##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-QSB

(Mark One)

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

For the quarterly period ended September 30, 2002.

|                                                                                          
|------------------------------------------------------------------------------------------
|o 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 1-15117.

On2 Technologies, Inc.

(Exact name of registrant as specified in its charter)


|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 84-1280679                          
|                                                              
|                                                              
|                                                              
|                                                              
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

|                                           |  |  |  |           
|------------------------------------------ |  |  |  | ----------
|21 Corporate Drive, Clifton Park, New York |  |  |  | 12065     
|                                          
|                                          
|                                          
|                                          
|(Address of principal executive offices)   |  |  |  | (Zip Code)

(518) 348-0099, ext. 231

(Registrants telephone number, including area code)


145 Hudson Street, New York, New York 10013-2103

(Former name, former address and former fiscal year, if changed since last report)


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   þ   No   o

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.    o   Yes   o   No

-1-



---



##### Table of Contents



APPLICABLE ONLY TO CORPORATE ISSUERS:

State the number of shares outstanding of each of the issuers classes of
common equity, as of the latest practicable date:

The number of shares of the Registrants Common Stock, par value $0.01 (Common
Stock), outstanding as of November 11, 2002 was 59,588,485.

Transitional Small Business Disclosure Format (Check one):    o   Yes   o   No

-2-



---

TABLE OF CONTENTS



|                                         |                                                                                                |                                                      |  |  |  |  |  | 
|---------------------------------------- | ---------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION          
|                                         | Item 1. Consolidated Financial Statements                                                     
|                                         | CONDENSED CONSOLIDATED BALANCE SHEETS                                                         
|                                         | UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                     
|                                         | UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                     
|                                         |                                                                                                | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                                         | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|                                         | Item 3. Controls and Procedures:                                                              
|PART II  OTHER INFORMATION             
|                                         | ITEM 1. LEGAL PROCEEDINGS                                                                     
|                                         | ITEM 2. CHANGES IN SECURITIES                                                                 
|                                         | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.                                                     
|                                         | SIGNATURES                                                                                    
|UNIT SUBSCRIPTION AND SECURITY AGREEMENT
|CERTIFICATION                           
|CERTIFICATION                           



---



##### Table of Contents



Table of Contents

PART I  FINANCIAL INFORMATION

|                                                                                                                   |  |      |    | 
|------------------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                                   |  | Page
|                                                                                                                   |  |     
|Item 1. Consolidated Financial Statements                                                                          |  |      |    | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Condensed Consolidated Balance Sheets at September 30, 2002 (unaudited) and
December 31, 2001                      |  |      | 4  | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Unaudited Condensed Consolidated Statements of Operations,
Three and Nine Months Ended September 30, 2002 and 2001 |  |      | 5  | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Unaudited Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2002 and 2001            |  |      | 6  | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Notes to Unaudited Condensed Consolidated Financial Statements                                                     |  |      | 8  | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                      |  |      | 13 | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Item3. Controls and Procedures                                                                                     |  |      | 21 | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|PART II  OTHER INFORMATION                                                                                        |  |      |    | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Item 1. Legal Proceedings                                                                                          |  |      | 21 | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Item 2. Changes in Securities                                                                                      |  |      | 21 | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Item 6. Exhibits and Reports on Form 8-K                                                                           |  |      | 21 | 
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|                                                                                                                  
|Signatures                                                                                                         |  |      | 23 | 

-3-



---



##### Table of Contents












PART I  FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

ON2 TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |             |           |  | 
|----------------------------------------------------- | ----------------------------------------------------------- | ------------------------------------ | ------------------------------------------ | ------------------------------------ | ------------ | ------------- | --------- | ------------ | ----------- | --------- |  | 
|                                                      |                                                             |                                      |                                            |                                      |              | September 30, |           | December 31,
|                                                      |                                                             |                                      |                                            |                                      |              | 2002          |           | 2001        
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |             
|                                                      |                                                             |                                      |                                            |                                      |              | (unaudited)   |           |              |             |          
|                                                      |                                                             |                                      |                                            | ASSETS                               |              |               |           |              |             |           |  | 
|                                                     
|                                                     
|                                                     
|                                                     
|Current assets:                                       |                                                             |                                      |                                            |                                      |              |               |           |             
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Cash and cash equivalents                                   |                                      | $                                          | 489,843                              |              |               | $         | 215,726      |            
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Accounts receivable, net of allowance for doubtful accounts |                                      |                                            | 835,474                              |              |               |           | 678,920      |            
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Prepaid expenses and other current assets                   |                                      |                                            | 276,567                              |              |               |           | 222,950      |            
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      | Total current assets                       |                                      |              | 1,601,884     |           |              |             | 1,117,596 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Property and equipment, net                           |                                                             |                                      | 467,894                                    |                                      |              |               | 1,406,143 |             
|                                                     
|                                                     
|                                                     
|                                                     
|Purchased technology and other intangible assets, net |                                                             |                                      | 620,352                                    |                                      |              |               | 1,120,843 |             
|                                                     
|                                                     
|                                                     
|                                                     
|Other assets                                          |                                                             |                                      | 16,154                                     |                                      |              |               | 282,080   |             
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      | Total assets                               |                                      | $            | 2,706,284     |           |              | $           | 3,926,662 | 
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      |                                            | LIABILITIES AND STOCKHOLDERS EQUITY |              |               |           |              |             |           |  | 
|                                                     
|                                                     
|                                                     
|                                                     
|Current liabilities:                                  |                                                             |                                      |                                            |                                      |              |               |           |             
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Accounts payable                                            |                                      | $                                          | 436,984                              |              |               | $         | 498,671      |            
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Accrued and other liabilities                               |                                      |                                            | 370,435                              |              |               |           | 489,306      |            
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Deferred revenue                                            |                                      |                                            | 4,140                                |              |               |           | 35,047       |            
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Current portion of capital lease obligations                |                                      |                                            | 2,646                                |              |               |           |             |            
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      | Total current liabilities                  |                                      |              | 814,205       |           |              |             | 1,023,024 | 
|                                                     
|                                                     
|                                                     
|                                                     
|Capital lease obligations, net of current portion     |                                                             |                                      | 7,305                                      |                                      |              |               |          |             
|                                                     
|                                                     
|                                                     
|                                                     
|Convertible debentures, net                           |                                                             |                                      | 563,467                                    |                                      |              |               | 2,000,000 |             
|                                                     
|                                                     
|                                                     
|                                                     
|Commitments and contingencies                         |                                                             |                                      |                                            |                                      |              |               |           |             
|                                                     
|                                                     
|                                                     
|                                                     
|Stockholders equity:                                 |                                                             |                                      |                                            |                                      |              |               |           |             
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |                                                             | Preferred stock                      |                                            |                                      | 102,975      |               |           |              | 129,286     |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |                                                             | Common stock                         |                                            |                                      | 590,186      |               |           |              | 385,650     |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |                                                             | Additional paid-in capital           |                                            |                                      | 105,411,689  |               |           |              | 99,548,997  |          
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |                                                             | Accumulated other comprehensive loss |                                            |                                      | (13,499      | )             |           |              | (10,068     | )        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |                                                             | Accumulated deficit                  |                                            |                                      | (104,770,044 | )             |           |              | (99,150,227 | )        
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      | Total stockholders equity                 |                                      |              | 1,321,307     |           |              |             | 903,638   | 
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            
|                                                      |                                                             |                                      | Total liabilities and stockholders equity |                                      | $            | 2,706,284     |           |              | $           | 3,926,662 | 
|                                                      |                                                             |                                      |                                            |                                      |              |               |           |              |            

