UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K/A

(Amendment No. 3)

(Mark One)
x	ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2006
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

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, Suite 103, Clifton Park, NY (Address of principal executive offices)	12065 (Zip Code)

Registrant’s telephone number, including area code:

(518) 348-0099

Securities to be Registered Pursuant to Section 12(b) of the Act:

Title of Each Class	Name(s) of Each Exchange on Which Listed
Common Stock	American Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-seasoned issuer, as defined in Rule 405 of the Securities Act.  

Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  

Yes  o No x

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x No o

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x

        Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, or a non-accelerated filer. (Check one):

Large Accelerated Filer o Accelerated Filer o   Non-Accelerated Filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.  

Yes o No x

The aggregate market value of the voting and non-voting common equity held by stockholders of the registrant as of October 8, 2007, was approximately $172,493,000.

(APPLICABLE ONLY TO CORPORATE REGISTRANTS)

State the number of shares outstanding of each of the issuer's classes of common stock, $0.01 par value ("Common Stock"), as of the latest practicable date: 117,342,165 shares as of October 8, 2007.

EXPLANATORY NOTE

This Amendment No. 3 on Form 10-K/A amends our Annual Report on Form 10-K for the year ended December 31, 2006 originally filed on March 23, 2007 (“Original Annual Report”) and our Amendment No. 1 to our Annual Report on Form 10-K/A filed on April 30, 2007 (“Amendment No. 1”). (This Amendment No. 3 on Form 10-K/A does not amend our Amendment No. 2 to our Annual Report on Form 10-K/A filed on May 10, 2007.) The purpose of this Amendment No. 3 on Form 10-K/A is to make the following amendments to the Original Annual Report and to Amendment No. 1:

· Original Annual Report, Item 1 (Description of Business): In the second introductory paragraph of the “Our Technology, Products and Services” section and in the Encoding Tools for Customer Formats segment of that section, we correct an error in the percentage of 2005 revenue accounted for by the licensing of our Flash® encoding products. In the introductory paragraph of the “Services” section, we correct an error in the percentage of 2005 revenue accounted for by the provision of engineering, consulting and support services.

· Original Annual Report, Item 5 (Market for Common Equity and Related Stockholder Matters): In the Equity Compensation Plan Information December 31, 2006 table, we correct an error in the weighted-average exercise price of outstanding options, warrants and rights for equity compensation plans approved by security holders (and in the total for equity compensation plans whether or not so approved).

· Original Annual Report, Item 6 (Selected Financial Data): In the Statements of Operations Data table, we correct an EDGAR conversion error made by a third party EDGAR service provider in the “Basic and diluted net loss attributable to common stockholders per common share” line. Specifically, a number of cells in the line were shifted leftward resulting in incorrect net loss entries for 2004, 2005 and 2006 and a blank net loss entry for 2003.

· Original Annual Report, Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations): In the Revenue segment of the “Results of Operations” section (narrative and, where applicable, table), we correct errors in (i) 2005 VPx license revenue and Flix® license revenue (and the sum of the two), (ii) the percentage of 2005 total sales revenue accounted for by license revenue, (iii) the percentage of 2005 total sales revenue accounted for by engineering services and support revenue and (iv) 2004 license revenue. In the eighth paragraph of the “Liquidity and Capital Resources” section, we correct an error in the financing cost amount associated with warrants sold in August 2006 and discussed in that paragraph. In the “Tabular Disclosure of Contractual Obligations” section, we correct an error in operating lease for office space payments due in less than one year (and the totals for all operating lease for office space payments, for all payments due in less than one year, and for all payments for contractual obligations).

· Amendment No. 1, Item 11 (Executive Compensation): In the Summary Compensation Table, we correct the dollar amounts recognized for financial statement purposes for the fair value of option awards made in 2006 to Anthony Principe, Eric L. Ameres, Matthew Frost and Timothy C. Reusing (and the resulting total 2006 compensation for each such individual), and we correct the dollar amount recognized for financial statement purposes for the fair value of all other compensation paid in 2006 to Douglas A. McIntyre (and the resulting total 2006 compensation for such individual). In the Outstandig Equity Awards at 2006 Fiscal Year-End table, we correct the option exercise price of options granted to Anthony Principe on August 26, 2002. In the “Potential Payments Upon Termination” section, within the table pertaining to Eric Ameres, we correct the total amount payable to Mr. Ameres in the event of a non-extension of the term of his employment agreement by the Company. In the Non-Management Director Compensation for Fiscal 2006 table, we correct the dollar amount recognized for financial statement purposes for the fair value of option awards made in 2006 to J. Allen Kosowsky.

In order to preserve the nature and character of the disclosures made in the Original Annual Report and Amendment No. 1, except as specifically discussed in this Amendment No. 3 to the Annual Report on Form 10-K/A, no attempt has been made in this amendment to modify or update such disclosures for events which occurred subsequent to the original filings. This Amendment No. 3 to the Annual Report on Form 10-K/A does not otherwise alter the disclosures set forth in the Original Annual Report or Amendment No. 1 and, in particular, does not alter management’s conclusions set forth in Item 9A regarding the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934) as of the end of the period covered by this Form 10-K/A for the fiscal year ended December 31, 2006.

