Forward-Looking Statements

This document contains forward-looking statements concerning our expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In most cases, you can identify forward-looking statements by terminology such as "may," "might," "will," "would," "can", "could," "should," "expect," "foresee," "plan," "anticipate," "assume," "believe," "estimate," "predict," "potential," "objective," "forecast," "goal" or "continue," the negative of such terms, their cognates, or other comparable terminology. Forward-looking statements include statements with respect to:

• future revenues, income taxes, net loss per share, acquisition costs and related amortization, and other measures of results of operations;

• the effects of acquiring Hantro;

• difficulties in controlling expenses, legal compliance matters or internal control over financial reporting review, improvement and remediation;

• risks associated with the ineffectiveness of the Company's internal control over financial reporting and our ability to remediate material weaknesses;

• the financial performance and growth of our business, including future international growth;

• our financial position and the availability of resources;

• the availability of credit and future debt and/or equity investment capital;

• future competition; and

• the degree of seasonality in our revenue.

These forward-looking statements are only predictions, and actual events or results may differ materially. The statements are based on management's beliefs and assumption using information available at the time the statements were made. We cannot guarantee future results, levels of activity, performance or achievements. Factors that may cause actual results to differ are often presented with the forward-looking statements themselves. Additionally, other risks that may cause actual results to differ from predicted results are set forth in "Risk Factors That May Affect Future Operating Results" in the Company's Annual Report on Form 10-K for the year ended December 31, 2007, as well as in Item 1A of Part II of this quarterly report on Form 10-Q.

Many of the forward-looking statements are subject to additional risks related to our need to either secure additional financing or to increase revenues to support our operations or business or technological factors. We believe that between the funds we have on hand and the funds we expect to generate, we have sufficient funds to finance our operations for the next 12 months. We have based our forecasts on assumptions we have made relating to, among other things, the market for our products and services, economic conditions and the availability of credit to us and our customers. If these assumptions are incorrect, we may not have sufficient resources to fund our operations for this entire period, however. Additional funds may also be required in order to pursue strategic opportunities or for capital expenditures. Because of the recent tightening in global credit markets, we may not be able to obtain financing on favorable terms, or at all. 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-Q. In evaluating our business, you should give careful consideration to the information set forth under the caption "Risk Factors That May Affect Future Operating Results" in the Company's Annual Report on Form 10-K for the year ended December 31, 2007 in addition to the other information set forth herein, including Item 1A of Part II of this quarterly report on Form 10-Q.

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.

Costs Associated with Restatement of Financial Statements

Since December 31, 2007, we have incurred legal and accounting and other costs related to the Audit Committee review and restatement of our financial statements for the second and third quarters of 2007. These restatements are set forth in Amendment No. 1 to our Quarterly Report on Form 10-Q, filed on June 27, 2008 and Amendment No. 1 to our Quarterly Report on Form 10-Q for the period ended September 30, 2007, both filed on June 27, 2008, and are also described in our Annual Report on Form 10-K for the year ended December 31, 2007, filed on June 28, 2008. In connection with this, we incurred costs of approximately $2,186,000, as of September 30, 2008, of which we expensed approximately $373,000 in the first quarter of 2008 and an additional $1,813,000 the second quarter of 2008. We expensed these costs in the period in which the legal, accounting and other services were provided and we recorded these costs as general and administrative expenses. The Company believes it continues to have sufficient cash and other resources available to meet working capital and other needs that might arise over the next twelve months.

Acquisition of Hantro Products Oy

On May 21, 2007, we entered into an exchange agreement with Nexit Ventures Oy, as the authorized representative of the holders of all outstanding equity securities (including outstanding share options) of Hantro to acquire all outstanding equity securities of Hantro in exchange for cash and common stock. We completed the acquisition on November 1, 2007 for a total purchase price of $49,501,000. Under the terms of the exchange agreement, On2 paid $6,608,102 in cash and issued 25,438,817 shares of the Company's common stock, par value $.01 per share, directly to the Hantro security holders, of which two million On2 shares are being held in escrow until the anniversary of the Hantro closing to secure the indemnification obligations of the shareholders of Hantro. At that time, Hantro and its subsidiary became wholly-owned subsidiaries of the Company.

The exchange agreement also required On2 to issue additional shares of common stock, depending on Hantro's net revenue in 2007. Hantro's 2007 net revenue exceeded €9,000,000, and accordingly, the Company became obligated to issue to the former security holders of Hantro an additional 12,500,000 shares of On2 common stock (the maximum number of shares issuable as contingent payment). On July 8, 2008, the Company issued 11,100,440 of the shares due to the former Hantro security holders, and on August 28, 2008 issued the remaining 1,399,560 shares.