See accompanying notes to condensed consolidated financial statements

-4-



---



##### Table of Contents






ON2 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |           | 
|------------------------------------------------------------ | ------------------------------------------ | - | ------------------ | ------- | ----------------- | - | ---------- | --------- | ---- | - | ---------- | --------- |  | - | ----------- | --------- | 
|                                                             |                                            |   | Three Months Ended |         | Nine Months Ended
|                                                             |                                            |   | September 30,      |         | September 30,    
|                                                             |                                            |   |                    |         |                  
|                                                             |                                            |   | 2002               |         | 2001              |   | 2002       |           | 2001
|                                                             |                                            |   |                    |         |                   |   |            |           |     
|Revenues                                                     |                                            | $ | 824,311            |         |                   | $ | 497,556    |           |      | $ | 2,539,989  |           |  | $ | 1,301,504   |          
|                                                            
|                                                            
|                                                            
|                                                            
|Operating expenses:                                          |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Cost of revenues                           |   |                    | 422,376 |                   |   |            | 754,888   |      |   |            | 1,630,549 |  |   |             | 2,046,692 | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Research and development                   |   |                    | 455,197 |                   |   |            | 842,045   |      |   |            | 1,846,792 |  |   |             | 3,259,537 | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Sales and marketing                        |   |                    | 108,170 |                   |   |            | 332,787   |      |   |            | 847,714   |  |   |             | 1,744,598 | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | General and administrative (1)             |   |                    | 604,479 |                   |   |            | 1,048,915 |      |   |            | 2,515,327 |  |   |             | 4,383,271 | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Impairment charges                         |   |                    |        |                   |   |            | 83,333    |      |   |            | 30,000    |  |   |             | 533,333   | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Cost curtailment and
restructuring charges |   |                    | 502,161 |                   |   |            |          |      |   |            | 580,949   |  |   |             | 293,200   | 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Non-cash stock-based
compensation          |   |                    |        |                   |   |            | 43,707    |      |   |            |          |  |   |             | 143,707   | 
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Total operating expenses                                     |                                            |   | 2,092,383          |         |                   |   | 3,105,675  |           |      |   | 7,451,331  |           |  |   | 12,404,338  |          
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Loss from operations                                         |                                            |   | (1,268,072         | )       |                   |   | (2,608,119 | )         |      |   | (4,911,342 | )         |  |   | (11,102,834 | )        
|                                                            
|                                                            
|                                                            
|                                                            
|Interest and other income
(expense), net                     |                                            |   | (3,966             | )       |                   |   | (477,258   | )         |      |   | (13,542    | )         |  |   | (1,555,357  | )        
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Loss before provision for income
taxes                       |                                            |   | (1,272,038         | )       |                   |   | (3,085,377 | )         |      |   | (4,924,884 | )         |  |   | (12,658,191 | )        
|                                                            
|                                                            
|                                                            
|                                                            
|Provision for income taxes                                   |                                            |   | 9,100              |         |                   |   | 16,652     |           |      |   | 27,314     |           |  |   | 47,502      |          
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Net loss                                                     |                                            |   | (1,281,138         | )       |                   |   | (3,102,029 | )         |      |   | (4,952,198 | )         |  |   | (12,705,693 | )        
|                                                            
|                                                            
|                                                            
|                                                            
|Non-cash convertible preferred
stock dividend                |                                            |   | 667,619            |         |                   |   | 2,600,878  |           |      |   | 667,619    |           |  |   | 4,129,816   |          
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Net loss attributable to common
stockholders                 |                                            | $ | (1,948,757         | )       |                   | $ | (5,702,907 | )         |      | $ | (5,619,817 | )         |  | $ | (16,835,509 | )        
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Basic and diluted net loss per
common share                  |                                            | $ | (0.03              | )       |                   | $ | (0.16      | )         |      | $ | (0.11      | )         |  | $ | (0.53       | )        
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          
|Weighted average basic and diluted
common shares outstanding |                                            |   | 56,093,779         |         |                   |   | 35,003,671 |           |      |   | 51,321,159 |           |  |   | 31,738,183  |          
|                                                             |                                            |   |                    |         |                   |   |            |           |      |   |            |           |  |   |             |          

See accompanying notes to unaudited condensed consolidated financial statements

(1)  Excluding $43,707 and $143,707 of non-cash stock-based compensation for
the three and nine months ended                   September 30, 2001, respectively.
Excluding $502,161 and $580,949 of cost

-5-



---



##### Table of Contents



curtailment charges for the three months and nine months ended September 30,
2002, respectively, consisting of property-lease termination, relocation
costs, severance and loss on disposal of fixed assets.

-6-



---



##### Table of Contents






ON2 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |   |            |  
|------------------------------------------------------------ | -------------------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------------------- | ---------- | ------------------------------- | --------- | ---------- | ----------- | - | ---------- | -
|                                                             |                                                                |                                                                             |                                                          |            | Nine Months Ended September 30,
|                                                             |                                                                |                                                                             |                                                          |            |                                
|                                                             |                                                                |                                                                             |                                                          |            | 2002                            |           | 2001      
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |           
|Cash flows from operating activities:                        |                                                                |                                                                             |                                                          |            |                                 |           |            |            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Net loss                                                       |                                                                             | $                                                        | (4,952,198 | )                               |           | $          | (12,705,693 | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                | Adjustments to reconcile net loss to net cash used in operating activities: |                                                          |            |                                 |           |            |             |   |           
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Non-cash stock based compensation                        |            |                                 |           |            |             |   | 143,707    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Depreciation and amortization                            |            |                                 | 1,214,215 |            |             |   | 2,387,135  |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Amortization of debt discount                            |            |                                 | 1,467     |            |             |   | 1,603,397  |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Deferred compensation                                    |            |                                 |          |            |             |   | 44,570     |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Restructuring and impairment charges                     |            |                                 | 30,000    |            |             |   | 826,533    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Impairment of equity investments                         |            |                                 |          |            |             |   | 125,000    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Allowance for doubtful
accounts                          |            |                                 |           |            |             |   | 92,666     |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Charge related to conversion of debentures               |            |                                 | 23,996    |            |             |   |           |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Loss on disposal of fixed
assets                         |            |                                 | 288,548   |            |             |   |            |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                | Changes in operating assets and liabilities, net of effect of acquisitions: |                                                          |            |                                 |           |            |             |   |           
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Accounts receivable, net                                 |            |                                 | (156,554  | )          |             |   | (118,751   | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Prepaid expenses and other current assets                |            |                                 | (50,453   | )          |             |   | 110,237    |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Other assets                                             |            |                                 | 252,546   |            |             |   | 12,302     |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Accounts payable, accrued expenses and other liabilities |            |                                 | (180,558  | )          |             |   | (1,372,991 | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                |                                                                             | Deferred revenue                                         |            |                                 | (30,907   | )          |             |   | (47,557    | )
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Net cash used in operating activities                        |                                                                |                                                                             | (3,559,898                                               | )          |                                 |           | (8,899,445 | )          
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Cash flows from investing activities:                        |                                                                |                                                                             |                                                          |            |                                 |           |            |            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Purchases of property and equipment                            |                                                                             |                                                          | (68,863    | )                               |           |            | (89,479     | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from the sale of fixed assets                         |                                                                             |                                                          |           |                                 |           |            | 25,000      |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Cash paid for acquisitions, net of cash
acquired               |                                                                             |                                                          |           |                                 |           |            | (42,415     | )
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Net cash provided by (used) in investing activities          |                                                                |                                                                             | (68,863                                                  | )          |                                 |           | (106,894   | )          
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Cash flows from financing activities:                        |                                                                |                                                                             |                                                          |            |                                 |           |            |            
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Principal payments on capital lease obligations                |                                                                             |                                                          | (1,829     | )                               |           |            | (26,100     | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Principal payments on notes payable                            |                                                                             |                                                          |           |                                 |           |            | (251,311    | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from the issuance of Series C-VI Preferred Stock, net |                                                                             |                                                          |           |                                 |           |            | 2,000,000   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from the sale of common stock                         |                                                                             |                                                          | 3,258,138  |                                 |           |            | 4,289,140   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from the issuance of convertible debentures           |                                                                             |                                                          | 650,000    |                                 |           |            | 2,000,000   |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from exercise of common stock options and warrants    |                                                                             |                                                          |           |                                 |           |            | 13,500      |  
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Net cash provided by financing activities                    |                                                                |                                                                             | 3,906,309                                                |            |                                 |           | 8,025,229  |            
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  
|Net change in cash and cash equivalents                      |                                                                |                                                                             | 277,548                                                  |            |                                 |           | (981,110   | )          
|                                                            
|                                                            
|                                                            
|                                                            
|Effect of exchange rate changes on cash and cash equivalents |                                                                |                                                                             | (3,431                                                   | )          |                                 |           | (4,429     | )          
|                                                             |                                                                |                                                                             |                                                          |            |                                 |           |            |             |  

