UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2008

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

For the transition period from to

Commission File Number: 000-26223

TUMBLEWEED COMMUNICATIONS CORP.

(Exact name of registrant as specified in its charter)

Delaware

94-3336053

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

1600 Seaport Blvd., Suite 400, South Bldg.

Redwood City, CA

94063

(Address of principal executive offices)

(Zip Code)

(650) 216-2000

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filed,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


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

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

The number of shares of common stock outstanding as of July 31, 2008 was 53,163,991.

SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

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

•

consummation of the merger of the Company with Axway Inc. on the terms proposed or at all;

•

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

•

any revenue expected to be realized from backlog;

•

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

•

any statements regarding future economic conditions or performance;

•

any statements regarding implementing our business strategy;

•

any statements regarding attracting and retaining customers;

•

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

•

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

•

any statements of assumptions underlying any of the foregoing.

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

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

INDEX


		Page
	Part I

Item 1	Financial Statements (unaudited)	4
	Condensed Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007	4
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2008 and June 30, 2007	5
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and June 30, 2007	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4	Controls and Procedures	20

	Part II

Item 1	Legal Proceedings	21
Item 1A	Risk Factors	22
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3	Defaults Upon Senior Securities	28
Item 4	Submission of Matters to a Vote of Security Holders	28
Item 5	Other Information	29
Item 6	Exhibits	29
Signatures		30
Certifications

TRADEMARKS

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

PART I—FINANCIAL INFORMATION

ITEM 1—FINANCIAL STATEMENTS

TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands)

(unaudited)


	June 30, 2008			December 31, 2007
Assets
Current Assets:
Cash and cash equivalents	$	29,186		$	26,299
Accounts receivable, net of allowance for doubtful accounts of $365 at June 30, 2008 and $368 at December 31, 2007		9,558			13,074
Other current assets		2,588			1,733

Total current assets		41,332			41,106
Goodwill		48,074			48,074
Intangible assets, net		—			233
Property and equipment, net		1,891			2,038
Other assets		442			385

Total assets	$	91,739		$	91,836

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	126		$	820
Accrued liabilities		7,054			6,795
Acquisition-related expenses		1,710			—
Deferred revenue		21,414			20,996

Total current liabilities		30,304			28,611
Deferred revenue, excluding current portion		4,496			5,401
Other long-term liabilities		14			13

Total long-term liabilities		4,510			5,414

Total liabilities		34,814			34,025
Stockholders’ equity:
Common stock		52			52
Additional paid-in capital		367,697			365,155
Treasury stock		(796	)		(796	)
Accumulated other comprehensive income		190			94
Accumulated deficit		(310,218	)		(306,694	)

Total stockholders’ equity		56,925			57,811

Total liabilities and stockholders’ equity	$	91,739		$	91,836

See accompanying Notes to Condensed Consolidated Financial Statements

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Revenue:
Product revenue	$	5,892		$	5,121		$	10,890		$	11,018
Service revenue		8,640			7,973			16,852			16,995
Intellectual property		1,226			1,036			3,276			1,132

Total revenue		15,758			14,130			31,018			29,145

Cost of revenue:
Cost of product revenue		1,627			1,307			2,997			3,063
Provision for excess inventory		—			—			—			164
Cost of service revenue		1,578			1,929			3,324			3,828
Amortization of intangible assets		—			234			201			468

Total cost of revenue		3,205			3,470			6,522			7,523

Gross profit		12,553			10,660			24,496			21,622

Operating expenses:
Research and development		4,068			3,859			7,925			7,755
Sales and marketing		6,470			7,311			13,065			13,928
General and administrative		2,655			2,516			5,448			5,003
Amortization of intangible assets		—			44			32			227
Acquisition-related expenses		1,903			—			1,903			—

Total operating expenses		15,096			13,730			28,373			26,913

Operating loss		(2,543	)		(3,070	)		(3,877	)		(5,291	)
Other income, net		170			381			394			720

Net loss before income taxes		(2,373	)		(2,689	)		(3,483	)		(4,571	)
Income taxes		16			21			41			34

Net loss	$	(2,389	)	$	(2,710	)	$	(3,524	)	$	(4,605	)

Net loss per share-basic and diluted	$	(0.05	)	$	(0.05	)	$	(0.07	)	$	(0.09	)

Weighted average shares -basic and diluted		51,272			51,052			51,211			50,947

See accompanying Notes to Condensed Consolidated Financial Statements

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	Six months ended June 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(3,524	)	$	(4,605	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Stock-based compensation expense		2,484			2,300
Depreciation and amortization expenses		869			1,391
Bad debt credit		—			(47	)
Loss on disposal of property and equipment		15			40
Changes in operating assets and liabilities:
Accounts receivable		3,516			2,092
Other current assets and other assets		(912	)		(17	)
Accounts payable, accrued liabilities, and other long-term liabilities		(196	)		(1,842	)
Accrued merger-related and other costs		—			(97	)
Acquisition-related expenses		1,710			—
Deferred revenue		(487	)		97

Net cash provided by (used in) operating activities		3,475			(688	)

Cash flows from investing activities–purchase of property and equipment		(742	)		(1,156	)

Cash flows from financing activities–proceeds from issuance of common stock		58			1,325

Effect of exchange rate on cash and cash equivalents		96			11

Net increase (decrease) in cash and cash equivalents		2,887			(508	)
Cash and cash equivalents, beginning of period		26,299			30,511

Cash and cash equivalents, end of period	$	29,186		$	30,003

Supplemental disclosure of cash flow information:
Cash paid during the period for taxes	$	38		$	58

See accompanying Notes to Condensed Consolidated Financial Statements

Notes to Condensed Consolidated Financial Statements

(1) Organization

The condensed consolidated financial statements included herein have been prepared by Tumbleweed Communications Corp. (“Tumbleweed”) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with Tumbleweed’s audited financial statements and notes thereto included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2007, filed with the SEC on March 17, 2008.

