                                 |                                          
|                                                     |                                                                                   | Accounts receivable                             |                                          
|                                                     |                                                                                   | Current and other assets                        |                                          
|                                                     |                                                                                   | Accounts payable and accrued liabilities        |                                          
|                                                     |                                                                                   | Accrued restructuring                           |                                          
|                                                     |                                                                                   | Deferred revenue                                |                                          
|                                                     |                                                                                   |                                                 |                                          
|                                                     |                                                                                   |                                                 | Net cash used in operating activities    
|                                                     |                                                                                   |                                                 |                                          
|Cash flows from investing activities:                |                                                                                   |                                                 |                                          
|                                                     | Purchases of property and equipment                                               |                                                 |                                          
|                                                     | Proceeds from sales of property and equipment                                     |                                                 |                                          
|                                                     | Sales and maturities of short-term investments                                    |                                                 |                                          
|                                                     | Acquisitions, net of cash acquired                                                |                                                 |                                          
|                                                     | Cash transferred to TKK                                                           |                                                 |                                          
|                                                     | Purchase of investments                                                           |                                                 |                                          
|                                                     | Proceeds from sale of Interface product line                                      |                                                 |                                          
|                                                     | Other assets                                                                      |                                                 |                                          
|                                                     |                                                                                   |                                                 |                                          
|                                                     |                                                                                   |                                                 | Net cash used in investing activities    
|                                                     |                                                                                   |                                                 |                                          
|Cash flows from financing activities:                |                                                                                   |                                                 |                                          
|                                                     | Increase in borrowings                                                            |                                                 |                                          
|                                                     | Repayments of borrowings                                                          |                                                 |                                          
|                                                     | Proceeds from issuance of common stock, preferred stock and warrants              |                                                 |                                          
|                                                     | Repurchase of common stock                                                        |                                                 |                                          
|                                                     |                                                                                   |                                                 |                                          
|                                                     |                                                                                   |                                                 | Net cash provided by financing activities
|                                                     |                                                                                   |                                                 |                                          
|Effect of exchange rate fluctuations                 |                                                                                   |                                                 | (524                                     
|Net (decrease) increase in cash and cash equivalents |                                                                                   |                                                 | (32,347                                  
|Cash and cash equivalents, beginning of year         |                                                                                   |                                                 | 75,497                                   
|                                                     |                                                                                   |                                                 |                                          
|Cash and cash equivalents, end of year               |                                                                                   | $                                               | 43,150                                   
|                                                     |                                                                                   |                                                 |                                          
|Supplemental disclosures of cash flow information:   |                                                                                   |                                                 |                                          
|                                                     | Cash paid during the year for interest                                            |                                                 | $                                        
|                                                     |                                                                                   |                                                 |                                          
|                                                     | Cash paid during the year for taxes                                               |                                                 | $                                        
|                                                     |                                                                                   |                                                 |                                          
|Non-cash investing and financing activities:         |                                                                                   |                                                 |                                          
|                                                     | Issuance of warrants and options for debt issuance costs or equity offering costs |                                                 | $                                        
|                                                     |                                                                                   |                                                 |                                          
|                                                     | Equipment acquired under capital lease agreement                                  |                                                 | $                                        
|                                                     |                                                                                   |                                                 |                                          
|                                                     | Issuance of debt to acquire insurance contract                                    |                                                 | $                                        
|                                                     |                                                                                   |                                                 |                                          

See accompanying notes to consolidated financial statements.

46

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TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES        Notes to Consolidated Financial Statements Years ended December 31, 2001, 2000 and 1999

(1) Organization

Tumbleweed Communications Corp. ("Tumbleweed" or "we") is a leading provider of secure content management solutions for enabling business conducted on the
Internet. Tumbleweed Secure Guardian is a leading enterprise-wide policy-based security framework that offers a wide range of solutions to both protect and extend enterprise networks, move
business processes online and enable enterprises to communicate safely over the Internet. Tumbleweed solutions empower organizations to safely share and protect critical information, increase customer
loyalty and privacy and reduce costs.

On
August 2, 1999, we were reincorporated in the state of Delaware. The Certificate of Incorporation of the Delaware successor corporation authorizes 100 million shares of
common stock and 10 million shares of preferred stock at $0.001 par value per share. The accompanying consolidated financial statements have been retroactively restated to give effect to the
reincorporation. We maintain our headquarters in Redwood City, California and have incorporated subsidiaries in Japan, Switzerland, Germany, the United Kingdom, the Netherlands, Sweden, France,
Australia and Hong Kong

(2) Summary of Significant Accounting Policies



The accompanying consolidated financial statements include the accounts of Tumbleweed, our wholly owned subsidiary, Worldtalk Communications Corp. ("Worldtalk"),
our wholly owned subsidiaries in Switzerland, Germany, the United Kingdom, the Netherlands, Sweden, France, Australia and Hong Kong and our majority-owned subsidiary in Japan, Tumbleweed
Communications KK ("TKK"). The results of operations for TKK have been included in Tumbleweed's consolidated statements of operations except for the period from September 1, 1999 to
March 31, 2000, when it was an investment accounted for under the equity method. The results of operations for our wholly owned subsidiary, Interface Systems, Inc. ("Interface") have
been included commencing September 1, 2000, the effective date of its acquisition.

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



We consider all highly liquid investments purchased with remaining maturities of three months or less to be cash equivalents.



Property and equipment is 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; 33 years for buildings and improvements; and the shorter of the estimated useful life of the asset or
the remaining lease term for leasehold improvements. Equipment under capital lease is amortized over the shorter of the estimated useful life of the asset or the lease term. During 2001, we revised
the estimated useful lives of certain assets based on changes in the planned usage of those assets.



During 2000, we made investments in two non-publicly traded companies of $977,000 and $3.0 million. The investments are carried at cost as we
hold less than 20% of the voting equity and do

47

---

not have the ability to exercise significant influence, and are included in other assets in the accompanying balance sheet. We monitor these investments for impairment and make appropriate reductions
in carrying values when necessary. During 2001 we recorded a $3.4 million expense to recognize an other-than-temporary impairment in the value of these investments. One
of the investee companies provided services to us in the amount of approximately $633,000 and $542,000 for 2001 and 2000, respectively.