-7-



---



##### Table of Contents



|                                               |  |   |         |  |                                 |   |           |  |  |  | 
|---------------------------------------------- |  | - | ------- |  | ------------------------------- | - | --------- |  |  |  | 
|                                               |  |   |         |  | Nine Months Ended September 30,
|                                               |  |   |         |  |                                
|                                               |  |   |         |  | 2002                            |   | 2001     
|                                               |  |   |         |  |                                 |   |          
|Cash and cash equivalents, beginning of period |  |   | 215,726 |  |                                 |   | 1,561,495 | 
|                                               |  |   |         |  |                                 |   |          
|                                              
|                                              
|                                              
|                                              
|Cash and cash equivalents, end of period       |  | $ | 489,843 |  |                                 | $ | 575,956   | 
|                                               |  |   |         |  |                                 |   |          

ON2 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

Supplemental disclosure of cash flow information and non-cash investing and
financing activities:

|                                                            |          |   |                                 |        |      |   |   |        | 
|----------------------------------------------------------- | -------- | - | ------------------------------- | ------ | ---- | - | - | ------ | 
|                                                            |          |   | Nine Months Ended September 30,
|                                                            |          |   |                                
|                                                            |          |   | 2002                            |        | 2001
|                                                            |          |   |                                 |        |     
|Cash paid during the period for:                            |          |   |                                 |        |      |   |   |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Interest |   | $                               | 3,961  |      |   | $ | 6,153. | 
|                                                            |          |   |                                 |        |      |   |   |        | 
|                                                            | Taxes    |   | $                               | 18,214 |      |   | $ | 30,862 | 
|                                                            |          |   |                                 |        |      |   |   |        | 
|Acquisition of fixed assets under capital leases            |          | $ | 11,780                          |        |      | $ |  |       
|                                                            |          |   |                                 |        |      |   |   |        | 
|Conversion of debentures into shares of common stock        |          | $ | 2,000,000                       |        |      | $ |  |       
|                                                            |          |   |                                 |        |      |   |   |        | 
|Conversion of preferred stock into shares of common
stock # |          | $ | 26,311                          |        |      | $ |  |       
|                                                            |          |   |                                 |        |      |   |   |        | 

See accompanying notes to condensed consolidated financial statements

-8-



---



##### Table of Contents






ON2 TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Organization and Summary of Significant Accounting Policies

(a) Description of On2 Technologies, Inc.

On2 Technologies, Inc. (On2 or the Company) is a leading video
compression technology firm. The Company has developed its proprietary
technology platform and video compression/decompression software (codec) to
deliver high quality video at the lowest possible data rates to closed area
networks, such as set-top boxes, the Internet and wireless devices. The Company
offers a suite of products and professional services that encompass its
proprietary compression technology. The Companys professional service
offerings include customized engineering and consulting services and high-level
video encoding. In addition, the Company licenses its software products for use
with video delivery platforms.

The Companys business is characterized by rapid technological change, new
product development and evolving industry standards. Inherent in the Companys
business model are various risks and uncertainties, including its limited
operating history, unproven business model and the limited history of the
industry in which it operates. The Companys success may depend, in part, upon
the wide adoption of video delivery mediums, prospective product and service
development efforts, and the acceptance of the Companys technology solutions
by the marketplace.

(b) Basis of Presentation

The unaudited condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries from their respective
dates of acquisition. All significant inter-company balances and transactions
have been eliminated in consolidation.

The interim condensed consolidated financial statements are unaudited.
However, in the opinion of management, the interim data include all
adjustments, consisting only of normal, recurring adjustments, necessary for a
fair presentation of the consolidated results for the interim periods. The
condensed consolidated financial statements included herein have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). Certain information and footnote disclosures normally included in
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. The Company
believes that the disclosures included herein are adequate to make the
information presented not misleading. These condensed consolidated financial
statements have been prepared assuming the Company will continue as a going
concern. The condensed consolidated financial statements do not include any
adjustments that might result from the Companys inability to continue as a
going concern. These condensed consolidated financial statements should be
read in conjunction with the annual financial statements and notes thereto
included in the Companys Form 10-KSB Report filed with the SEC on March 15,
2002.

(c) Reclassifications

Certain reclassifications have been made to the condensed consolidated
financial statements of prior periods to conform to the current periods
presentation.

- 9 -



---



##### Table of Contents



(2) Property and Equipment

|                                               |       |   |                    |         |                   |   |           |           | 
|---------------------------------------------- | ----- | - | ------------------ | ------- | ----------------- | - | --------- | --------- | 
|                                               |       |   | September 30, 2002 |         | December 31, 2001
|                                               |       |   |                    |         |                  
|Furniture and fixtures                         |       | $ | 65,010             |         |                   | $ | 277,997   |          
|                                              
|                                              
|                                              
|                                              
|Computer equipment                             |       |   | 2,286,894          |         |                   |   | 2,895,367 |          
|                                              
|                                              
|                                              
|                                              
|Leasehold improvements                         |       |   | 63,224             |         |                   |   | 487,348   |          
|                                              
|                                              
|                                              
|                                              
|Licensed software                              |       |   | 587,626            |         |                   |   | 857,388   |          
|                                               |       |   |                    |         |                   |   |           |          
|                                               |       |   | 3,002,754          |         |                   |   | 4,518,100 |          
|                                              
|                                              
|                                              
|                                              
|Less accumulated depreciation and amortization |       |   | 2,534,860          |         |                   |   | 3,111,957 |          
|                                               |       |   |                    |         |                   |   |           |          
|                                               | Total |   | $                  | 467,894 |                   |   | $         | 1,406,143 | 
|                                               |       |   |                    |         |                   |   |           |          

Depreciation expense for the three and nine months ended September 30,
2002 was $238,821 and $730,334, respectively. Depreciation expense for the
three and nine months ended September 30, 2001 was $349,968 and $720,929,
respectively.