On June 5, 2008, Tumbleweed entered into an Agreement and Plan of Merger with Axway Inc., an indirect wholly owned subsidiary of Sopra Group SA. If the merger is consummated, Tumbleweed will become a wholly-owned subsidiary of Axway Inc., and each outstanding share of Tumbleweed will be converted into the right to receive $2.70 in cash without interest. On August 8, 2008, the stockholders of Tumbleweed approved the merger. However, consummation of the transaction remains subject to various closing conditions, including expiration of the review process under Exon-Florio.

The unaudited condensed consolidated financial statements included herein reflect all adjustments which are, in the opinion of management, necessary to state fairly the financial position of Tumbleweed and its subsidiaries as of June 30, 2008 and December 31, 2007, respectively, the results of operations for the three and six months ended June 30, 2008 and 2007, respectively, and cash flows for the six months ended June 30, 2008 and 2007, respectively. Such adjustments are of a normal recurring nature, unless otherwise indicated. The results for the three and six months ended June 30, 2008 are not necessarily indicative of the results expected for the full fiscal year ending December 31, 2008.

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

(2) Stock-Based Compensation

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

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

Tumbleweed estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table. The expected life of the options is based on the weighted average period of time that options granted are expected to be outstanding, giving consideration to vesting schedules and Tumbleweed’s historical exercise patterns. Tumbleweed’s expected volatility is based on the daily historical volatility of Tumbleweed’s common stock, over the expected life of the option. The risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of the option. When the expected term of Tumbleweed’s stock-based awards does not correspond with the terms for which interest rates are quoted, Tumbleweed performs a straight-line interpolation to determine the rate from the available term maturities. Tumbleweed has not historically paid dividends, thus the expected dividend yield is zero. Tumbleweed issues new shares of common stock upon the exercise of stock options. The assumptions for the three and six months ended June 30, 2008 and 2007, respectively, are as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Stock options:
Weighted average fair value of grants	$	0.96		$	1.95		$	0.88		$	1.85
Expected life		4.5 years			4.5 years			4.5 years			4.5 years
Volatility		70	%		73	%		70	%		73	%
Risk-free interest rate		3.01	%		4.76	%		2.80	%		4.71	%
Dividend yield		0	%		0	%		0	%		0	%

The aggregate intrinsic value of options exercised under Tumbleweed’s stock option plans for the three and the six months ended June 30, 2008 was approximately $36,000 and $37,000, respectively, determined as of the date of option exercise.

The cost of restricted stock awards is determined using the fair value of Tumbleweed’s common stock on the date of the grant, and compensation expense is recognized over the related vesting or performance period. The weighted average grant date fair value of restricted stock granted during the three and six months ended June 30, 2008 was $1.33 and $1.39, respectively. The weighted average grant date fair value of restricted stock granted during the six months ended June 30, 2007 was $3.28.

There is no tax benefit recorded for this expense due to full valuation allowances in the jurisdictions for which these options are deductible for tax purposes. Stock-based compensation expense is included in Tumbleweed’s condensed consolidated statement of operations as follows (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Cost of service revenue		45		39		82		65
Research and development		300		257		574		560
Sales and marketing		288		319		688		539
General and administrative		678		575		1,313		1,136

Total stock-based compensation expense	$	1,311	$	1,190	$	2,657	$	2,300

(3) Net Loss Per Share

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


	Three Months Ended June 30,		Six Months Ended June 30,
	2008	2007	2008	2007
Warrants and options excluded due to the exercise price exceeding the average fair market value of common stock during the period	12,722	9,003	13,953	6,851

(4) Concentrations of Credit Risk

Financial instruments, which potentially subject Tumbleweed to concentrations of credit risk, consist primarily of cash equivalents and accounts receivable. Tumbleweed’s cash equivalents generally consist of money market mutual funds with qualified financial institutions. To analyze accounts receivable, Tumbleweed performs periodic evaluations of its customers’ financial condition and, when necessary, records bad debt expense or credit. No single customer comprised 10% or more of Tumbleweed’s accounts receivable balance, net of allowance for doubtful accounts, at either June 30, 2008 or December 31, 2007. For the three months ended June 30, 2008, no single customer comprised 10% or more of Tumbleweed’s revenue. For the six months ended June 30, 2008, one customer comprised 10% of Tumbleweed’s revenue. For the three and six months ended June 30, 2007, no single customer comprised 10% or more of Tumbleweed’s revenue, respectively.

(5) Intangible Assets and Goodwill

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

A summary of intangible assets as of June 30, 2008 follows (in thousands):


	Amortization period (in years)	Gross carrying amount		Accumulated amortization			Net
Core/developed technology	3 to 4	$	5,850	$	(5,850	)	$	—
Customer base and reseller agreements	3		3,700		(3,700	)		—
Maintenance agreements	3 to 4		1,200		(1,200	)		—
Trademarks and trade names	4		350		(350	)		—

		$	11,100	$	(11,100	)	$	—

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


	Amortization period (in years)	Gross carrying amount		Accumulated amortization			Net
Core/developed technology	3 to 4	$	5,850	$	(5,675	)	$	175
Customer base and reseller agreements	3		3,700		(3,676	)		24
Maintenance agreements	3 to 4		1,200		(1,174	)		26
Trademarks and trade names	4		350		(342	)		8

		$	11,100	$	(10,867	)	$	233

Intangible assets were amortized in full during the three months ended March 31, 2008. No amortization of intangible assets is to be incurred subsequent to March 31, 2008.