Asset Impairment

During the quarter ended September 30, 2008, the global economy has dramatically weakened, which, among other factors, has contributed to the continued underperformance of our Hantro business and a decline in our overall market value. Based on these circumstances, at September 30, 2008, the Company performed an impairment review of its goodwill and intangible assets related to its Hantro business. The Company engaged an outside valuation specialist to perform the evaluation, utilizing management's inputs and assumptions, by analyzing the expected future cash flows of the business. Based on the results of the evaluation, the Company has determined that goodwill and other intangibles are impaired. Accordingly, the Company recorded an impairment charge during the quarter ended September 30, 2008, totaling $20,265,000 (goodwill) and $5,980,000 (intangible assets) to reduce their carrying value to an amount that is expected to be recoverable. Should the global economy continue to weaken, additional impairment charges may be necessary.

Overview

On2 Technologies is a developer of video compression technology and technology that enables multimedia in resource-limited environments, such as cellular networks transmitting to battery operated mobile handsets or High Definition (HD) video over the Internet. We have developed a proprietary technology platform and the TrueMotion® VPx family (e.g., VP6®, VP7™) of video compression/decompression ("codec") software to deliver high-quality video at the lowest possible data rates over proprietary networks and the Internet to personal computers, wireless devices, set-top boxes and other devices. Unlike many other video codecs that are based on standard compression specifications set by industry groups (e.g., MPEG-2 and H.264), our video compression/decompression technology is based solely on intellectual property that we developed and own ourselves. In addition, through our wholly-owned subsidiary, On2 Finland (formerly Hantro), a Finnish corporation which we acquired on November 1, 2007, we license to chip and mobile handset manufacturers the hardware and software designs that make the encoding or decoding of video possible on devices such as mobile handsets, set top boxes, portable media players and cameras. On2 Finland has its headquarters and research and development facility in Oulu, Finland and it has a global sales network with satellite offices in Korea, Japan, Taiwan, Germany, Hong Kong and Mainland China. Both On2 and On2 Finland also provide integration, customization and support services to enable high quality video on and faster interoperability between devices.

Since 2004, we have licensed our video compression technology to Macromedia, Inc. (now Adobe Systems Incorporated) for use in the Flash® multimedia player. In anticipation of Adobe using our codec in the Flash platform, we launched our business of developing and marketing video encoding software for the Flash platform. While our primary focus remains the development of video compression technology, our Flash encoding business is a significant part of our business.

We offer the following suite of products and services that incorporate our proprietary compression technology:

· Video codecs;

· Audio codecs; and

· Encoding and server software, for use with video delivery platforms.

We also offer the following suite of hardware and software products that incorporate our mobile video technology:

· TrueMotion VP6 and VP7 software video codec designs;

· MPEG-4, H.263, H.264 / AVC and VC-1 hardware and software video codec designs;

· Hardware and software JPEG codecs supporting up to 16MP;

· AMR-NB and Enhanced aacPlus audio codecs;

· Pre- and post-processing technologies (such as cropping, rotation, scaling) implemented in both software and hardware;

· File format and streaming components; and

· Recorder and player application logic.

In addition, we offer the following services in connection with both our proprietary video compression technology and our mobile video technology:

· Customized engineering and consulting services; and

· Technical support.

Most of our customers are hardware and software developers who use our products and services chiefly to provide the following video-related products and services to end users:

              TYPE OF CUSTOMER
                APPLICATION                          EXAMPLES
      Video and Audio Distribution     ·    Providing video-on-demand
      over Proprietary Networks        services to
                                            residents in multi-dwelling
                                       units (MDUs)
                                       ·    Video surveillance

      Video and Audio Distribution     ·    Video-on-demand
      over IP-based Networks           ·    Teleconferencing services
      (Internet)                       ·    Video instant messaging
                                       ·    Video for Voice-over-IP (VOIP)
                                       services

      Consumer Electronic Devices      ·    Digital video players
                                       ·    Digital video recorders
                                       ·    Mobile TV
                                       ·    Video Camera Recorder
                                       ·    Mobile Video Player

      Wireless Applications            ·    Delivery of video via satellite
                                       ·    Providing video to web-enabled
                                       cell phones
                                            and PDAs

      User-Generated Content (UGC)     ·    Providing encoding software for
      Sites                            use on UGC
                                            site operators' servers
                                       ·    Providing encoding software for
                                       users who
                                            are creating UGC
                                       ·    Providing transcoding software
                                       to allow UGC
                                            site operators to convert video
                                       from one
                                            format to another

On2's goal is to be a premier provider of video compression software and hardware technology and compression tools. We are striving to achieve that goal and the goal of building a stable base of quarterly revenues by implementing the following key strategies:

• Continuing our research and development efforts to improve our current codecs and developing new technologies that increase the quality of video technology and improve the experience of end users;

• Continuing our research and development efforts to design hardware decoders and encoders that minimize the space used on a chip and to continue to improve the quality of those products;