(3) Purchased Technology and Other Intangible Assets

|                              |       |   |               |         |              |   |           |           | 
|----------------------------- | ----- | - | ------------- | ------- | ------------ | - | --------- | --------- | 
|                              |       |   | September 30, |         | December 31,
|                              |       |   | 2002          |         | 2001        
|                              |       |   |               |         |             
|Purchased technology          |       | $ | 2,509,287     |         |              | $ | 2,509,287 |          
|                             
|                             
|                             
|                             
|Other intangible assets       |       |   |              |         |              |   | 30,000    |          
|                              |       |   |               |         |              |   |           |          
|                              |       |   | 2,509,287     |         |              |   | 2,539,287 |          
|                             
|                             
|                             
|                             
|Less accumulated amortization |       |   | 1,888,935     |         |              |   | 1,418,444 |          
|                              |       |   |               |         |              |   |           |          
|                              | Total |   | $             | 620,352 |              |   | $         | 1,120,843 | 
|                              |       |   |               |         |              |   |           |          

As of December 31, 2001, other intangibles consisted of a content library.
The Company recorded a charge of $30,000 for the three and nine months ended
September 30, 2002 related to the impairment of the value of the content
library, as it was determined that the library had no future value.
Amortization expense for the three and nine months ended September 30, 2002 was
$156,830 and $470,491, respectively, related to purchased technology.
Amortization expense for the three and nine months ended September 30, 2001 was
$467,861 and $1,415,078, respectively, and related to purchased technology,
goodwill and other intangible assets. As of December 31, 2001, the Company had
written off all remaining goodwill. The amortization of purchased technology
is included in cost of revenues for the three and nine months ended September
30, 2002 and 2001. The remaining amortization expense for the three and nine
months ended September 30, 2001 is included in general and administrative
expenses.

- 10 -



---



##### Table of Contents



(4) Convertible Debentures

Series B

On September 3, 2002 the Company issued $650,000 principal amount, 5.75%,
four-year Series A Secured Convertible Debentures due in 2006. The debentures
are convertible into the Companys $0.01 par value common stock (Common
Stock) at $0.112. In addition, the Company issued to the purchasers of the
debentures, warrants to acquire the Companys Common Stock. The Company sold
sixty-five units with a principal amount of $10,000 per unit; each unit
contained one warrant to purchase 20% warrant coverage shares of Common Stock.
The debentures require interest to be paid each November and May 15th. The
interest is payable in common stock, the amount, which is based on the average
closing price of the stock for the ten trading days prior to the payment date.

The common share equivalents for the debentures and the warrants are
5,803,571 and 1,160,714, respectively.

The Company allocated the proceeds received to the principal amount of the
debentures and the warrants based upon the relative fair value method. The
fair value of the warrants was determined using the Black Scholes pricing
model. The difference between the proceeds allocated to, and the relative fair
value of the debentures, which amounted to $88,000, was recorded as debt
discount and additional paid-in capital. The discount will be amortized over
the life of the bonds.

Series A

March 27, 2002, the holder of the $2,000,000 aggregate principal amount of
the Companys Series A Convertible Debentures (the Debentures) elected to
convert its principal into the underlying 4,444,444 shares of the Companys
common stock. The conversion ratio and the number of underlying shares of
common stock were determined upon execution of the original agreement in
January 2001. In connection with the conversion, the Company issued to the
holder of the Debentures a warrant to purchase 200,000 shares of common stock
at an exercise price of $0.43 per share. The warrant was immediately
exercisable and expires on March 26, 2007. The estimated fair value of the
warrant was $68,440 based upon the Black Scholes pricing model. The fair value
of the underlying shares of common stock was $1,955,556 on the date of
conversion. The Company recorded a charge of $23,997 for the nine months ended
September 30, 2002, which represented the difference between the value of the
underlying shares of common stock and the warrant issued and the original net
proceeds of $2,000,000.

(5) Stockholders Equity

(a) Preferred Stock

On January 4, 2002, the holder of 377,358 shares of Series C-II Preferred
Stock elected to convert the shares into 526,316 shares of underlying common
stock. The original conversion ratio was $2.65 per share, but was adjusted to
$1.90 per share as a result of certain anti-dilution provisions in the original
investment agreement.

On January 16, 2002, the holder of 169,811 shares of Series C-II Preferred
Stock and 922,428 shares of Series C-III Preferred Stock elected to convert the
shares into 236,842 and 1,176,199 shares of underlying common stock,
respectively. The original conversion ratio for the Series C-II Preferred
Stock was $2.65 per share, but was adjusted to $1.90 per share. The original
conversion ratio for the Series C-III Preferred Stock was $1.244 per share, but
was adjusted to $0.9756 per share. The adjustments were the result of certain
anti-dilution provisions in the original investment agreement.

- 11 -



---



##### Table of Contents



On June 3, 2002, the holder of 34,100 shares of Series B Preferred Stock
elected to convert the shares into 34,100 shares of underlying common stock.

On July 11, 2002, the holder of 1,127,411 shares of Series C-III Preferred
Stock elected to convert the shares into 1,437,577 shares of underlying common
stock. The original conversion ratio for the Series C-III Preferred Stock was
$1.244 per share, but was adjusted to $0.9756 per share as a result of certain
anti-dilution provisions in the original investment agreement.

The investors of the Series C-II Preferred Stock are entitled to certain
anti-dilution protections, triggered by certain subsequent issuances of debt or
equity by the Company. The anti-dilution provision for the Series C-II
Preferred Stock was triggered by the debenture offering in September 2002.
Accordingly, the conversion price of the Series C-II Preferred Stock was
adjusted to $1.75 per share, the Company issued an additional 45,684 warrants
and the exercise price of the warrants was reduced to $1.75 per share. The
Company recorded a deemed non-cash convertible preferred stock dividend of
$426,966 for the three months and nine months ended September 30, 2002, to
record the additional benefit received by the remaining Series C-II investors.

The investors of the Series C-III Preferred Stock are entitled to certain
anti-dilution protections, triggered by certain subsequent issuances of debt or
equity by the Company. The anti-dilution provision for the Series C-III
Preferred Stock was triggered by the debenture offering in September 2002.
Accordingly, the Company issued an additional 62,864 warrants and the exercise
price of the warrants was reduced to $0.84 per share. The Company recorded a
deemed non-cash convertible preferred stock dividend of $14,860 for the three
months and nine months ended September 30, 2002, to record the additional
benefit received by the remaining Series C-III investors.

Travelers is entitled to certain anti-dilution protections on its Series
C-IV and C-V Preferred Stock. The anti-dilution provision for the Series C-IV
and Series C-V Preferred Stock was triggered by the debenture offering in
September 2002. Accordingly, the conversion price of the Series C-IV Preferred
Stock was adjusted to $1.75 per share, the Company issued 53,323 additional
warrants and the exercise price of the warrants was reduced to $1.75 per share.
Additionally, the conversion price of the Series C-V Preferred Stock was
adjusted to $0.90 per share, the Company issued 100,609 additional warrants and
the exercise price of the warrants was reduced to $0.84 per share. The Company
recorded a deemed non-cash convertible preferred stock dividend of $225,793 for
the three months and nine months ended September 30, 2002, to record the
additional benefit received by Travelers for their anti-dilution provisions.