Goodwill represents the excess of the purchase price over the fair value of acquired net tangible and identified intangible assets. In accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but instead, is tested for impairment at least annually and more frequently if certain impairment conditions exist. Tumbleweed completed its annual assessment of goodwill in the three months ended June 30, 2008 and no impairment of goodwill was determined as a result of this assessment. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes.

(6) Comprehensive Loss

Comprehensive loss includes Tumbleweed’s net loss as well as foreign currency translation adjustments. Comprehensive loss for the three months ending June 30, 2008 and 2007, respectively, is as follows (in thousands):


	Three Months Ended June 30,						Six Months Ended June 30,
	2008			2007			2008			2007
Net loss	$	(2,389	)	$	(2,710	)	$	(3,524	)	$	(4,605	)
Other comprehensive income (loss)—translation adjustments		7			(6	)		96			11

Comprehensive loss	$	(2,382	)	$	(2,716	)	$	(3,428	)	$	(4,594	)

(7) Segment Information

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

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
North America	$	13,036	$	12,555	$	26,721	$	25,631
Europe, Middle East, and Africa		1,798		1,048		2,764		2,474
Asia Pacific		869		474		1,351		951
Other		55		53		182		89

Total	$	15,758	$	14,130	$	31,018	$	29,145

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
Managed file transfer and email security	$	12,343	$	11,633	$	24,125	$	24,773
Identity validation		2,189		1,461		3,617		3,240
Intellectual property		1,226		1,036		3,276		1,132

Total	$	15,758	$	14,130	$	31,018	$	29,145

Tumbleweed’s property and equipment located in the different geographic regions as of June 30, 2008 and December 31, 2007 are as follows (in thousands):


	June 30, 2007		December 31, 2007
North America	$	1,605	$	1,659
Bulgaria		279		361
Other		7		18

Total long-lived assets	$	1,891	$	2,038

(8) Contingencies

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

if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all of the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, Valicert would be responsible to pay its pro rata portion of the shortfall, up to the amount of the deductible retention under its insurance policy, which is $500,000. The timing and amount of payments that Valicert could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment required by the insurers pursuant to the $1 billion guaranty. The proposed settlement is subject to approval of the Court, which cannot be assured.

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

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

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

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

(9) Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require or permit assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. In February 2008, the FASB issued FASB Staff Position No. 157-2, which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Tumbleweed adopted SFAS 157 effective January 1, 2008 and the adoption had no material impact on its financial statements. Tumbleweed cash equivalents include investments in money market mutual funds, which are stated at net asset value. Tumbleweed believes that all of its cash and cash equivalents, including investments in money market mutual funds, are Level 1 in the SFAS 157 fair value hierarchy as detailed below:

Level 1 – quoted prices in active markets for identical assets or liabilities;

Level 2 – inputs other than Level 1 quoted prices that are directly or indirectly observable;

Level 3 – significant unobservable inputs that are supported by little or no market activity.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes to this Quarterly Report on Form 10-Q and Tumbleweed’s Annual Report on Form 10-K for 2007 filed with the Securities and Exchange Commission (“SEC”), as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included therein. The following discussion contains forward-looking statements that reflect Tumbleweed’s plans, estimates and beliefs. Tumbleweed’s actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and at Part II, Item 1A, “Risk Factors” to this Quarterly Report.

Overview

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

Our customers deploy our security products between their network and the Internet to effectively protect against inbound threats and outbound vulnerabilities, and to automatically encrypt and securely deliver data to third parties. In addition, all of our products are designed to integrate with existing business and email systems, requiring no significant change in existing firewall or system infrastructures. Our products can be used independently or in combination to create a comprehensive, secure Internet communications solution for our customers. All of our products offer multi-level security using industry standards, universal access, and proven scalability for high volume data traffic. Our suite is comprised of four products:

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

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

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

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Tumbleweed Validation Authority™ is a leading product for determining the validity of digital certificates.

We are trusted by more than 3,475 enterprise and government customers who use our products to securely connect with employees, partners, and customers. Our traditional market focus has been in the financial services, healthcare, and government markets, but we are expanding into other market sectors, such as retail, manufacturing, energy, transportation and technology. Many of the world’s most security conscious organizations use our products to safely exchange data, protect information assets, block email security threats, and ensure identity validation.

Revenue for the three months ended June 30, 2008 was $15.8 million as compared to $14.1 million for the same three months in 2007, and our net loss was $2.4 million as compared to $2.7 million during the same periods. Revenue for the six months ended June 30, 2008 was $31.0 million as compared to $29.1 million for the same six months in 2007, and our net loss was $3.5 million as compared to $4.6 million during the same periods. The increases in revenue and reductions in net loss were both due to increase in product revenue due to an increase in the volume of our license transactions, increase in service revenue due to an increase in support and maintenance revenue, and increase in intellectual property revenue due to a single large patent license agreement during the three months ended March 31, 2008 that generated revenue over both the three months period ended March 31, 2008 and the three months period ended June 30, 2008.

Net cash provided by operating activities for the six months ended June 30, 2008 was $3.5 million as compared to net cash used in operating activities for the six months ended June 30, 2007 of $688,000. The increase of $4.2 million in net cash provided by operating activities between the respective six month periods was primarily the result of a $1.1 million decrease in our net loss, a $1.7 million increase in the accrual for acquisition-related expenses, and a $1.6 million increase in the accounts payable, accrued liabilities, and other long-term liabilities.