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Table of Contents

PART I
	Item 1.	Description of Business	4
PART II
	Item 5.	Market for Common Equity and Related Stockholder Matters	17
	Item 6.	Selected Financial Data	22
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
PART III
	Item 11.	Executive Compensation	32

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Forward-Looking Statement

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.

These statements are only predictions, and actual events or results may differ materially. The forward-looking statements are based on management’s beliefs and assumption using information available at the time. 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, and in “Risk Factors” on page 15 of this Form 10-K.

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. However, additional funds may be required in order to pursue strategic opportunities or for capital expenditures. In addition, there is no assurance that additional funds will not be required to support our operations. 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-K. In evaluating our business, you should give careful consideration to the information set forth below under the caption “Risk Factors,” in addition to the other information set forth herein.

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.

Item 1. Description of Business

Overview

On2 Technologies is a leading developer of video compression technology. We have developed a proprietary technology platform and the TrueMotion® VPx family (e.g., VP5, 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 set-top boxes, personal computers and wireless 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.

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In 2004, we 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 has become an increasingly important part of our business.

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

Products	· · ·	Video codecs; Audio codecs; and Encoding and server software, for use with video delivery platforms
Services	· ·	Customized engineering and consulting services; and Technical support

Many of our customers are 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 over Proprietary Networks	· ·	Providing video-on-demand services to residents in multi-dwelling units (MDUs) Video surveillance
Consumer Electronic Devices	· ·	Digital video players Digital video recorders
Wireless Applications	· ·	Delivery of video via satellite Providing video to web-enabled cell phones and PDAs
Video and Audio Distribution over IP-based Networks (Internet)	· · · ·	Video-on-demand Teleconferencing services Video instant messaging Video for Voice-over-IP (VOIP) services
User-Generated Content (“UGC”) Sites	· · ·	Providing encoding software for 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

In addition, we have recently begun marketing encoding software for use either by end users or by developers who want to add video-encoding functionality to the software they have developed.

We earn revenue chiefly through licensing our software 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. The royalties may come in the form of either a fee for each unit of the customer’s products containing the relevant On2 software products 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 and/or maximum amounts (e.g., annual caps).

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We have recently begun selling additional products and services that relate to our existing relationships with licensees. 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 our customers’ 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.

As part of our strategy to develop complementary products that could allow us to capitalize on our customers’ success, in April 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 core video engine for Flash 8 video, which is the latest version of Flash video and 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 by taking the well-regarded Flix software and updating it with Flash 8 encoding capability, 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.

A primary factor that will be critical to our success is our ability to improve continually on our current video compression software, 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 high 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 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, an increasing number of our license agreements with customers 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 only 37 employees and in light of the vast range of conceivable 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.

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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 (“UGC”), have sprung up and seen their popularity soar. Although initially that consumer generated content consisted primarily of text content and still photographs, the availability of relatively inexpensive digital video cameras, 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 has 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 increase interest by UGC site operators and device manufacturers to allow users to access UGC content by means of mobile devices, 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 is just now beginning to become available on chip-based devices, such as mobile devices and set top boxes. We are therefore witnessing a twofold demand: to integrate Flash 8 video onto non-PC platforms and, until most devices can play Flash 8 content, to provide transcoding software that allows Flash 8 content to be decoded and re-encoded into a format that is supported on devices, such as the 3GPP standard. 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.

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A continuing trend in our business is the growing presence of Microsoft, Inc. as a principal competitor in the market for digital media creation and distribution technology. Microsoft currently competes with us in the market for digital media servers, players, codecs and other technology and services related to digital distribution of media. Microsoft distributes its competing streaming encoder, media server, player, tools and digital rights management products by bundling them with its Windows operating systems and servers at no additional cost or otherwise making them available free of charge or at a low cost. Microsoft’s practices have caused, and may continue to cause, pricing pressure on our revenue generating products and services and may affect usage of our competing products and formats. Microsoft’s marketing and licensing model has in some cases led, and could continue to lead, to longer sales cycles, decreased sales, loss of existing and potential customers and reduced market share. In addition, we believe that Microsoft has used and may continue to use its competitive position in the computer industry and its financial resources to secure preferential or exclusive distribution, use and bundling contracts for its media delivery technologies and products with third parties, such as ISPs, content delivery networks, content providers, entertainment and media companies, VARs and OEMs, including those third parties with whom we have relationships. Finally, Microsoft’s DRM (digital rights management) product, which prevents unauthorized copying and re-distribution of proprietary content, is widely accepted among movie studios and others in the content industry. Unfortunately, Microsoft’s DRM does not integrate well with non-Microsoft video and audio software, such as ours.