(b) Common Stock

Equity-Line of Credit

On April 30, 2002, the Companys stockholders approved the sale of up to
an additional 9,000,000 shares of common stock to Crossover Ventures, under an
equity-line of credit. Pursuant to two outstanding common stock purchase
agreements with Crossover Ventures, the Company can sell up to an aggregate of
24,500,000 shares of Common Stock.

As of September 30, 2002, the Company had sold 21,113,000 shares of Common
Stock for net proceeds of approximately $7,439,000 under the stock purchase
agreements.

- 12 -



---



##### Table of Contents



(6) E-coin Settlement

On April 26, 2002, the Company entered into a settlement agreement with
Ecoin Co. Ltd. in connection with the litigation previously disclosed in the
Companys Annual Report on Form 10-KSB for the fiscal year ending December 31,
2001. Pursuant to this settlement agreement, Ecoin agreed to pay a total of
$225,000 to the Company in exchange for a mutual release of all past claims
between the parties. The settlement is payable to the Company as follows:
$100,000 received on May 10, 2002; $50,000 received on November 1, 2002 and
$75,000 to be received on or before May 1, 2003.

(7) Cost Curtailment and Restructuring Charges

In August 2002, the Board approved a plan to relocate the Companys
offices from New York City and consolidate operations in the Albany, New York
area for the purpose of decreasing the Companys operating expenses. Beginning
in July 2002 the Company began staff reductions that continued through July and
August. In August 2002 the Company terminated the building lease in New York
City. The charges were $502,161 for the three months ended September 30, 2002
and $580,949 for the nine months ended September 30, 2002. The charges were
comprised of the following: (1) $112,906 related to severance accrued and paid
for terminated employees; (2) $172,234 in penalties to terminate the lease on
the Companys office space in New York City; (3) $7,261 in relocation costs
incurred to relocate the Companys offices to the Albany, New York area; (4)
$288,548 in the write-off of the net carrying value of fixed assets abandoned
as a result of closing the New York City office.

In 2001, the Company completed certain restructuring initiatives that were
related to the plan established by the Board of Directors in December 2000.
Although identified as of December 31, 2000, our obligations could not be
measured at that time. As a result, we recorded a non-cash restructuring charge
of $293,200 for the six months ended June 30, 2001. The non-cash restructuring
charge was comprised of the following: (1) $210,000 related to the termination
of an employment contract which was satisfied through the issuance of 150,000
shares of Common Stock in February 2001 and (2) $83,200 related to the
termination of a commercial lease obligation in San Francisco which was
satisfied through the issuance of 80,000 shares of Common Stock in March 2001.

- 13 -



---



##### Table of Contents






Item 2.  Managements Discussion and Analysis of Financial Condition and Results of Operations.

This document 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. These statements relate to future events or our future
financial performance and are not statements of historical fact. In some
cases, you can identify forward-looking statements by terminology such as
may, will, should, expect, plan, anticipate, believe, estimate,
predict, potential, objective, forecast, goal or continue, the
negative of such terms, or other comparable terminology. These statements are
only predictions, and actual events or results may differ materially. Although
we believe that the expectations reflected in the forward-looking statements
are reasonable, we cannot guarantee future results, levels of activity,
performance or achievements, and in all cases, such statements are subject to
the Companys ability to secure additional financing or to increase revenues to
support its operations. If the Company cannot secure additional financing or
increase its revenues to support its operations, the Companys status as a
going concern will remain in doubt. In this regard, the business and operations
of the Company are subject to substantial risks that increase the uncertainty
inherent in the forward-looking statements contained in this Form 10-QSB.

The inclusion of the forward-looking statements should not be regarded as
a representation by the Company, or any other person, that such forward-looking
statements will be achieved. We undertake no duty to update any of the
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of the foregoing, readers are cautioned not to
place undue reliance on the forward-looking statements contained in this
report.

Overview

We are a leading video compression technology firm. We have developed a
proprietary technology platform and video compression/decompression software
(codec) to deliver high quality video at the lowest possible data rates to
closed area networks, such as set-top boxes, the Internet and wireless devices.
We offer a suite of products and services that encompass our proprietary
compression technology. Our service offerings include customized engineering
and consulting services and technical support and high-level video encoding. In
addition, we license our software products, which include video and audio
codecs and encoding and server software, for use with video delivery platforms.

In view of the rapidly evolving nature of our business and our limited
operating history, we have limited experience forecasting our revenues and
operating costs. Therefore, we believe that period-to-period comparisons of
financial results are not necessarily meaningful and should not be relied upon
as an indication of our future performance. To date, we have incurred
substantial costs to create technology products and services. As of September
30, 2002, we had an accumulated deficit of $104.1 million. We will continue to
incur costs to develop, introduce and enhance products and services, build
brand awareness and grow our business. We may also incur significant additional
costs related to technology, marketing and technologies to respond to changes
in this rapidly developing industry. These costs may not correspond with any
meaningful increases in revenues in the near term, if at all. As such, these
costs may result in negative operating cash flows until such time as we
generate sufficient revenues to offset such costs.

- 14 -



---



##### Table of Contents



Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of
operations are based on our condensed consolidated financial statements that
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). The preparation of our condensed consolidated
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could materially differ from those
estimates. The condensed consolidated financial statements and the related
notes thereto should be read in conjunction with the following discussion of
our critical accounting policies and our Form 10-KSB filed with the SEC on
March 15, 2002. Our critical accounting policies and estimates are:



| |  |  | Revenue recognition                                                 
| | - |  | --------------------------------------------------------------------
|
| |  |  | Valuation of goodwill, intangible assets and other long-lived assets

Revenue recognition.We currently recognize revenue from professional
services and the sale of software licenses. As described below, significant
management judgments and estimates must be made and used in determining the
amount of revenue recognized in any given accounting period. Material
differences may result in the amount and timing of our revenue for any given
accounting period depending upon judgments made by or estimates utilized by
management.

We recognize revenue in accordance with SOP 97-2, Software Revenue
Recognition (SOP 97-2), as amended by SOP 98-4, Deferral of the Effective
Date of SOP 97-2, Software Revenue Recognition and SOP 98-9, Modification of
SOP 97-2 with Respect to Certain Transactions (SOP 98-9). Under each
arrangement, revenues are recognized when a non-cancelable agreement has been
signed and the customer acknowledges an unconditional obligation to pay, the
products or applications have been delivered, there are no uncertainties
surrounding customer acceptance, the fees are fixed and determinable, and
collection is considered probable. Revenues recognized from multiple-element
software arrangements are allocated to each element of the arrangement based on
the fair values of the elements, such as product licenses, post-contract
customer support, or training. The determination of the fair value is based on
the vendor specific objective evidence available to us. If such evidence of
the fair value of each element of the arrangement does not exist, we defer all
revenue from the arrangement until such time that evidence of the fair value
does exist or until all elements of the arrangement are delivered.