Backlog

Our backlog consists of deferred revenue as well as contractual commitments that are not due and payable as of the balance sheet date, or for which the product or service has not yet been delivered, and/or for which collectibility is not considered probable. Our backlog excludes all items relating to consulting and training services. Backlog was $26.0 million and $26.7 million at June 30, 2008 and December 31, 2007, respectively. We believe that $19.7 million of the backlog at June 30, 2008 will be recognized as revenue in the next 12 months in accordance with our revenue recognition policies, with the balance to be recognized thereafter.

Outlook

We believe that our success in the remainder of 2008 will depend on our ability to continue to effectively manage the transition from being primarily a direct sales organization to having a greater portion of our business come through reseller partners, to expand our international revenue, to introduce competitive products while transitioning from our historic “waterfall” engineering practices to an “agile” product development model, and to maintain control over expenses and cash. We believe that key risks include overall economic conditions and the overall level of information technology spending; economic and business conditions within our customers’ vertical markets, including the financial services, healthcare, and government industries; timing of the closure of customer contracts; operational execution in growing our sales internationally; and competitive factors in our rapidly changing industry. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies of a similar size and industry, particularly given that we operate in rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. Please refer to the “Risk Factors” section at Part II, Item 1A for additional information.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

Reclassifications

Certain reclassifications have been made to amounts from prior years to properly state cash capital expenditures in the consolidated financial statement of cash flows and to conform to the current year presentation. The effects of these reclassifications were immaterial to operating and investing cash flows in 2007.

Revenue Recognition

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

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

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

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

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

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

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

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

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

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

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

We typically grant our customers a warranty which guarantees that our products will substantially conform to our current specifications for 90 days from the delivery date pursuant to the terms of the arrangement. We account for the estimated cost of product and service warranties in accordance with Statement of Financial Accounting Standards (“SFAS 5”), Accounting for Contingencies, provided that it is probable that a liability exists, and provided the cost to repair or otherwise satisfy the claim can be reasonably estimated. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims for the three months ended June 30, 2008 and 2007 were $39,000 and $6,000, respectively. Costs related to warranty claims for the six months ended June 30, 2008 and 2007 were $ 241,000 and $121,000, respectively.

Stock-based Compensation Expense

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

Valuation of Allowance for Doubtful Accounts

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

Valuation of Long-Lived Assets and Goodwill

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

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significant underperformance relative to historical or projected future operating results;

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

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significant negative industry or economic trends;

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

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our market capitalization relative to our net book value.

We evaluate whether goodwill is impaired on at least an annual basis in accordance with SFAS 142, Goodwill and Other Intangible Assets (“SFAS 142”) or more frequently if certain indicators are present. If this evaluation indicates that the value of the goodwill may be impaired, we make an assessment of the impairment of the goodwill using the two-step method prescribed by SFAS 142. Any such impairment charge could be significant and have a material adverse effect on our reported financial statements. We did not record any impairment charges on our goodwill during the three months ended June 30, 2008 and 2007, respectively.

Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by us for federal income tax purposes. As of June 30, 2008 we had goodwill of $48.1 million.

RESULTS OF OPERATIONS

Three and Six Months Ended June 30, 2008 and 2007

Revenue for the three and six months ended June 30, 2008 was $15.8 million and $31.0 million, respectively, as compared to $14.1 million and $29.1 million, respectively, for the same three and six months in 2007. Net losses for the three and six months ended June 30, 2008 were $2.4 million and $3.5 million, respectively, as compared to $2.7 million and $4.6 million, respectively, for the same three and six months in 2007.

Net loss for both the three and six month periods of 2008 decreased primarily due to increases in revenue and decreases in cost of revenue. The increase in total revenue of $1.6 million for the three months ended June 30, 2008 was due to increases in product revenue, service revenue, and intellectual property revenue. The increase in total revenue of $1.9 million for the six months ended June 30, 2008 was primarily due to an increase in intellectual property revenue of $2.1 million, partially offset by a combined decrease in product and service revenue of $271,000.

Total cost of revenue decreased to $3.2 million for the three months ended June 30, 2008 from $3.5 million for the same three months in 2007 due to a $351,000 decrease in service costs and a $234,000 decrease in the amortization of intangible assets, partially offset by a $320,000 increase in product costs. Total cost of revenue decreased to $6.5 million for the six months ended June 30, 2008 from $7.5 million for the same six months in 2007 due to a $504,000 decrease in service costs, a $267,000 decrease in the amortization of intangible assets, and a $164,000 decrease in provision for excess inventory. The decreases in service costs for the three and six month periods ended June 30, 2008 were primarily due to decreases in employee and employee-related costs. The decreases in the amortization of intangible assets were due to completing the amortization of the customer base and reseller agreements acquired during the acquisitions of Corvigo, Inc. and Tumbleweed Communications Limited (formerly Incubator Limited) during the three months ended March 31, 2008. In addition, the increase in product costs for the three months was primarily due to an increase in the number of appliances shipped during the period as compared to the same three months in 2007.