Goodwill and intangible assets relating to purchase business combinations are recorded at cost less accumulated amortization. Up until December 31, 2001
goodwill and intangible assets relating to purchase business combinations were amortized on a straight-line basis over their estimated useful lives ranging from one to five years. In
July 2001, the FASB issued SFAS 142,Goodwill and Other Intangible Assets. SFAS 142 will require that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 will also require
that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable. We are required to adopt the provisions of SFAS 142 effective January 1, 2002.



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 our software development have not been material.



Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of cash equivalents and accounts receivable. Our cash
equivalents generally consist of money market funds with qualified financial institutions. To reduce credit risk with accounts receivable, we perform ongoing evaluations of our customers' financial
conditions and maintain allowances for credit losses, when necessary.



We recognize revenue in accordance with American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, Software Revenue
Recognitionand SOP 98-9,Software Revenue Recognition with Respect to Certain
Arrangements, which generally requires revenue recognized from software arrangements to be allocated to each element of the arrangement based on the relative fair values of the
elements, such as software products, consulting, training, installation, or post-contract customer support. Fair values are based upon vendor specific objective evidence. If such evidence
does not exist for delivered elements, we record revenue using the residual method. If such evidence does not exist for undelivered elements, all revenue from the arrangement is deferred until such
time that evidence of fair value does exist, or until all elements of the arrangement are delivered, or revenue is

48

---

recorded ratably if the only undelivered element is post-contract customer support. Revenues from software agreements are recognized when persuasive evidence of an agreement exists,
delivery of the product has occurred, the fee is fixed or determinable, and collectibility is probable.

Our
customer contracts are generally multiple-element arrangements; that is, they involve us providing a combination of products and services to a customer. Revenue is allocated to the
various elements based on the relative fair values of the elements. Revenue allocated to the various elements is recognized when the basic revenue recognition criteria are met for that element or
group of elements.

License
and intellectual property (IP) revenue consists of initial license fees and the sale of distribution rights. License revenue typically is recognized upon shipment of the
software. IP revenue from patent license agreements whereby licensees gain access to our patented technology over the duration of certain patents in exchange for a one-time upfront
licensing fee is recognized upon execution of the patent license agreement and when billable. Revenue from the sale of distribution rights is recognized upon the execution of a distribution agreement.
Service fee revenue consists of consulting fees and support and maintenance fees. Consulting fees related to installation are recognized upon acceptance of the installation while all other consulting
fees are recognized based on percentage of completion. Support and maintenance fees are paid for ongoing customer support as well as for the right to receive future upgrades to our products during the
term of the maintenance agreement. Revenue from support and maintenance is recognized ratably over the period the support is provided. Transaction fees are based on the volume of transactions by our
customers, and the related revenue is recognized based on payment schedules and transaction reports from our customers. A number of our contracts include minimum transaction volume requirements. In
these cases, the minimum guaranteed revenue is recognized when fees are due and payable during those months where transaction volume does not exceed the designated minimums.

We
provide limited warranty rights to its customers, which are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") 5,Accounting
for Contingencies. Estimated warranty obligations are provided by charges to operations in the period in which the related revenue is recognized. To date, the estimated
warranty obligations have not been considered significant.



We expense advertising costs as incurred. Total advertising expense was $527,000, $450,000, and $399,000 for 2001, 2000, and 1999, respectively.



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.

49

---



We account for our stock-based compensation arrangements for employees using the intrinsic-value method pursuant to Accounting Principles Board Opinion ("APB")
25,Accounting for Stock Issued to Employees. As such, compensation expense is recorded for fixed plan stock options on the date of grant when the fair
value of the underlying common stock exceeds the exercise price for stock options or the purchase price for issuance or sales of common stock. Expense associated with stock-based compensation is being
amortized on an accelerated basis over the vesting period of the individual award consistent with the method described in Financial Accounting Standards Board ("FASB") Interpretation 28. Options
granted to consultants and other non-employees are considered compensatory and are accounted for at fair value pursuant to SFAS 123,Accounting for
Stock-Based Compensation. We disclose the pro forma effects of using the fair value method of accounting for all stock-based compensation arrangements in accordance with
SFAS 123.



Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period.
Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common and potential common shares outstanding during the period if their effect is
dilutive. The following potential common shares have been excluded from the determination of diluted net loss per share for all periods because the effect of such shares would have been
anti-dilutive (in thousands):

Years Ended December 31,2001

2000

1999Shares issuable under stock options

8,898

7,243

4,475Shares of restricted stock subject to repurchase

14



Shares issuable pursuant to warrants or rights to purchase common stock

552

484

5409,464

7,727

5,015




Our other comprehensive income (loss) consists entirely of cumulative translation adjustments resulting from the application of our foreign currency translation
policy. The tax effects of translation adjustments were not significant.



The fair value of our cash, cash equivalents, accounts receivable, accounts payable and equipment loan facilities approximate their carrying values due to the
short maturity or variable-rate structure of those instruments.

50

---



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 our allowance for doubtful accounts, the valuation of
long-term assets, and revenue recognition. Actual results could differ from those estimates.



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 (loss) 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, 2001, and 2000 no foreign currency translation exposures were hedged.



We review our long-lived assets, including goodwill and intangible assets, for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of 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 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.



Certain reclassifications, none of which affected net income, have been made to prior year amounts to conform to the current year presentation.



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

51

---

amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment.

We
have adopted the provisions of SFAS 141 and will adopt SFAS 142 effective January 1, 2002. In connection with SFAS 142's transitional goodwill impairment
evaluation, the Statement will require us to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. To accomplish this, we must identify our
reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of
the date of adoption. We will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the
extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and we must perform the second step of the transitional
impairment test. In the second step, we must compare the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized
and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with Statement 141, to its carrying amount, both of which would be measured as of the date of
adoption. This second step is required to be completed as soon as possible, but no later than
the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in our consolidated statement of operations.