Our software licensing arrangements typically consist of two elements: a
software license and post-contract customer support (PCS). We recognize
license revenues based on the residual method after all elements other than PCS
have been delivered as prescribed by SOP 98-9. We recognize PCS revenues over
the term of the maintenance contract or on a per usage basis, whichever is
stated in the contract. Vendor specific objective evidence of the fair value of
PCS is determined by reference to the price the customer will have to pay for
PCS when it is sold separately (i.e. the renewal rate). Each license agreement
offers additional PCS at a stated price. Revenue is recognized on a per copy
basis for licensed software when each copy of the licensed software purchased
by the customer or reseller is delivered. We do not allow returns, exchanges
or price protection for sales of software licenses to our customers or
resellers, and we do not allow our resellers to purchase software licenses
under consignment arrangements.

When engineering and consulting services are sold together with a software
license, the arrangement typically requires customization and integration of
the software into a third party hardware platform. In these arrangements, we
require the customer to pay a fixed fee for the engineering and consulting
services and a licensing fee in the form of a per-unit royalty. We account for
engineering and consulting arrangements in accordance with SOP 81-1,
Accounting for Performance of Construction Type and

- 15 -



---



##### Table of Contents



Certain Production Type Contracts, (SOP 81-1). When reliable estimates
are available for the costs and efforts necessary to complete the engineering
or consulting services and those services do not include contractual milestones
or other acceptance criteria, we recognize revenue under the percentage of
completion contract method based upon input measures, such as hours. When such
estimates are not available, we defer all revenue recognition until we have
completed the contract and have no further obligations to the customer.

Encoding Services consist of services that convert video and audio content
into formats for delivery to end-users. Encoding services are generally
provided under per unit or time and materials contracts. Under these
contracts, we recognize revenue when services have been rendered and we have no
further interest or obligation in the goods and services, which is generally
the date on which the goods or services have been delivered to the customer.

Valuation of goodwill and intangible assets.We evaluate our long-lived
assets in accordance with SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS No.
121). Long-lived assets that are not identified with an impaired asset are
reviewed for impairment whenever events or changes in circumstances indicate
that the net carrying value of the asset may not be recoverable. Certain
circumstances include a deterioration of our financial resources, poor economic
trends within the industry, significant changes in our business model or a
significant decline in the demand for video delivery solutions. In such
circumstances, the net carrying value of the asset is compared to the
undiscounted future cash flows of the business segment to which that asset is
attributable. As we operate under one business segment, the net carrying value
of all long-lived assets are compared to our consolidated undiscounted future
cash flows. Impairment losses are measured by the amount in which the net
carrying value of the assets exceed the fair value.

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and
Other Intangible Assets (SFAS No. 142). SFAS 142 requires goodwill and
other intangible assets to be tested for impairment at least annually, and
written off when impaired, rather than being amortized as previously required.
As of September 30, 2002, we had no recorded goodwill. As of September 30,
2002, our intangible assets consisted primarily of purchased technology, which
we will continue to amortize over its remaining useful life. The purchased
technology will be fully amortized as of September 2003. Therefore, we believe
that the adoption of SFAS 142 will not have a significant impact on our results
of operations or financial position.

Results of Operations

Revenues.Revenues for the three months ended September 30, 2002 were
$824,311 as compared to $497,556 for the three months ended September 30, 2001.
Revenues for the nine months ended September 30, 2002 were $2,539,989 as
compared to $1,301,504 for the nine months ended September 30, 2001. Revenues
for the three and nine months ended September 30, 2002 were derived primarily
from engineering and consulting services and the sale of software licenses.
Revenues for the three and nine months ended September 30, 2001 were primarily
derived from encoding services, consulting and engineering services. The
increase in revenues is attributed to an improvement in our product and service
offerings and the development of certain video-on-demand initiatives in Asia.
For the three months ended September 30, 2002, approximately 75% of the
Companys gross revenues were generated from two customers. Approximately 50%
was generated from the Companys Japanese reseller, MCS K.K., for encoders and
servers and 25% was generated from the sale of VP5 encoders to America Online.

- 16 -



---



##### Table of Contents



Operating expenses.The Companys operating expenses consist of cost of
revenues, research and development, sales and marketing, general and
administrative expenses, impairment charges, cost curtailment and restructuring
charges and non-cash stock based compensation. Operating expenses for the
three months ended September 30, 2002 were $2,092,383 as compared to $2,980,675
for the three months ended September 30, 2001. Operating expenses were
$7,451,331 for the nine months ended September 30, 2002 as compared to
$12,279,338 for the nine months ended September 30, 2001.

Cost of Revenues.Cost of revenues includes personnel and consulting
compensation costs, related overhead expenses, certain hardware costs,
bandwidth costs, fees paid for licensed technology, depreciation costs and the
amortization of purchased technology. Cost of revenues for the three months
ended September 30, 2002 were $422,376 as compared to $754,888 for the three
months ended September 30, 2001. Cost of revenues for the nine months ended
September 30, 2002 were $1,630,549 as compared to $2,046,692 for the nine
months ended September 30, 2001. The decrease in expenses for the three months
ended September 30, 2002 is primarily attributable to a reduction in headcount
and related overhead costs. The decrease in expenses for the nine months ended
September 30, 2002 is due primarily to a reduction in headcount.

Research and Development.Research and development expenses primarily
consist of salaries and related expenses and consulting fees associated with
the development and production of our products and services, operating lease
costs and depreciation costs. Research and development expenses for the three
months ended September 30, 2002 were $455,197 as compared to $842,045 for the
three months ended September 30, 2001. Research and development expenses for
the nine months ended September 30, 2002 were $1,846,792 as compared to
$3,259,537 for the nine months ended September 30, 2001. The decreases in
expenses were primarily attributed to a reduction in compensation and benefits
costs resulting from a reduction in headcount.

Sales and Marketing.Sales and marketing expenses consist primarily of
salaries and related costs of sales, business development and marketing
personnel, tradeshow costs, marketing and promotional costs incurred to create
brand awareness and public relations expenses. Sales and marketing expenses
for the three months ended September 30, 2002 were $108,170 as compared to
$332,787 for the three months ended September 30, 2001. Sales and marketing
expenses for the nine months ended September 30, 2002 were $847,714 as compared
to $1,744,598 for the nine months ended September 30, 2001. The decreases were
primarily attributed to a reduction in compensation and benefits costs
resulting from a reduction in headcount and a sharp decrease in advertising and
marketing costs.

General and Administrative. General and administrative expenses consist
primarily of salaries and related personnel costs for general corporate
functions including finance, human resources, legal and facilities, outside
legal and professional fees and insurance. General and administrative expenses
for the three months ended September 30, 2002 were $604,479 as compared to
$1,048,915 for the three months ended September 30, 2001. General and
administrative expenses for the nine months ended September 30, 2002 were
$2,515,327 as compared to $4,383,271 for the nine months ended September 30,
2001. The decreases were primarily attributable to decreased personnel, a
decrease in the amortization of goodwill and certain intangible assets due to
impairment and a general decrease in unallocated operating overhead
attributable to an entity-wide decrease in personnel.