Revenue. Revenue, which consists of product revenue, service revenue, and intellectual property revenue, results from new contracts and backlog. We define backlog as deferred revenue, contractual commitments that are not due and payable as of the balance sheet date, or for which the product or service has not yet been delivered and/or for which collectibility is not considered probable. Product revenue consists of license fees and appliance fees (for products that are delivered on an appliance platform), and subscription-based license fees. Service revenue includes support and maintenance fees, consulting fees, and training fees. Intellectual property revenue consists of patent license agreement fees. Total revenue for the three months ended June 30, 2008 was $15.8 million as compared to $14.1 million for the same three months in 2007. The increase in total revenue was primarily due to a $771,000 increase in product revenue, a $667,000 increase in service revenue, and a $190,000 increase in intellectual property revenue. Total revenue for the six months ended June 30, 2008 increased to $31.0 million from $29.1 million for the same six months in 2007. The increase in total revenue was primarily due to a $2.1 million increase in intellectual property, partially offset by a $143,000 decrease in service revenue and a $128,000 decrease in product revenue.

Product revenue increased to $5.9 million for the three months ended June 30, 2008 from $5.1 million for the same three months in 2007. The increase in product revenue was due to an increase in the volume of our license transactions, reflecting an expansion of our customer base. Product revenue remained relatively unchanged and was $10.9 million for the six months ended June 30, 2008 and $11.0 million for the same six months in 2007

Service revenue increased to $8.6 million for the three months ended June 30, 2008 from $8.0 million for the same three months in 2007. The increase in service revenue was primarily due to an increase in support and maintenance revenue of $506,000 for the three months ended June 30, 2008 due to the increased number of customers covered by support agreements. Service revenue remained relatively unchanged and was $16.9 million for the six months ended June 30, 2008 and $17.0 million for the same six months in 2007.

Intellectual property revenue increased to $1.2 million for the three months ended June 30, 2008 from $1.0 million for the same three months in 2007. Intellectual property revenue increased to $3.3 million for the six months ended June 30, 2008 from $1.1 million for the same six months in 2007. The increases in intellectual property revenue were due to a patent license agreement during the six months ended June 30, 2008, with no comparable transactions in 2007.

Cost of revenue. Cost of revenue is comprised of costs for product revenue, service costs, provision for excess inventory, and the amortization of intangible assets for core/developed technology and maintenance agreements relating to corporate acquisitions by us. Cost of product revenue is primarily comprised of royalties paid to third parties for software licensed by us for inclusion in our products, and the cost of our products sold on appliances including related shipping and warranty costs. Service costs are comprised primarily of employee and employee-related costs, including stock-based compensation expense, for customer support, consulting and customer-facing training, and contract development projects with third parties. Provision for excess inventory is comprised of costs associated with excess inventory resulting from our transitions to new appliance manufacturers. Total cost of revenue decreased to $3.2 million, or 20% of total revenue, for the three months ended June 30, 2008 from $3.5 million, or 25% of total revenue, for the same three months in 2007. The decrease in total cost of revenue was due to a $351,000 decrease in service costs and a $234,000 decrease in the amortization of intangible assets, partially offset by a $320,000 increase in product costs. Total cost of revenue decreased to $6.6 million, or 21% of total revenue, for the six months ended June 30, 2008 from $7.5 million, or 26% of total revenue, for the same six months in 2007. The decrease in total cost of revenue was due to a $504,000 decrease in service costs, a $267,000 decrease in the amortization of intangible assets, and a $164,000 decrease in provision for excess inventory.

Cost of product revenue increased to $1.6 million, or 10% of total revenue, for the three months ended June 30, 2008 from $1.3 million, or 9% of total revenue, for the same three months in 2007. The increase in product costs was primarily due to an increase of $230,000 in appliance costs due to increases in the number of appliances shipped to our customers as customer adoption of our appliance products increased. Cost of product revenue decreased slightly to $3.0 million, or 10% of total revenue, for the six months ended June 30, 2008 from $3.1 million, or 11% of total revenue, for the same six months in 2007.

Provision for excess inventory is the estimated loss for excess inventory and purchase commitments associated with transitioning our hardware products to new appliance manufacturers. Provision for excess inventory for the six months ended June 30, 2007 was $164,000, or 1% of total revenue. There was no such expense during either the three or six months ended June 30, 2008.

Service costs decreased to $1.6 million, or 10% of total revenue, for the three months ended June 30, 2008 from $1.9 million, or 14% of total revenue, for the same three months in 2007. Service costs decreased to $3.3 million, or 11% of total revenue, for the six months ended June 30, 2008 to $3.8 million, or 13% of total revenue, for the same six months in 2007. The decreases in service costs for the three and six month periods ended June 30, 2008 were due to decreases in employee and employee-related costs of $297,000 and $461,000, respectively, mainly as a result of lower average services headcount. Average services headcount decreased to 65 and 66, respectively, for the three and six months ended June 30, 2008, from 80 and 79, respectively, for the three and six months ended June 30, 2007 primarily due to our efforts to control expenses.

Amortization of intangible assets included in cost of revenue for the three and six months ended June 30, 2007 was $234,000, or 2% of total revenue and $468,000, or 2% of total revenue, respectively. There was no amortization of intangible assets included in cost of revenue for the three months ended June 30, 2008 due to the amortization in full of all intangible assets, including those for which amortization is included in cost of revenue, in the three months ended March 31, 2008.

Research and development expenses. Research and development expenses are primarily comprised of employee and employee-related costs, including stock-based compensation expense and other costs required for the development and quality assurance of our products. Research and development expenses for the three months ended June 30, 2008 increased to $4.1 million, or 26% of total revenue, from $3.9 million, or 27% of total revenue, for the same three months in 2007. Research and development expenses for the six months ended June 30, 2008 increased slightly to $7.9 million, or 26% of total revenue, from $7.8 million, or 27% of total revenue, for the same six months in 2007. The increases in research and development expenses were primarily due to $243,000 and $126,000 increases in consulting costs for the three and six months ended June 30, 2008, respectively. The consulting costs increased as a result of greater utilization of third-parties to assist in our research and development processes.