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

In
June 2001, the FASB issued SFAS 143,Accounting for Asset Retirement Obligations, which addresses financial accounting
and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition, construction, development, or normal use of the asset. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. We are required to adopt the provisions of
SFAS 143 for the quarter ending March 31, 2003. We do not expect the adoption of SFAS 143 to have a material impact on our financial position or results of operations.

On
October 3, 2001, the FASB issued SFAS 144,Accounting for the Impairment or Disposal of Long-Lived Assets,
which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS 144 supersedes SFAS 121, it retains many of the fundamental
provisions of that SFAS 121. SFAS 144 also supersedes the accounting and reporting provisions of APB Opinion 30 for the disposal of a segment of a business. By broadening the
presentation of discontinued operations to include more disposal transactions, SFAS 144 enhances companies' ability to provide information that helps financial statement users to assess the
effects of a disposal transaction on the ongoing operations of an entity. SFAS 144 is effective for the quarter ending March 31, 2002. We do not expect the adoption of SFAS 144 to
have a material impact on our financial position or results of operations.

52

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(3)  Business Combinations



On January 31, 2000, we completed our acquisition of Worldtalk. Under the terms of the merger agreement, each Worldtalk share of common stock has been
converted into 0.26 of a share of ourny's common stock. A total of 3,798,398 shares of our common stock was exchanged for 14,609,374 shares of Worldtalk common stock. The business combination was
accounted for as a pooling of interests and, accordingly, the our historical financial statements have been restated to include the accounts and results of operations of Worldtalk.



On September 1, 2000, we acquired Interface, which developed and sold software-based tools and solutions to integrate legacy systems with Internet
technology, distribute mainframe documents, and provide host connectivity. The acquisition was accounted for using the purchase method of accounting and accordingly, the purchase price was allocated
to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Since September 1, 2000, Interface's results of operations have been included in our
Consolidated Statements of Operations. The fair value of the intangible assets was determined based upon a valuation using a combination of methods, including a cost approach for the assembled
workforce, and an income approach for the core technology.

The
purchase price of $77.1 million consisted of an exchange of 1,249,210 shares of our common stock with a fair value of $64.2 million, assumed stock options with a fair
value of $7.9 million, cash paid of $2.0 million, and other acquisition related expenses of $2.9 million consisting primarily of payments for investment banker's fees, legal fees,
accounting fees, and printer fees.

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

Property and equipment

$
4,263Net current assets


971Deferred compensation


2,254Identifiable intangible assets


4,325Assembled workforce


1,961In-process research and development


1,960Goodwill


61,391Total

$
77,125


53

---



The results of operations previously reported by the separate enterprises, Tumbleweed and Worldtalk, and the combined amounts presented in the accompanying
consolidated financial statements are summarized as follows (in thousands):

1999RevenuesTumbleweed

$
5,777Worldtalk


10,979Total

$
16,756Net LossTumbleweed

$
(16,416
)Worldtalk


(7,806
)Total

$
(24,222
)


The
following unaudited pro forma summary presents our consolidated results of operations for the years ended December 31, 2000 and 1999 as if the Interface acquisition had been
consummated at the beginning of each period. The pro forma consolidated results of operations include certain pro forma adjustments, including amortization of goodwill and other intangible assets,
amortization of deferred compensation and the elimination of the charge for acquired in process research and development.

Pro
forma results for the years ended December 31, 2000 and 1999 are as follows (in thousands, except per share amounts):

2000

1999Revenues

$
44,267

$
20,108Net loss


(64,069
)

(54,899
)Net loss per sharebasic and diluted

$
(2.07
)
$
(3.45
)


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

54

---



(4) Financial Statement Components

A summary of cash and cash equivalents as of December 31, 2001 and 2000 follows (in thousands):

2001

2000Cash

$
1,596

$
13,731Money market mutual funds


41,554


61,766Cash and cash equivalents


43,150


75,497Less restricted cash equivalents


(2,083
)

(1,929
)Unrestricted cash and cash equivalents

$
41,067

$
73,568


Restricted
cash consists of lease deposits related to one of the Company's facilities in Redwood City, California.

A
summary of property and equipment as of December 31, 2001 and 2000 follows (in thousands):

2001

2000Office furniture

$
2,150

$
3,307Computers and equipment


9,151


11,375Land and buildings





3,436Leasehold improvements


1,200


2,40512,501


20,523Less accumulated depreciation


(7,566
)

(6,823
)$
4,935

$
13,700


A
summary of goodwill and other intangible assets as of December 31, 2001 and 2000 follows (in thousands):

2001

2000Goodwill

$
13,459

$
74,850Developed and core technology





4,325Acquired workforce





2,023Capitalized organizational and software development costs





231$
13,459


81,429Less accumulated amortization


(6,772
)

(11,813
)$
6,687

$
69,616


A
summary of accrued liabilities as of December 31, 2001 and 2000 follows (in thousands):

2001

2000Accrued compensation

$
3,965

$
7,694Professional fees


930


3,128Accrued sales and foreign taxes


1,594


1,705Accrued royalties


164


2,106Other


1,414


2,200$
8,067

$
16,833


55

---

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

Years Ended December 31,2001

2000

1999Interest income

$
1,959

$
3,512

$
1,761Interest expense


(117
)

(160
)

(200
)Other, net


282


34


565$
2,124

$
3,386

$
2,126


Allowance for doubtful accounts

Our
allowance for doubtful accounts was $1,985 and $1,125 as of December 31, 2001 and 2000, respectively. During 2001 we recorded bad debt expense of $2,070 and recognized
write-offs net of recoveries of $1,210.

(5) Restructuring

In January 2001, our Board of Directors approved a restructuring program. The restructuring program is intended to align our cost structures with our
company-wide focus on customer service, sales and research and development. The restructuring involved consolidating our facilities in the United States and closing international sales
office locations in Paris, France; Chatsworth, Australia; and Stockholm, Sweden. The restructuring program also realigned the professional services organization and reduced headcount in most areas of
our business.