Impairment Charges.Impairment charges were $0 and $30,000 for the three
and nine months ended September 30, 2002 as compared to $83,333 for the three
months ended September 30, 2001 and $533,333 for the nine months ended
September 30, 2001. The decrease relates to the write-down of the value of a
content library. We acquired the content library, consisting primarily of
licensed content for distribution through DVD sales and the Internet, in April
2000. The library was originally acquired for the Companys broadband content
network, which ceased operations in the second quarter of 2000. However,

- 17 -



---



##### Table of Contents



the Company continued to sell the licensed Quickband content, via DVD
sales, through a distribution agreement acquired in connection with the
library. As of December 31, 2000, we terminated all operations related to our
content assets. At that time, we determined that further distribution of the
Quickband content would result in recurring losses. We made the decision to
sell the library and reduced the carrying value of the library to $500,000 at
December 31, 2000. This amount represented the estimated fair value based upon
interest in the library at that time from several potential buyers, which never
materialized. We periodically reviewed the value of the library against market
demand and recorded the subsequent impairment charges based upon the perceived
value of the library and its content in the market. There will no additional
charges related to the impairment of the content library in future periods.

Cost Curtailment and Restructuring Charges.Cost curtailment and
restructuring charges for the three months ended September 30, 2002 were
$502,161 as compared to zero for the three months ended September 30, 2001.
Cost curtailment and restructuring charges for the nine months ended September
30, 2002 were $580,949 as compared to $293,200 for the nine months ended
September 30, 2001. The charges were comprised of the following: (1) $112,906
related to severance accrued and paid for terminated employees resulting from
the elimination of the Companys New York City office; (2) $172,234 in
penalties to terminate the lease on the Companys office space in New York
City; (3) $7,261 in relocation costs incurred to relocate the Companys offices
to the Albany, New York area; (4) $288,548 write-off of the net carrying value
of fixed assets abandoned as a result of closing the New York City office.

In 2001, we completed additional restructuring initiatives that were
related to the plan established by the Board of Directors in December 2000.
Although identified as of December 31, 2000, our obligations could not be
measured at that time. As a result, we recorded a non-cash restructuring charge
of $293,200 for the six months ended June 30, 2001. The non-cash restructuring
charge was comprised of the following: (1) $210,000 related to the termination
of an employment contract which was satisfied through the issuance of 150,000
shares of Common Stock in February 2001 and (2) $83,200 related to the
termination of a commercial lease obligation in San Francisco which was
satisfied through the issuance of 80,000 shares of Common Stock in March 2001.

Non-Cash Stock Based Compensation.We did not have non-cash stock based
compensation for the three and nine months ended September 30, 2002. Non-cash
stock based compensation for the three and nine months ended September 30, 2001
was $43,707 and $143,707, respectively, and represented shares of common stock
issued to our Non-Executive Chairman in lieu of cash compensation

Interest and other income (expense), net.Interest and other income
(expense), net was $(3,966) for the three months ended September 30, 2002 as
compared to $(477,258) for the three months ended September 30, 2001. Interest
and other income (expense), net was $(13,542) for the nine months ended
September 30, 2002 as compared to $(1,555,357) for the nine months ended
September 30, 2001. Interest and other income (expense), net primarily consists
interest earned on our rental security deposits and money market accounts,
interest paid for capital lease obligations and the amortization of debt
discounts. For the nine months ended September 30, 2002, interest and other
income (expense), net includes a charge of $23,996 related to the conversion of
our Series A Convertible Debentures into common stock. The decrease in expenses
is primarily attributable to the amortization of a debt discount for the three
and nine months ended September 30, 2001 related to our convertible debenture
financing.

At September 30, 2002, we had approximately 25 full-time employees.

- 18 -



---



##### Table of Contents



Liquidity and Capital Resources

At September 30, 2002, we had cash reserves of $489,843 as compared to
$215,726 at December 31, 2001.

Net cash used in operating activities was $3,559,898 and $8,899,445 for
the nine months ended September 30, 2002 and 2001, respectively. The decrease
in net cash used in operating activities was primarily attributable to an
increase in revenue and a decrease in our net operating losses, excluding
depreciation and amortization, non-cash stock based charges, impairment charges
and the amortization of debt discounts, a decrease in other assets partially
offset by increases in accounts receivable and an decrease in accounts payable
and accrued expenses.

Net cash used in investing activities was $68,863 and $106,894 for the
nine months ended September 30, 2002 and 2001, respectively. The decrease is
primarily due to cash paid for acquisitions for the nine months ended September
30, 2001

Net cash provided by financing activities was $3,906,309 and $8,025,229
for the nine months ended September 30, 2002 and 2001, respectively. The
decrease is primarily attributable to $2,000,000 of net proceeds received from
the issuance of convertible debentures, $2,000,000 of net proceeds received
from the issuance of C-VI Preferred stock and over $1,000,000 more received in
proceeds from the issuance of common stock for the nine months ended June 30,
2001, offset by principal payments on notes payable.

We currently have no material commitments for the next 12 months other
than those under our operating lease arrangements. These arrangements consist
primarily of lease arrangements for our office space in Albany, New York. The
aggregate required payments for the next 12 months under these arrangements are
$59,266. Notwithstanding the above, our most significant non-contractual
operating costs for the next 12 months are compensation and benefit costs,
insurance costs and general overhead costs such as telephone and utilities.
During the next 12 months, we anticipate incurring approximately $250,000 to
$350,000 per month in cash operating costs.

We currently have two equity lines of credit. In December 2000, we entered
into a common stock purchase agreement with Crossover Ventures, Inc., for the
sale, from time to time, of our Common Stock. Pursuant to the common stock
purchase agreement; Crossover Ventures has committed to purchase up to
$23,000,000 of our Common Stock over a 36-month period. Crossover Ventures can
also be required to invest an additional $17,000,000 upon the attainment of
certain trading volumes and weighted average market prices in our Common Stock.
However, our ability to procure funds through the common stock purchase
agreement is limited depending on the trading volumes and the weighted average
market prices of our Common Stock. Our stockholders have approved the sale of
up to 15,500,000 shares of our common stock under this stock purchase
agreement.

As a result of the price and volume limitations contained in the December
2000 stock purchase agreement, in November 2001 we entered into a second common
stock purchase agreement with Crossover Ventures, for sale, from time to time,
of our Common Stock. Under the November 2001 stock purchase agreement,
Crossover Ventures has committed to purchase an additional $23,000,000 over a
36-month period, with an additional commitment for $17,000,000 upon the
attainment of certain price and volume thresholds. Under the November 2001
stock purchase agreement, as long as the volume weighted average price of our
stock for the 30-day period preceding a draw-down notice is at least $0.30, we
may request, and Crossover Ventures is obligated to fund, an amount between (a)
a minimum of $300,000 or (b) a maximum equal to the greater of $500,000 or
$300,000 plus 4.5% of the volume weighted average

- 19 -



---



##### Table of Contents



stock price for the preceding 30-day period multiplied by the total
trading volume for the preceding three-month period. If the volume weighted
average price of our stock is below $0.30 and greater than $0.10, the minimum
amount that we may request and, if requested, that the Investor must provide is
ratably reduced from $300,000 to $100,000. We have registered the shares
issued under this common stock purchase agreement with the Securities and
Exchange Commission. Additionally, on April 30, 2002, our stockholders approved
the sale of up to 9,000,000 shares to Crossover Ventures under this common
stock purchase agreement.

As of November 13, 2002, we had sold 21,112,776 shares of common stock
under both common stock purchase agreements for net proceeds of approximately
$7.4 million.