Sales and marketing expenses. Sales and marketing expenses are primarily comprised of employee and employee-related costs, including stock-based compensation expense, travel expenses, and costs associated with marketing programs. Sales and marketing expenses decreased to $6.5 million, or 41% of total revenue, for the three months ended June 30, 2008 from $7.3 million, or 52% of total revenue, for the same three months in 2007. Sales and marketing expenses for the six months ended June 30, 2008 decreased to $13.1 million, or 42% of total revenue, from $13.9 million, or 48%, for the same six months in 2007. The decreases in sales and marketing expenses were primarily due to decreases in marketing programs expenses, travel expenses, and recruiter search fees. Marketing programs expenses decreased by $441,000 and $558,000, respectively, for the three and six months ended June 30, 2008 due to reduction in marketing headcount and more cost-effective marketing programs. Average marketing headcount decreased to 9 for both the three and six months ended June 30, 2008, from 17 for both the three and six months ended June 30, 2007 primarily due to our efforts to control expenses. Travel expenses decreased by $85,000 and $170,000, respectively, for the three and six months ended June 30, 2008 due to more cost effective travel programs. Recruiter search fees decreased by $51,000 and $155,000, respectively, for the three and six months ended June 30, 2007 due to using more cost effective recruiting practices, including an in-house recruiter.

General and administrative expenses. General and administrative expenses consist primarily of employee and employee-related costs, including stock-based compensation expense, for our administrative, finance, legal, and human resources departments, as well as public reporting costs and professional fees including intellectual property enforcement and protection costs. General and administrative expenses for the three months ended June 30, 2008 increased to $2.7 million, or 17% of total revenue, from $2.5 million, or 18% of total revenue, for the same three months in 2007. General and administrative expenses for the six months ended June 30, 2008 increased to $5.4 million, or 18% of total revenue, from $5.0 million, or 17% of total revenue, for the same six months in 2007. The increases in general and administrative expenses were primarily due to increases of $103,000 and $177,000 in stock-based compensation expenses for the three and six months ended June 30, 2008, respectively. Stock-based compensation expenses increased due to a change in the compensation structure of certain executive officers in 2008, whereby those executives would be paid their incentive compensation in shares of restricted stock as opposed to cash. In addition, general and administrative expenses for the six months ended June 30, 2008 increased primarily due to an increase in incentive compensation related to the increase in the licensing of intellectual property.

Amortization of intangible assets. Amortization of intangible assets included in operating expenses consists of the amortization of intangible assets for customer base and reseller agreements and trademarks and tradenames recorded as a result of the Valicert, Tumbleweed Communications Limited (formerly Incubator Limited), and Corvigo, Inc. acquisitions. Amortization of intangible assets included in operating expenses for the six months ended June 30, 2008 was $32,000, or 0% of total revenue. There was no amortization of intangible assets included in operating expenses for the three months ended June 30, 2008 due to the amortization in full of all intangible assets, including those for which amortization is included in operating expenses, in the three months ended March 31, 2008. Amortization of intangible assets included in operating expenses for the three and six months ended June 30, 2007 was $44,000, or 0% of total revenue, and $227,000, or 1% of total revenue, respectively.

Acquisition-related expenses. Acquisition-related expenses consist of costs related to potential acquisition of Tumbleweed by Axway, Inc. An Agreement and Plan of Merger, dated June 5, 2008 was approved by the shareholders on August 8, 2008, but remains subject to various closing conditions. Acquisition-related expenses of $1.9 million for the three months ended June 30, 2008 consist primarily of $1.2 million of legal costs and $700,000 of other costs.

Other income, net. Other income, net, is generally comprised of interest income earned on investment securities. Other income, net, decreased to $170,000 for the three months ended June 30, 2008 from $381,000 for the same three months in 2007. Other income, net for the six months ended June 30, 2008 decreased to $394,000 from $720,000 for the same six months in 2007. The decreases in other income, net were primarily due to decreases in interest income caused by decreases in interest rates.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations primarily through the issuance of equity securities. As of June 30, 2008, we had approximately $29.2 million in cash and cash equivalents.

Net cash provided by operating activities for the six months ended June 30, 2008 was $3.5 million, which was primarily the result of a $3.5 million reduction in our accounts receivable balance, a $1.7 million increase in our liability for acquisition related expenses, and $2.5 million in stock-based compensation expense, partially offset by our $3.5 million net loss and a $487,000 decrease in deferred revenue. Our accounts receivable balance decreased due to an increase in cash collections from our customers.

Net cash provided by operating activities for the six months ended June 30, 2008 was $3.5 million as compared to net cash used in operating activities for the six months ended June 30, 2007 of $688,000. This was primarily the result of a $1.1 million decrease in our net loss for the six months ended June 30, 2008 compared to the same six months in 2007, a $1.7 increase in the accrual for acquisition-related expenses, and a $1.6 million increase in the accounts payable, accrued liabilities, and other long-term liabilities.

Net cash used in investing activities for the six months ended June 30, 2008 decreased to $742,000 from $1.2 million for the same six months in 2007 due to lower purchases of property and equipment. The decrease during the six months ended June 30, 2008 as compared to the six months ended June 30, 2007 was due to a greater level of investment made in the six months ended June 30, 2007 to strengthen our internal information technology infrastructure than during the six months ended June 30, 2008.