Restructuring
and related charges expensed during 2001 was comprised of the following:

Used

Remaining

ExpenseEmployee separation

$
2,642




$
2,642Facilities charges, asset impairment, and other


33


2,335


2,368Stock compensation credit, net


(336
)




(336
)Total restructuring charges

$
2,339

$
2,335

$
4,674


Employee
separation for approximately 100 employees includes severance pay and medical and other benefits. The $2.3 million of the remaining restructuring accrual represents lease
settlement payments on facilities no longer required primarily due to the reduction in headcount which will be paid in the first quarter of 2002. The charges were partially offset by a
non-cash credit related to previously recorded stock-based compensation on unvested options held by terminated employees.

56

---

(6) Goodwill Impairment

During the three months ended March 31, 2001, we performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection
with the acquisition of Interface. The assessment was performed primarily due to changes in the economy, the overall decline in the industry growth rate, and our lower actual and projected operating
results including that of the business acquired from Interface. Our assessment is supported by the significant sustained decline in our stock price since the valuation date of the shares issued in the
Interface acquisition. As a result of the assessment, we recorded a $51.0 million impairment charge to reduce goodwill and other intangible assets to their estimated fair value. The charge was
based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 15%. The assumptions supporting the cash flows, including the discount rate, were
determined using our best estimates as of March 31, 2001. The remaining intangible assets were amortized in full over their remaining useful life during 2001. The impairment consists of the
following charge:

Goodwill

$
49,210Developed and core technology


1,127Acquired workforce


646Total impairment

$
50,983


(7) Related Party Transactions



In February 1999 we issued 3,914,989 shares of Series C preferred stock at a price of $3.58 to Hikari Tsushin ("Hikari"), a Japanese company,
resulting in gross proceeds to us of approximately $14.0 million. In August 1999, in connection with the initial public offering, Hikari purchased 400,000 shares of common stock at
$12.00 per share, resulting in gross proceeds to us of approximately $4.8 million. Hikari owned none of our outstanding common stock as of December 31, 2001 and 2000, respectively.

On
March 31, 1999, Tumbleweed KK ("TKK"), a wholly-owned Japanese subsidiary of Tumbleweed until August 31, 1999 when it became an equity investee, entered into a
one-year License and Distribution Agreement with Hikari. A summary of the terms of this agreement is as follows:



57

---



On
July 1, 1999, we entered into a Technology License Agreement with TKK. A summary of the terms of this agreement is as follows:



On
August 31, 1999, TKK sold 200 shares of its common stock, representing a 50% ownership interest in TKK, to Hikari for ¥350,000,000 (which approximated
$3.2 million as of August 31, 1999). Following Hikari's investment, Hikari and Tumbleweed had equal board representation in TKK. As a result of the equity transaction and the change in
board constituency, we no longer believed we had control of TKK. Consequently, beginning September 1, 1999we began accounting for our investment in TKK on the equity method of accounting rather
than the consolidation method. Because TKK sold shares to Hikari, our share of the book value of TKK's net assets exceeded the carrying amount of the investment by $1.49 million. As a result we
recorded $1.49 million in additional paid-in capital in 1999.

On
May 15, 2000, we repurchased 5% of the outstanding shares of TKK's common stock from Hikari for ¥70,000,000 (which approximated $645,000 as of May 15, 2000),
increasing our ownership interest in TKK to 55% and resumed consolidating the Japanese subsidiary effective April 1, 2000. On August 29, 2000, we repurchased an additional 25% of the
outstanding shares of the jointly owned Japanese subsidiary for approximately $13.8 million, increasing our ownership position to 80%. We recorded approximately $13.5 million of goodwill
as a result of these transactions.

Prior
to selling a 50% ownership interest in TKK on August 31, 1999, we recorded consolidated revenues from third-party customers of TKK of $914,000 in 1999. Hikari has
historically been a significant customer of TKK, representing approximately 84% of TKK's third party revenues recorded during the aforementioned period. Subsequent to the divestiture on
August 31, 1999, we recorded $300,000 in royalties received from TKK based on license revenue TKK earned from Hikari and an additional $17,000 in service revenue resulting from support and
maintenance we provided directly to Hikari.

During
the three months ended March 31, 2000, we recorded revenues from TKK of approximately $367,000. We recorded revenues from Hikari of $232,000, $514,000, and $787,000 in
2001, 2000, and 1999, respectively.



In July 1999, in exchange for marketing and publicity services, we issued a warrant to a customer to acquire 100,000 shares of our common stock. The
warrant is exercisable immediately in three tranches: 50,000 shares at an exercise price of $20 per share; 25,000 shares at an exercise price of $30

58

---

per share; and 25,000 shares at an exercise price of $40 per share (see Note 10). In June 1999, we entered into a license agreement and a consulting agreement with this customer and
recorded revenues of approximately $408,000 and $567,000 in 2001and 2000, respectively, and deferred revenues of approximately $156,000 and $147,000 as of December 31, 2001 and 2000,
respectively. The total amount due from this customer was approximately $373,000 and $0 and total amount due from us to this customer was approximately $0 and $175,000 as of December 31, 2001
and 2000, respectively.

(8) Debt

Debt at December 31, 2001 and 2000 consisted of the following:

December 31,2001

2000Equipment loan facilities

$
322

$
871Capital leases


66


213Total debt


388


1,084Less current portion


379


587Total long-term portion

$
9

$
497


In
July 1998, we entered into a debt agreement with a bank, which includes a $750,000 equipment loan facility. In June 1999, we obtained a second equipment
loan facility in the amount of $1.0 million with the same bank. The first equipment loan in the amount of $750,000 expired in December 2001 and the second equipment loan in the amount of
$1.0 million expires in December 2002. Borrowings under both equipment loan facilities bear interest at prime rate plus 0.75%, are due and payable in 36 equal monthly installments and
are secured by certain of our assets. As of December 31, 2001, total borrowings under the equipment loan facility was $322,000 in the aggregate and $678,000 remained available under the
facilities. The weighted average interest rate for the equipment loans was 8.21%, 10.00%, and 8.45%, and for 2001, 2000, and 1999, respectively. At December 31, 2002 the loan has aggregate
maturities of $322,000 due in 2002.