Based on our current working capital requirements, we may require
additional funding during the next 12 months to finance our current level of
operations. We may require additional financing to fund revenue growth,
develop new technologies or acquire strategic assets. Our management continues
to monitor our operating cash flows to determine the further need for
additional capital. At this time, we can offer no assurances that further
capital, if, necessary, will be received.

We have experienced significant operating losses and negative operating
cash flows to date. Our managements plan to increase our cash flows from
operations relies significantly on increases in revenue generated from our
broadband technology services, products and licenses and decreases in operating
expenses. However, there are no assurances that we will be successful in
effecting such increases. The market for distribution of broadband technology
services is highly competitive. Additionally, our capital requirements depend
on numerous factors, including market acceptance of our technology and
services, research and development costs and the resources we spend on
marketing and selling our products and services. Additionally, we continue to
evaluate investments in complementary businesses, products and services, some
of which may be significant.

In the event we cannot procure appropriate capital resources, through net
operating cash flows, we may be required to reduce the development of our
products and services, significantly scale back current operations until funds
become available on terms acceptable to us and/or cease operations as the
company is now organized.

Impact of Recently Issued Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 141, Business Combinations (SFAS
No. 141). SFAS No. 141 changes the accounting for business combinations,
requiring that all business combinations be accounted for using the purchase
method and that intangible assets be recognized as assets apart from goodwill
if they arise from contractual or other legal rights, or if they are separable
or capable of being separated from the acquired entity and sold, transferred,
licensed, rented or exchanged. SFAS No. 141 is effective for all business
combinations initiated after June 30, 2001. The adoption of SFAS No. 141 did
not have a material impact on our financial statements.

In July 2001, the FASB issued SFAS 142, Goodwill and Other Intangibles
(SFAS No. 142). SFAS No. 142 specifies financial accounting and reporting
for acquired goodwill and other intangible assets. Goodwill and intangible
assets with indefinite useful lives will not be amortized but rather will be
tested at least annually for impairment. SFAS No. 142 is effective for fiscal
years beginning after December 15, 2001. SFAS No. 142 requires that the useful
lives of intangible assets acquired on or before June 30, 2001 be reassessed
and that the remaining amortization periods be adjusted accordingly. SFAS No.
142 also requires that previously recognized intangible assets deemed to have
indefinite lives are to be tested for impairment. Goodwill recognized on or
before June 30, 2001, is to be assigned to one or more reporting units and is
to be tested for impairment as of the beginning of the fiscal year in which

- 20 -



---



##### Table of Contents



SFAS No. 142 is initially applied in its entirety. As of June 30, 2002,
we had no recorded goodwill or indefinite lived intangibles. As of September
30, 2002, our intangible assets consisted primarily of purchased technology,
which we will continue to amortize over its remaining useful life through
September 2003. However, we will continually evaluate our purchased technology
upon significant changes in certain circumstances that may result in an
impairment of the net carrying value. Therefore, we believe that the adoption
of SFAS 142 will not have a significant impact on our results of operations or
financial position.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations (SFAS No. 143), which is effective October 1, 2003.
SFAS No. 143 requires, among other things, the accounting and reporting of
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development, or normal operation of
a long-lived asset. We are currently assessing, and have not yet determined,
the effect of SFAS No. 143 on our financial position and results of operations.

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, (SFAS No. 144). SFAS 144 is
effective October 1, 2002, but may be early adopted. SFAS No. 144 addresses
accounting and reporting of all long-lived assets, except goodwill, that are
either held and used or disposed of through sale or other means. We are
currently assessing the impact of SFAS 144 on our financial position and
results of operations, but believe its adoption will not have a material impact
on our results of operation or financial position.




Item 3.  Controls and Procedures:

(a) Evaluation of Disclosure Controls and Procedures:

Disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports filed or submitted under the Exchange
Act is recorded, processed, summarized and reported, within the time periods
specified in the SECs rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports filed under the Exchange
Act is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. Within the 90 days prior to the
filing of this report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys management, including
the Companys Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Companys disclosure controls
and procedures. Based upon and as of the date of that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Companys
disclosure controls and procedures are effective to ensure that information
required to be disclosed in the reports the Company files and submits under the
Exchange Act is recorded, processed, summarized and reported as and when
required.

(b) Changes in Internal Controls:

There were no changes in the Companys internal controls or in other
factors that could have significantly affected those controls subsequent to the
date of the Companys most recent evaluation.

- 21 -



---



##### Table of Contents






PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

From time to time the Company is party to various legal proceedings arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Companys consolidated financial position, results of operations or liquidity.




ITEM 2.  CHANGES IN SECURITIES

Notes 4 and 5 to the interim consolidated financial statements in Part I of
this Form are hereby incorporated by reference.




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits

|        |  |                                                                                                                                                   
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                   
|Number  |  | Description                                                                                                                                       
|        |  |                                                                                                                                                   
|4.1     |  | Unit Subscription and Security Agreement                                                                                                          
|       
|       
|       
|       
|99.1    |  | 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.
|       
|       
|       
|       
|99.2    |  | 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.

(b) Reports on Form 8-K

None.

- 22 -



---



##### Table of Contents






SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant
has caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.

|                  |  |                                                     
|----------------- |  | ----------------------------------------------------
|                  |  | On2 Technologies, Inc.                              
|                  |  |                                                     
|                  |  | (Registrant)                                        
|                  |  |                                                     
|                  |  |                                                     
|                 
|                 
|                 
|                 
|November 12, 2002 |  | /s/ Mark J. Meagher                                 
|                  |  |                                                     
|(Date)            |  | (Signature)                                         
|                  |  | Mark J. Meagher                                     
|                  |  | Executive Vice President and Chief Financial Officer
|                  |  | (Principal Financial Officer)                       
|                  |  |                                                     
|                  |  |                                                     
|                  |  |                                                     
|                  |  |                                                     
|                 
|                 
|                 
|                 
|November 12, 2002 |  | /s/ Anthony Principe                                
|                  |  |                                                     
|                 
|                 
|                 
|                 
|                  |  |                                                     
|(Date)            |  | Signature)                                          
|                  |  | Anthony Principe                                    
|                  |  | Vice President and Controller                       
|                  |  | (Principal Accounting Officer)                      

- 23 -



---



##### Table of Contents



CERTIFICATIONS

I, Douglas A. McIntyre, certify that:

1) I have reviewed this quarterly report on Form 10-QSB of On2 Technologies,
Inc.:

2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4) The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined) in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5) The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for
the registrants auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and

6) The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                        |  |                                                
|----------------------- |  | -----------------------------------------------
|Date: November 12, 2002 |  | By: /s/ Douglas A. McIntyre                    
|                        |  |                                                
|                        |  | Douglas A. McIntyre                            
|                        |  | Chairman, President and Chief Executive Officer





---



##### Table of Contents



CERTIFICATIONS

I, Mark Meagher, certify that:

1) I have reviewed this quarterly report on Form 10-QSB of On2 Technologies,
Inc.:

2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;

3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;

4) The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined) in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5) The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for
the registrants auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and

6) The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                        |  |                                                     
|----------------------- |  | ----------------------------------------------------
|Date: November 12, 2002 |  | By: /s/ Mark Meagher                                
|                        |  |                                                     
|                        |  | Mark Meagher                                        
|                        |  | Executive Vice President and Chief Financial Officer