Net cash provided by financing activities for the six months ended June 30, 2008 decreased to $58,000 from $1.3 million for the same six months in 2007 primarily due to a decrease in the proceeds from the exercise of stock options.

As of June 30, 2008, our principal commitments consisted of obligations related to outstanding operating leases and unconditional purchase obligations. We do not anticipate a substantial increase in operating lease obligations in the immediate future.

We have an operating lease covering approximately 40,000 square feet of office space in Redwood City, California. This lease expires in July 2008 with current monthly rent payments of approximately $88,000. In April 2008, we entered into a new, three year operating lease covering approximately 37,000 square feet of office space in Redwood City, California which we occupied starting in late July 2008. The base monthly rent payments will be approximately $86,000.

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

OFF-BALANCE SHEET ARRANGEMENTS

At June 30, 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

Future cash payments for contractual obligations and commercial commitments as of June 30, 2008, are as follows (in thousands):


	Less Than 1 Year		1 – 3 Years		3 – 5 Years		More Than 5 Years		Total
Operating leases	$	460	$	2,963	$	1,443	$	—	$	4,866
Unconditional purchase obligations		527		1,579		—		—		2,106

Total	$	987	$	4,542	$	1,443	$	—	$	6,972

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

We do not use derivative financial instruments for speculative trading purposes, nor do we hedge our foreign currency exposure in a manner that entirely offsets the effects of changes in foreign exchange rates. We have evaluated our need for a hedging program in the past and will continue to do so in the future.

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 June 30, 2008, none of our cash equivalents were subject to market risk.

ITEM 4.

CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

Tumbleweed’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2008. Based on such evaluation, Tumbleweed’s Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2008, Tumbleweed’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Tumbleweed in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by Tumbleweed in the reports that it files or submits under the Exchange Act are accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in internal controls.

No changes in Tumbleweed’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, Tumbleweed’s internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

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

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

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

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

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

ITEM 1A.

RISK FACTORS

Failure to complete the merger with Axway could materially and adversely affect Tumbleweed’s results of operations and Tumbleweed’s stock price.

Consummation of the merger is subject to various closing conditions, including expiration of the review process under Exon-Florio. There can be no assurance that these conditions will be met or waived, that the necessary approvals will be obtained, or that Tumbleweed will be able to successfully consummate the merger on the terms proposed or at all. If the merger is not consummated:

•

the market price of Tumbleweed’s common stock may significantly decline, in part because the current market price reflects a market belief that the merger will be completed;

•

there may be substantial disruption to the business of Tumbleweed and a distraction of our workforce and management team from day-to-day operations; and

•

we will nonetheless remain liable for significant transaction costs, including legal, accounting, financial advisory and other costs relating to the merger.

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

We have a history of losses and may experience losses in the future. Our prospects must be considered in light of the risks, expenses, delays and difficulties frequently encountered by companies engaged in rapidly evolving technology markets like ours. We incurred net losses of $10.8 million and $4.9 million in 2007 and 2006, respectively. As of June 30, 2008, we had incurred cumulative net losses of $310.2 million.

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

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

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

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

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

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

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

We may have difficulty in executing our business operations.

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

•

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

•

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

•

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

•

growing our international sales;

•

building an adequate pipeline of prospective sales;

•

accurately forecasting revenues;

•

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

•

developing products with strong market appeal;

•

transitioning from our historical “waterfall” engineering practices to an “agile” product development model;

•

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

•

controlling expenses, particularly sales, product development, and general and administrative expenses;

•

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

•

otherwise executing on our strategic plans.

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

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

We are substantially dependent on the continued services and performance of our executive officers and other key personnel and do not have long-term employment agreements with any of our key personnel. The loss of the services of any of our executive officers or other key employees, including experienced and/or highly skilled members of our sales force, our product development team, and our product management team, could significantly delay or prevent the achievement of the goals of our strategic and operating plan.

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

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

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

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

Larger companies, such as Cisco Systems, Google, Microsoft, Secure Computing, Sterling Commerce, Inc. (a unit of AT&T Corp.), Axway, Inc. (as subsidiary of Sopra Group, SA), Symantec, and Websense are concentrating an increasing amount of their substantially greater financial and other resources on the markets in which we participate, which represents a serious competitive threat to Tumbleweed.

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

Competitors may develop new technologies or products in advance of us or establish business models or technologies disruptive to us. Our business may be materially adversely affected by the announcement or introduction of new products, including hardware and software products and services by our competitors, and the implementation of effective marketing or sales strategies by our competitors. We may experience product performance challenges, especially with our core products, namely, our managed file transfer products and our email security products, that create negative publicity or otherwise inhibit our ability to maintain or increase our sales, which may also adversely affect our business. The material adverse effect to our business in any of the foregoing scenarios could include a decrease in demand for our products and services and an increase in the length of our sales cycle due to customers taking longer to compare products and services and to complete their purchases.

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

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

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

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

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

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

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

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

Risks inherent in the transition to new products include:

•

the difficulty in forecasting customer preferences or demand accurately;

•

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

•

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

•

delays in initial shipments of new products.

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

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

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

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

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

The loss of one or more of our major customers, the failure to attract new customers on a timely basis, or a reduction in revenue associated with existing or proposed customers would harm our future revenue and prospects. For the three months ended June 30, 2008, no single customer comprised 10% or more of Tumbleweed’s revenue. For the six months ended June 30, 2008, one customer comprised 10% of Tumbleweed’s revenue. For the three and six months ended June 30, 2007 no single customer comprised 10% or more of Tumbleweed’s revenue, respectively. No single customer comprised 10% or more of Tumbleweed’s accounts receivable balance, net of allowance for doubtful accounts, at either June 30, 2008 or December 31, 2007. Five customers comprised approximately 16% of our revenue for both the three months ended June 30, 2008 and 2007. For the six months ended June 30, 2008 and 2007, five customers comprised approximately 17% and 11% of our revenue, respectively.