(9) Income Taxes

The differences between the amount of income tax expense recorded and the amount of income tax benefit calculated using the U.S. federal statutory rate of 34% for
the years ended December 31, 2001, 2000 and 1999 are as follows (in thousands):

2001

2000

1999Statutory federal income tax benefit

$
(38,764
)
$
(23,615
)
$
(8,133
)State income tax


12


10


Foreign income tax expense


141


366


301Nondeductible stock compensation expense








1,188Net operating loss, not utilized


18,161


19,657


6,945Goodwill amortization and other permanent differences


20,603


3,959


Income tax expense

$
153

$
375

$
301


59

---

The
tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of December 31, 2001 and 2000, are
presented below (in thousands):

2001

2000Net operating loss carryforwards

$
66,947

$
50,528Property and equipment





232Deferred stock compensation


2,631


2,287Deferred research and development costs


802


Tax credit carryforwards


4,735


3,784Reserves and accruals not currently deductible


2,410


3,880Restructuring


2,064


Total deferred tax assets


79,589


60,711Less: valuation allowance


78,171


59,028Net deferred tax assets


1,418


1,683Property and equipment


(1,418
)

Purchase accounting adjustment





(1,683
)Net deferred tax liabilities

$


$



We
believe that sufficient uncertainty exists with respect to future realization of these deferred tax assets and therefore, have established a valuation allowance
against our net deferred tax assets.

As
of December 31, 2001, we have federal and state net operating loss carryforwards of approximately $183 million and $48 million, respectively. The federal net
operating loss carryforwards expire in 2007 through 2021 and the state net operating loss carryforwards expire in 2001 through 2011.

Gross
deferred tax assets as of December 31, 2001 include approximately $14.9 million relating to the exercise of stock options, which is subject to a valuation allowance
of approximately $78.1 million. Upon reversal of this valuation allowance, the tax benefit thus realized will be credited to stockholders' equity.

As
of December 31, 2001, we have federal and California research and development tax credit of approximately $3.1 million and $2.3 million, respectively. We also
have a California Manufacturing Credit carryforward of $101,000. The research and development tax credit for federal income tax purposes will expire in 2006 through 2021. The California credits
carryforward indefinitely.

Our
future ability to utilize the net operating loss and tax credit carryforwards may be subject to certain limitations in the event of ownership changes as defined in Section 382
of the Internal Revenue Code.

(10) Stockholders' Equity

In August 1999, we sold 4,219,592 shares of our common stock (of which 219,592 shares were sold pursuant to the Underwriters' over-allotment
option) through our initial public offering (IPO). Net proceeds from the offering were approximately $45.8 million after deducting the underwriting discount and other offering expenses. At the
time of the IPO, all of our outstanding preferred stock automatically converted into 12,331,434 shares of common stock.

60

---

In
August 2000, we completed a primary and secondary public offering of 3,000,000 shares of our common stock at a price of $56.00 per share. Of the 3,000,000 shares of common
stock, 1,500,000 primary shares were sold by Tumbleweed and 1,500,000 secondary shares were sold by stockholders of Tumbleweed. We did not receive any of the proceeds from shares sold by our
stockholders. Net proceeds of approximately $77.9 million were received from the offering of primary shares.



On September 30, 1993, we adopted the 1993 Stock Option Plan ("the Plan"). In 1999, our 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, we 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 10 years. Vesting periods are determined by the 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.



The 1999 Omnibus Stock Incentive Plan ("the Incentive Plan") was approved by stockholders on August 3, 1999, for the benefit of our officers, directors,
key employees, advisors and consultants. An aggregate of 5,831,500 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.



The 1999 Employee Stock Purchase Plan ("the Purchase Plan") was approved by 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.



The 2000 NSO Incentive Stock Plan ("the NSO Incentive Plan") was adopted by our Board of Directors on July 10, 2000. The NSO Incentive Plan qualifies as a
"broadly based" plan and is for the benefit of our 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.

61

---

Under
the terms of the NSO Incentive Plan, the exercise price for stock options is determined by the Board of Directors, Compensation Committee, or Administrator ("Administrator"),
generally 100% of the fair market value on the date of grant. The option term is determined by the Administrator, generally no longer than 10 years. Vesting periods are determined by the
Administrator 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.



On September 1, 2000, we assumed the Interface 1992 Stock Option Plan ("1992 Plan") and 1993 Stock Option Plan for Non-Employee Directors
("Directors Plan"). 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. The
Directors Plan provided for the grant to non-employee directors of non-qualified options at market price on the date of grant. The Directors Plan provides for discretionary
grants with vesting determined at the time of grant with a term of ten years. A total of 236,000 shares of our common stock were reserved for issuance upon the exercise of stock options assumed in
connection with the acquisition of Interface. We registered an additional 304,023 shares for issuance from the 1992 Plan, which will be used to grant options to Interface employees at the time of the
merger and who remain employed by Tumbleweed. The Directors Plan was terminated upon its assumption by Tumbleweed, and no further options will be granted under it.