• Using the success of current customer implementations of our TrueMotion technology (e.g., Adobe® Flash 8, Skype) and other high-profile customers (e.g., Sun Microsystems) to increase our brand recognition, promote new business and encourage proliferation across platforms;

• Updating and enhancing our existing consumer products, such as the Flix line and embedded technologies;

• Employing flexible licensing strategies to offer customers more attractive business terms than those available for competing technologies;

• Attempting to negotiate licensing arrangements with customers that provide for receipt of recurring revenue and/or that offer us the opportunity to market products that complement our customers' implementations of our software; and

• Using the expertise of our subsidiary, On2 Finland, to develop hardware designs of our TrueMotion codecs and optimizations for embedded processors that will allow those products to be easily implemented on devices.

We earn revenue chiefly through licensing our software technology and hardware designs and providing specialized software engineering and consulting services to customers. In addition to up-front license fees, we often require that customers pay us royalties in connection with their use of our software and hardware products. The royalties may come in the form of either a fee for each unit of the customer's products containing our software products or hardware designs that are sold or distributed or payments based on a percentage of the revenues that the customer earns from any of its products or services that use our software. Royalties may be subject to guaranteed minimum amounts (e.g., minimum annual royalties) and/or maximum amounts (e.g., annual caps) that may vary substantially from deal to deal.

We also sell additional products and services that relate to our existing relationships with licensees of our TrueMotion codec products. For instance, if a customer has licensed our software to develop its own proprietary video format and video players, we may sell encoding software to users who want to encode video for playback on that customer's players, or we may provide engineering services to companies that want to modify our customer's software for use on a specific platform, such as a cell phone. As with royalties or revenue share arrangements, complementary sales of encoding software or engineering services should allow us to participate in the success of our customers' products. For instance, if a customer's video platform does well commercially, we would expect there to be a market for encoding software and/or engineering services in support of that platform.

We made the decision to acquire Hantro in part to assist us in achieving our strategic goal of implementing our TrueMotion codecs in hardware and developing highly optimized software libraries for operation on the digital signal processors (DSPs) used in embedded devices. The Hantro acquisition has allowed us to increase the resources devoted to improving the ease of implementation of our codecs across platforms. Prior to the acquisition, we did not have a broad selection of off-the-shelf optimized software that we could license to customers who were interested in implementing our codecs on devices. Those customers were therefore frequently required to pay us to customize our software, or to perform the customizations themselves, or to hire third-party consultants to perform the customizations. The Hantro acquisition has given us access to experienced internal resources to enable us to develop hardware and software implementations that will allow customers to implement our codecs quickly and efficiently on embedded devices.

As part of our strategy to develop complementary products that could allow us to capitalize on our customers' success, in 2005 we completed the acquisition from Wildform, Inc., of its Flix line of encoding software. The Flix software allows users to prepare video and other multimedia content for playback on the Adobe Flash player, which is one of the most widely distributed multimedia players. Adobe is currently using our VP6 software as the video engine for Flash 8 video, which is used in the Flash 8 and Flash 9 players. We therefore believed that there was an opportunity for us to sell Flash 8 encoding software to end users, such as video professionals and web designers, and to software development companies that wish to add Flash 8 encoding functionality to their software. We concluded that we could best take advantage of the anticipated success of Flash 8 by taking the most up-to-date Flash 8 encoding software straight from the company that developed Flash 8 video and combining it with the already well-known Flix brand, which has existed since the advent of Flash video and has a loyal following among users. Following Adobe's announcement in late 2007 of support for the H.264 codec in its Flash 9 player, we announced support for H.264 in our Flix products and have been adding support for additional codecs. These additional features have helped to make the Flix product line a more complete encoding solution for users.

A primary factor that will be critical to our success is our ability to improve continually on our current TrueMotion video compression technology, so that it streams the highest-quality video at the lowest transmission rates (bit rate). We believe that our video compression software is highly efficient, allowing customers to stream good quality video (as compared with that of our competitors) at low bit rates (i.e., over slow connections) and unsurpassed high-resolution video at higher bit rates (i.e., over broadband connections). As connection speeds increase, however, the advantage that our highly efficient software has over competing technology may decrease.

Another factor that may affect our success is the relative complexity of our TrueMotion video compression software compared with other compression software producing comparable compression rates and image quality. Software with lower complexity can run on a computer chip that is less powerful, and therefore generally less expensive, than would be required to run software that is comparatively more complex. In addition, the process of getting software to operate on a chip is easier if the software is less complex. Increased compression rates frequently result in increased complexity. While potential customers desire software that produces the highest possible compression rates while producing the best possible decompressed image, they also want to keep production costs low by using the lowest-powered and accordingly least expensive chips that will still allow them to perform the processing they require. In addition, in some applications, such as mobile devices, constraints such as size and battery life rather than price issues limit the power of the chips embedded in such devices. Of course, in devices where a great deal of processing power can be devoted to video compression and decompression, the issue of software complexity is less important. In addition, in certain applications, savings in chip costs related to the use of low complexity software may be offset by increased costs (or reduced revenue) stemming from less efficient compression (e.g., increased bandwidth costs).