In addition, a significant amount of our past business has been in three vertical markets: financial services, healthcare, and government. This concentration, especially with respect to the financial services market, which has constituted approximately 29% of our business, poses risks, particularly the risk that adverse conditions within the vertical market could result in reduced information technology spending in that vertical, which in turn could adversely impact our operating results.

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

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

•

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

•

the inability of the appliance manufacturer to perform in accordance with our expectations, including our expectations regarding the hardware appliances’ compliance with any applicable regulations;

•

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

•

product or component shortages that could result in increased product costs;

•

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

•

oversupply or obsolescence of inventory, which may result in the need to reduce our prices and/or reduce the value of our inventory; and

•

product quality issues.

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

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

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

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

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

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

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

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

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

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

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

Products and services provided to our international customers accounted for 17% and 11% of our revenues for the three months ended June 30, 2008 and 2007, respectively. Products and services provided to our international customers accounted for 14% and 12% of our revenues for the six months ended June 30, 2008 and 2007, respectively. Conducting business outside of the United States subjects us to additional risks, including:

•

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

•

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

•

difficulties in staffing and managing foreign operations;

•

increased income tax expenses;

•

problems in collecting accounts receivable; and

•

difficulties in authenticating customer information.

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

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

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

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

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

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

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

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

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

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

A principal stockholder of the Company, Empire Capital Partners (“Empire”) and its affiliates, has announced it is considering alternative courses of action to maximize its investment in the Company. This action may include seeking representation of the Board of Directors, making recommendations to management concerning business strategies, strategic partnerships, dividend policies and other matters, or seeking to acquire control of the Company through a merger, proxy solicitation, tender offer, exchange offer, or otherwise. Although members of our management and our Board of Directors have met and may continue to meet with representatives of Empire with a view to soliciting, and when appropriate, incorporating their views, the Company may be unwilling or unable to satisfy Empire’s expectations, and in any event the Company’s operations may suffer because management is distracted by its dealings with the stockholder. If Empire were to initiate a proxy solicitation to elect its own slate of directors or to seek to acquire control of the Company in a manner that was opposed by the Board of Directors, the Company would be required to aggressively respond, which could disrupt operations and have a material adverse effect on operating results. According to their public filings, Empire Capital Partners and its affiliates beneficially own 6,613,894 shares of common stock, or 12.4% of the Company’s outstanding shares as of July 31, 2008.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On June 10, 2008, we held our Annual Meeting of Stockholders. The stockholders voted on the following matters:

1) Election of directors: Christopher H. Greendale, Standish H. O’Grady, and James A. Heisch were nominated and elected as Class III directors for terms expiring in 2011. Votes were counted as follows:


	For	Withheld
Christopher H. Greendale	45,023,375	1,945,517
Standish H. O’Grady	46,183,477	785,415
James A. Heisch	45,023,386	1,945,506

As of June 30, 2008, our board of directors was comprised of each of our Class III Directors listed in the table above, our Class I Directors, Jeffrey C. Smith and Kenneth R. Klein, and our Class II Directors, Dr. Deborah D. Rieman, Dr. Taher A. Elgamal, and James P. Scullion.

2) Ratification of the selection of KPMG LLP as our independent auditors for the fiscal year ending December 31, 2008. The selection of KPMG LLP was ratified by a vote of 46,372,094 for and 519,731 votes against, with 77,067 votes abstaining.

ITEM 5.

OTHER INFORMATION

Not applicable.

ITEM 6.

EXHIBITS

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


Exhibit Number		Description

3.1(1)		Amended and Restated Certificate of Incorporation of Registrant

3.2(1)		Amended and Restated Bylaws of Registrant

10.1(2)		Merger agreement between Axway Inc. and Tumbleweed, dated June 5, 2008

10.2(3)		Amendment to the employment agreement between James P. Scullion and Tumbleweed, dated June 9, 2008

31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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

(2)	Incorporated by reference to our Current Report on Form 8-K, filed June 6, 2008.

(3)	Incorporated by reference to our Current Report on Form 8-K, filed June 9, 2008.

SIGNATURES

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


	TUMBLEWEED COMMUNICATIONS CORP.

Date: August 11, 2008	By:	/s/ JAMES P. SCULLION
		James P. Scullion
		*Chairman and Chief Executive Officer* *(Principal Executive Officer)*

Date: August 11, 2008	By:	/s/ TIMOTHY G. CONLEY
		Timothy G. Conley
		*Senior Vice President of Finance and* *Chief Financial Officer* *(Principal Financial Officer and* *Principal Accounting Officer)*

INDEX TO EXHIBITS


Exhibit Number		Description

3.1(1)		Amended and Restated Certificate of Incorporation of Registrant

3.2(1)		Amended and Restated Bylaws of Registrant

10.1(2)		Merger agreement between Axway Inc. and Tumbleweed, dated June 5, 2008

10.2(3)		Amendment to the employment agreement between James P. Scullion and Tumbleweed, dated June 9, 2008

31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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

(2)	Incorporated by reference to our Current Report on Form 8-K, filed June 6, 2008.

(3)	Incorporated by reference to our Current Report on Form 8-K, filed June 9, 2008.

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TUMBLEWEED COMMUNICATIONS CORP 10-Q