A
summary of all stock option activity follows:

|                            |  | Options Available
for Grant |   | Options Outstanding |   | Weighted Average
Exercise Price
|--------------------------- |  | --------------------------- | - | ------------------- | - | -------------------------------
|Balances, December 31, 1998 |  | 4,282,773                   |   | 3,115,670           |   | $                              
|Authorized                  |  | 5,031,500                   |   |                    |   |                                
|Granted                     |  | (2,887,186                  | ) | 2,887,186           |   |                                
|Exercised                   |  |                            |   | (877,893            | ) |                                
|Canceled                    |  | 650,376                     |   | (650,376            | ) |                                
|                            |  |                             |   |                     |   |                                
|Balances, December 31, 1999 |  | 7,077,463                   |   | 4,474,587           |   |                                
|Authorized                  |  | 1,721,235                   |   |                    |   |                                
|Granted                     |  | (5,469,939                  | ) | 5,469,939           |   |                                
|Exercised                   |  |                            |   | (1,234,033          | ) |                                
|Canceled                    |  | 1,467,530                   |   | (1,467,530          | ) |                                
|Expired                     |  | (4,169,694                  | ) |                    |   |                                
|                            |  |                             |   |                     |   |                                
|Balances, December 31, 2000 |  | 626,595                     |   | 7,242,963           |   |                                
|Authorized                  |  | 4,450,000                   |   |                    |   |                                
|Granted                     |  | (6,895,088                  | ) | 6,895,088           |   |                                
|Exercised                   |  |                            |   | (788,869            | ) |                                
|Canceled                    |  | 4,451,450                   |   | (4,451,450          | ) |                                
|Expired                     |  | (67,317                     | ) |                    |   |                                
|                            |  |                             |   |                     |   |                                
|Balances, December 31, 2001 |  | 2,565,640                   |   | 8,897,732           |   | $                              
|                            |  |                             |   |                     |   |                                

62

---

The following table summarizes information about stock options outstanding as of December 31, 2001:

Exercise Prices

Number Outstanding

Weighted Average
Exercise Price

Average Remaining
Contractual Life
(Years)

Number Exercisable

Weighted Average
Exercise Price$
0.50

212,914

$
0.50

6.4

176,450

$
0.500.772.72

2,182,454


1.69

9.0

564,867


1.513.036.75

3,798,543


3.36

9.3

265,962


3.236.8117.11

467,432


12.80

7.2

317,261


12.6817.1325.00

840,847


19.78

8.6

318,114


20.3125.3845.25

1,155,441


34.23

8.4

546,133


34.6847.9471.50

107,101


54.83

8.5

56,333


55.8876.3885.13

83,000


82.86

8.2

37,310


82.81118.44

50,000


118.44

8.2

47,468


118.44$
0.50118.44

8,897,732

$
10.94

8.8

2,329,898

$
18.60


Stock-Based Compensation

We use the intrinsic value method prescribed by APB No. 25 in accounting for our stock-based compensation arrangements for employees. Compensation cost has
been recognized for fixed stock option issuances in the accompanying consolidated financial statements because the fair value of the underlying common stock exceeds the exercise price of the stock
options at the date of grant. We have recorded deferred compensation expense of approximately $0, $4.0 million and $7.3 million, for the difference at the grant date between the exercise
price and the fair value of the common stock underlying the options granted in the years ended December 31, 2001, 2000, and 1999, respectively. These amounts are being amortized on an
accelerated basis over the vesting period, generally four years, consistent with the method described in FASB Interpretation No. 28. Amortization of deferred compensation of approximately
$3.1 million, $4.9 million, and $3.5 million was recognized in the years ended December 31, 2001, 2000, and 1999, respectively. Had compensation cost for the Company's
stock-based compensation plan been determined consistent with the fair value approach set forth in
SFAS No. 123, the Company's net losses for the years ended December 31, 2001, 2000, and 1999, would have been as follows (in thousands, except per share amounts):

2001

2000

1999Net loss as reported

$
(114,165
)
$
(69,829
)
$
(24,222
)Net loss pro forma

$
(123,658
)
$
(84,600
)
$
(23,738
)Basic and diluted net loss per share as reported

$
(3.78
)
$
(2.51
)
$
(1.65
)Basic and diluted net loss per share pro forma

$
(4.10
)
$
(3.04
)
$
(1.62
)


For
purposes of computing pro forma net income, the fair value of each option grant and stock purchases under the Purchase Plan is estimated on the date of grant using a Black-Scholes
option

63

---

pricing model. The assumptions used to value the option grants and purchase rights are stated as follows:

Years Ended December 31,2001

2000

1999Stock options:Expected life of options granted before IPO





2.0 yearsExpected life of options granted after IPO

3.0 years

3.0 years

1.0 yearVolatility

100%

100%

78%Risk-free interest rate

4.55%

6.17%

5.42%Dividend yield

0%

0%

0%Purchase plan options:Expected life

0.5 year

0.5 year

1.0 yearVolatility

100%

100%

78%Risk-free interest rate

3.55%

6.39%

5.42%Dividend yield

0%

0%

0%




In connection with the November 1998 Bridge Loan Facility, we issued a warrant to acquire 20,973 shares of Series C preferred stock at an exercise
price of $3.58. In December 1999, an option for a cashless exercise was completed resulting in the issuance of 19,107 shares of our common stock and eliminating the outstanding warrant balance.

In
connection with the February 1999 Series C financing, our financial advisor earned the right to receive a warrant to acquire 58,725 shares of Series C convertible
preferred stock at an exercise price of $3.58. The value of the warrant was included as an issuance cost of the Series C financing. The warrant was exercised at the time of the IPO in
August 1999.

In
connection with the May 1999 Series C financing, we issued a warrant to acquire 16,778 shares of Series C convertible preferred stock at an exercise price of
$3.58. The value of the warrant was included as an issuance cost of the Series C financing. The warrant was exercised at the time of the IPO in August 1999.

In
July 1999, in exchange for marketing and publicity assistance from a customer we issued a warrant to acquire 100,000 shares of our common stock. The warrant is exercisable
immediately in three tranches: 50,000 shares at an exercise price of $20 per share; 25,000 shares at an exercise price of $30 per share; and 25,000 shares at an exercise price of $40 per share. Using
the Black-Scholes option pricing model, the total fair value of the warrant was estimated to be $127,000, based on the following assumptions: no dividends; contractual term of three years;
risk-free interest rate of 4.8%; and expected volatility of 60%. The fair value of the warrant was charged to sales and marketing expense in the third quarter of 1999. In June 1999,
the Company entered into a license agreement and a consulting agreement with the customer for approximately $355,000 in aggregate. The first tranch of 50,000 shares for $20 per share was exercised on
a net issuance basis in July 2000.