One of the most significant recent trends in our business is our increasing reliance on the success of the product deployments of our customers. As referenced above, our license agreements with customers increasingly provide for the payment of license fees that are dependent on the number of units of a customer's product incorporating our software that are sold or the amount of revenue generated by a customer from the sale of products or services that incorporate our software. We have chosen this royalty-dependent licensing model because, as a company of 111employees competing in a market that offers a vast range of video-enabled devices, we do not have the product development or marketing resources to develop and market end-to-end video solutions. Instead, our codec software is primarily intended to be used as a building block for companies that are developing end-to-end video products and/or services.

Under our agreements with certain customers, we have retained the right to market products that complement those customer applications. These arrangements allow us to take advantage of our customers' superior ability to produce and market end-to-end video products, while offering those customers the benefit of having us produce technologically-advanced products that should contribute to the success of their applications. As with arrangements in which we receive royalties, the ability to market complementary products can yield revenues in excess of any initial, one-time license fee. In instances where we have licensed our products to well-known customers, our right to sell complementary products may be very valuable. But unlike royalties, which we receive automatically without any additional effort on our part, the successful sale of complementary products requires that we effectively execute an end-user product development and marketing program. Until recently, we have generally produced software targeted at developers, who integrate our software into their products, and developing and marketing products aimed at end users is therefore a relatively new business for us.

We believe that we have adopted the licensing model most appropriate for a business of our size and expertise. However, a natural result of this licensing model is that the amount of revenue we generate is highly dependent on the success of our customers' product deployments. In certain circumstances, we may decide to reduce the amount of up-front license fees and charge a higher per-unit royalty. If the products of customers with whom we have established per unit royalty or revenue sharing relationships or for which we expect to market complementary products do not generate significant sales, these revenues may not attain significant levels. Conversely, if one or more of such customers' products are widely adopted, our revenues will likely be enhanced.

We are continuing to participate in the trend towards the proliferation of user generated video content on the web. As Internet use has grown worldwide and Internet connection speeds have increased, sites such as MySpace and YouTube, which allow visitors to create and view user generated content, have sprung up and seen their popularity soar. Although consumer generated content initially consisted primarily of text content and still photographs, the availability of relatively inexpensive digital video cameras and video-enabled mobile phones, the growth in the number of users with access to broadband Internet connections, and improvements in video compression technology have contributed to a rapid rise in consumer-created video content. Weblogs (blogs) and podcasts (broadcasts of audio content to iPod® and MP3 devices) have evolved to include video content. The continued proliferation of UGC video on the Internet and the popularity of Adobe Flash video on the web have had a positive effect on our business and have given us the opportunity to license Flash encoding tools for use in video blogs, video podcasts, and to UGC sites or to individual users of those services.

We have recently experienced an increased interest by UGC site operators and device manufacturers to allow users to access UGC content by means of mobile handsets, set-top boxes, and other devices. Many of the UGC sites use Flash 8 VP6 video, and while Flash 8 video is available on a vast number of PCs, it has only recently become available on devices using DSPs, such as mobile devices and set top boxes. We are therefore witnessing demand on two fronts: (1) demand to integrate Flash 8 video onto non-PC platforms, and (2) until most devices can play Flash 8 content, demand to provide transcoding software that allows Flash 8 content to be decoded and re-encoded into a format (such as the 3GPP standard) that is supported on devices. We are actively working to provide solutions for both of these demands and plan to continue to respond as necessary to the evolution and migration of Flash video.

H.264 continues to rise as a competitor in the video compression field. H.264 is a standards-based codec that is the successor to MPEG-4. We believe that our technology is superior to H.264, and that we can offer significantly more flexibility in licensing terms than customers get when licensing H.264. H.264 has nevertheless gained significant adoption by potential customers because, as a standards-based codec, it has the advantage of having numerous developers who are programming to the H.264 standard and developing products based on that standard. In addition, a number of manufacturers of multimedia processors have done the work necessary to have H.264 operate on their chips, which makes H.264 attractive to potential customers who would like to enable video on devices. For example, Apple Inc. uses H.264 in its QuickTime player and has thus chosen H.264 for the current generation of video iPods. Finally, there is already a significant amount of professional content that has been encoded in H.264. These advantages may make H.264 attractive to potential customers and allow them to implement a solution based on H.264 with less initial development time and expense than a solution using On2 TrueMotion video might require. In addition, there are certain customers that prefer to license standards-based codecs. In . . .