64

---



In conjunction with various financing arrangements and employment recruitment services provided to the Company in 1994, 1995, 1998, 1999, and 2001, we issued warrants to purchase an
aggregate of approximately 583,113 shares of common stock at prices ranging from $2.53 per share to $69.62 per share and expiration dates ranging from July 2002 to July 2006. In addition
to those warrants, we also issued two shares of Series B redeemable preferred stock now exercisable for common stock in lieu of the preferred stock at $8.62 per share. In July 2000,
6,500 shares at $23.08 were exercised on a net issuance basis.

As
of December 31, 2001 and 2000, 551,613 and 483,915 warrants to purchase common stock remain outstanding, respectively. Of the warrants that remain outstanding at
December 31, 2001, 25,000 expire in July 2002, 585 expire in July 2003, 4,633 expire in August 2004, 11,858 expire in December 2004, 76,207 expire in Feb 2006, and
the remaining 433,330 expire in July 2006.

(11) Employee Benefit Plan

We have a 401(k) plan that allows eligible employees to contribute a percentage of their compensation, limited to $10,500 in 2001 and 2000 and $10,000 in 1999. On
April 1, 2000, we began matching each eligible employee's contribution 100% up to 4% of the employee's salary. Our matching contributions and earnings thereon vested immediately. Our matching
contributions to employees' 401(k) plans totaled approximately $649,000 and $603,000 for the years ended December 31, 2001 and 2000, respectively.

(12) Commitments and Contingencies



We lease our facilities and certain equipment under operating lease agreements. The facilities leases expire at various dates through 2005. We also lease certain
equipment under capital lease agreements. These leases expire at various dates through 2003. Future minimum lease payments as of December 31, 2001, are as follows (in thousands):

|Year Ending December 31,          |  | Operating Leases |       | Capital Leases |  
|--------------------------------- |  | ---------------- | ----- | -------------- | -
|2002                              |  | $                | 2,829 |                | $
|2003                              |  |                  | 2,293 |                |  
|2004                              |  |                  | 1,758 |                |  
|2005                              |  |                  | 128   |                |  
|2006                              |  |                  |      |                |  
|Thereafter                        |  |                  |      |                |  
|                                  |  |                  |       |                |  
|Future minimum lease payments     |  | $                | 7,008 |                |  
|                                  |  |                  |       |                |  
|Less amount representing interest |  |                  |       |                |  
|                                  |  |                  |       |                |  
|                                  |  |                  |       |                |  
|Less current portion              |  |                  |       |                | $
|                                  |  |                  |       |                |  
|Long-term portion                 |  |                  |       |                | $
|                                  |  |                  |       |                |  

65

---

Total
rent expense under operating leases for the years ended December 31, 2001, 2000, and 1999, was $3.4 million, $2.9 million, and $1.9 million,
respectively.



On July 7, 2000, three complaints were filed by David H. Zimmer, Congressional Securities, Inc. and other plaintiffs against Interface and various
additional defendants, including Interface's President and Chief Executive Officer, Robert A. Nero and Fiserv Correspondent Services, Inc., in the United States District Court for the Southern
District of New York. The three cases contain substantially similar allegations of false and misleading representations by various defendants allegedly designed to inflate Interface's stock price. The
complaints seek relief under the federal securities laws on behalf of purported classes of persons who purchased, held, or sold shares of Interface stock, and under various other causes of action. On
September 27, 2000, we filed (i) a motion to strike or dismiss for failure to meet certification requirements of the Private Securities Litigation Reform Act, (ii) a motion to
dismiss for failure to state a claim, and (iii) a motion to dismiss because of improper venue, or in the alternative, motion to transfer the lawsuits to the Eastern District of Michigan. On
July 27, 2001, the Court granted our motion to transfer the lawsuits to the Eastern District of Michigan, and left the decision of the pending motions to dismiss to the transferee court. The
United States District Court for the Eastern District of Michigan held a status conference on the cases on October 23, 2001, without resolving either of our pending motions. The accompanying
financial statements do not include any costs for damages, if any, that might result from this uncertainty. We believe these actions are without merit and intend to vigorously defend and seek their
dismissal.

(13) Segment Information

As defined by SFAS 131,Disclosure About Segments of an Enterprise and Related Information, our chief
operating decision-makers are our Chief Executive Officer and our Chief Operating Officer. Our CEO and COO review financial information presented on a consolidated basis accompanied by disaggregated
information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed by our CEO and COO is the
information presented in the accompanying consolidated statement of operations. Therefore, we operate in a single operating segment. The amount of revenue by product and service has not been provided
as management has determined that it is impracticable to do so.

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

|                                            |  | Years Ended December 31, |        | 
|------------------------------------------- |  | ------------------------ | ------ | 
|
|North America                               |  | $                        | 22,099 | 
|Europe                                      |  |                          | 4,379  | 
|Asia and Australia                          |  |                          | 2,570  | 
|                                            |  |                          |        | 
|Total revenue from continuing product lines |  | $                        | 29,048 | 
|                                            |  |                          |        | 

66

---

Substantially
all of the Company's long-lived assets are located in the United States.

Item 9Changes in and disagreements with accountants on accounting and financial disclosure.

Not
applicable.

67

---



PART III

Item 10Directors and Executive Officers.

The information required by this item, insofar as it relates to our 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 our executive officers is contained in Part I under the
heading "Our Executive Officers."

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.

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 Transactions" and is incorporated herein by reference.

68

---



PART IV

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





No
reports on Form 8-K were filed by the registrant during the fiscal quarter ended December 31, 2001.

|Exhibit
Number |  | Exhibit Description                                                                                                                                                                                                            
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1(2)         |  | Agreement and Plan of Merger, dated as of November 18, 1999, among Tumbleweed Communications Corp., Keyhole Acquisition Corp. and Worldtalk Communications Corporation                                                         
|2.2(6)         |  | Agreement and Plan of Merger, dated as of June 28, 2000, among Tumbleweed Communications Corp., Maize Acquisition Sub, Inc., and Interface Systems, Inc.                                                                       
|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(5)         |  | Amended and Restated Investor's Rights Agreement, dated as of January 31, 2000, among the Registrant, Jeffrey C. Smith, Jean-Christophe D. Bandini, the holders of the Registrant's preferred stock, and certain other
persons.
|4.3(1)         |  | Warrant to Purchase Stock, dated November 30, 1998, issued to Silicon Valley Bank                                                                                                                                              
|10.1(4)        |  | 1993 Stock Option Plan                                                                                                                                                                                                         
|10.2(7)        |  | 1999 Omnibus Stock Incentive Plan, as amended                                                                                                                                                                                  
|10.3(4)        |  | 1999 Employee Stock Purchase Plan                                                                                                                                                                                              
|10.4(9)        |  | 2000 NSO Incentive Stock Plan, as amended                                                                                                                                                                                      
|10.5(1)        |  | Software License, Development and Services Agreement, dated December 17, 1997, between the Registrant and United Parcel Service General Services, Co.                                                                          
|10.6(1)        |  | Posta License and Distribution Agreement, dated as of March 31, 1999, between Tumbleweed Software, K.K. and K.K. Hikari Tsushin                                                                                                
|10.7(1)        |  | OEM Object Code License Agreement, dated as of March 30, 1998, between the Registrant and RSA Data Security, Inc.                                                                                                              

69

---

|10.8(4)   |  | Form of Indemnity Agreement                                                                                            
|--------- |  | -----------------------------------------------------------------------------------------------------------------------
|10.9(8)   |  | Employment Agreement, dated February 21, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.          
|10.10(10) |  | Employment Agreement, dated June 10, 2001, between Elizabeth D. Jordan and Tumbleweed Communications Corp.             
|10.11     |  | Secured Promissory Note, dated September 19, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.      
|10.12     |  | Security and Pledge Agreement, dated September 19, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.
|21.1      |  | Subsidiaries of the Registrant                                                                                         
|23.1      |  | Consent of KPMG LLP                                                                                                    

---

70

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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 29th day of March, 2002.

| |  | TUMBLEWEED COMMUNICATIONS CORP.
| |  | -------------------------------
| |  | By:                            

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/JEFFREY C. SMITHJeffrey C. Smith           |  | Chairman of the Board and Chief Executive Officer                                                                        |  | March 29, 2002
|/s/ELIZABETH D. JORDANElizabeth D. Jordan     |  | Senior Vice PresidentFinance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | March 29, 2002
|/s/CHRISTOPHER GREENDALEChristopher Greendale |  | Director                                                                                                                 |  | March 29, 2002
|/s/ERIC J. HAUTEMONTEric J. Hautemont         |  | Director                                                                                                                 |  | March 29, 2002
|/s/KENNETH R. KLEINKenneth R. Klein           |  | Director                                                                                                                 |  | March 29, 2002
|/s/DAVID F. MARQUARDTDavid F. Marquardt       |  | Director                                                                                                                 |  | March 29, 2002
|/s/STANDISH H. O'GRADYStandish H. O'Grady     |  | Director                                                                                                                 |  | March 29, 2002
|/s/DEBORAH D. RIEMANDeborah D. Rieman         |  | Director                                                                                                                 |  | March 29, 2002
|/s/DOUGLAS A. SABELLADouglas A. Sabella       |  | Director, President and Chief Operating Officer                                                                          |  | March 29, 2002

71

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INDEX TO EXHIBITS

|Exhibit
Number |  | Exhibit Description                                                                                                                                                                                                            
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1(2)         |  | Agreement and Plan of Merger, dated as of November 18, 1999, among Tumbleweed Communications Corp., Keyhole Acquisition Corp. and Worldtalk Communications Corporation                                                         
|2.2(6)         |  | Agreement and Plan of Merger, dated as of June 28, 2000, among Tumbleweed Communications Corp., Maize Acquisition Sub, Inc., and Interface Systems, Inc.                                                                       
|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(5)         |  | Amended and Restated Investor's Rights Agreement, dated as of January 31, 2000, among the Registrant, Jeffrey C. Smith, Jean-Christophe D. Bandini, the holders of the Registrant's preferred stock, and certain other persons.
|4.3(1)         |  | Warrant to Purchase Stock, dated November 30, 1998, issued to Silicon Valley Bank                                                                                                                                              
|10.1(4)        |  | 1993 Stock Option Plan                                                                                                                                                                                                         
|10.2(7)        |  | 1999 Omnibus Stock Incentive Plan, as amended                                                                                                                                                                                  
|10.3(4)        |  | 1999 Employee Stock Purchase Plan                                                                                                                                                                                              
|10.4(9)        |  | 2000 NSO Incentive Stock Plan, as amended                                                                                                                                                                                      
|10.5(1)        |  | Software License, Development and Services Agreement, dated December 17, 1997, between the Registrant and United Parcel Service General Services, Co.                                                                          
|10.6(1)        |  | Posta License and Distribution Agreement, dated as of March 31, 1999, between Tumbleweed Software, K.K. and K.K. Hikari Tsushin                                                                                                
|10.7(1)        |  | OEM Object Code License Agreement, dated as of March 30, 1998, between the Registrant and RSA Data Security, Inc.                                                                                                              
|10.8(4)        |  | Form of Indemnity Agreement                                                                                                                                                                                                    
|10.9(8)        |  | Employment Agreement, dated February 21, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.                                                                                                                  
|10.10(10)      |  | Employment Agreement, dated June 10, 2001, between Elizabeth D. Jordan and Tumbleweed Communications Corp.                                                                                                                     
|10.11          |  | Secured Promissory Note, dated September 19, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.                                                                                                              
|10.12          |  | Security and Pledge Agreement, dated September 19, 2001, between Douglas A. Sabella and Tumbleweed Communications Corp.                                                                                                        
|21.1           |  | Subsidiaries of the Registrant                                                                                                                                                                                                 
|23.1           |  | Consent of KPMG LLP                                                                                                                                                                                                            

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