We believe that the latest generation of codec technology, which includes VP7, is superior to Microsoft’s video compression software. We also believe that companies may become more comfortable with using DRM technology produced by companies other than Microsoft.

H.264 is also a competitor in the video compression field. H.264 is a standards-based codec that is the successor to MPEG-4. We believe our technology is superior to H.264, and that we can offer significantly more flexibility in licensing terms than customers will receive 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, as a result, has chosen H.264 for the current generation of video iPods®. 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 Video might require. In addition, there are certain customers that prefer to license standards-based codecs.

The market for digital media creation and delivery technology is constantly changing and becoming increasingly competitive. Our strategy includes focusing on providing our customers with video compression/decompression technology that delivers the highest possible video quality at the lowest possible data rates. To do this, we devote a significant portion of our engineering capacity to research and development. We also are devoting significant attention to enabling our codecs to operate on a wide array of chips. This should encourage use by customers who want to develop video-enabled consumer products in a short timeframe. We are doing this both by bolstering our team of engineers who integrate our codecs on chips and by developing relationships with chip companies and enabling them to perform such integration.

Although we expect that competition from Microsoft, H.264 developers, and others will continue to intensify, we expect that our video compression technology will remain competitive and that our relatively small size will allow us to innovate in the video compression field and respond to emerging trends more quickly than monolithic organizations, such as Microsoft and the MPEG consortium. We also focus on developing relationships with customers who find it appealing to work with a smaller company that is not bound by complex and rigid standards-based licenses and fee structures and that is able to offer sophisticated custom engineering services.

Development of Our Business

We detail the history and evolution of our business under the section “Management’s Discussion and Analysis of Financial Condition and of Operation - Company  - History”.

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Business Strategy

Our goal is to be a premier provider of video compression/decompression software 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 current codecs and developing new technology that increase the quality of video technology and improve the experience of end users;

• Using the success of current customer implementations of our technology (e.g., Adobe Flash 8, Skype) to increase our brand recognition, promote new business and encourage proliferation across platforms;

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

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

• Entering into 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

• Expanding into international markets by contracting with resellers of our products and services and by developing relationships with large, innovative customers.

Our Technology, Products and Services

We have designed our technology to deliver the highest-quality video at the lowest possible data rates and to encode (compress) and decode (decompress) video on comparatively low-powered chips suitable for consumer electronics products. We currently develop and license a number of products related to our TrueMotion™ line of codecs and TrueCast® line of server and player products for proprietary networks, the Internet and consumer electronic industries. The licensing of our proprietary TrueMotion codec and TrueCast server technology has accounted for 19%, 44%, and 99% of our revenue for the three fiscals years ended December 31, 2006, 2005 and 2004, respectively.

We also develop and license a number of products used for encoding video in the Adobe Flash 8 video format, which is used in the Flash 8 and Flash 9 video players. We market these products, which include software packages for end users and software development kits for use by developers, as part of our Flix® product line. The licensing of our Flashencoding products has accounted for 64% and 59% of our revenue for the two fiscal years ended December 31, 2006 and December 1, 2005, respectively. Prior to 2005, Macromedia did not use On2’s video compression technology in Flash.

VP6 Codec

We launched the Beta version of our TrueMotion VP6 series of codecs in May 2003 and the official version in October 2003, and we have since released updated versions VP6.1 and VP6.2. VP6 represented a significant improvement over its predecessors, offering a 40% image quality improvement over and 50% faster playback than the previous version of On2’s technology, VP5. VP6 improves upon all the features contained in VP5 and supports real-time encoding at full D1 resolution. Because Adobe/Macromedia is currently using VP6 in its Flash 8 video format, VP6 has become our most widely-deployed technology. Because of VP6’s broad use, and despite the fact that it is not our latest technology, we continue to make improvements to the VP6 technology. It also consistently outperforms Windows Media 9 based on tests of Peak Signal-to-Noise Ratios (PSNR) measured at data rates ranging from dial-up (28.8 Kbps) to DVD and HD (6 to 8 Mbps). Since our introduction of VP6, we have ported it to the following digital signal processors (DSPs) across a range of resolutions: Texas Instruments’ TMS320C64x, Analog Devices’ Blackfin, ARC International’s ARCTangent, Equator Technologies’ MAP-CA and the ARM 7 and ARM 9.

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VP7 Codec

We introduced the official version of our TrueMotion VP7 codec in early March 2005. Like prior versions of the TrueMotion codecs, VP7 shows a marked improvement over its predecessors, producing up to a 30% image quality improvement over VP6. Like its predecessor, in objective PSNR tests, VP7 shows better performance than its main competitors, including Windows Media 9, Real 10, and MPEG-4-compatible codecs at data rates ranging from dial-up (28.8 Kbps) to DVD and HD. In addition, VP7 regularly outperforms all but the best implementations of H.264 across data-rates and is highly competitive with the most advanced H.264 implementations. As with VP6, VP7 also supports real-time encodingat full D1 resolution. We have made significant progress - much of it in 2006 - in having VP7 implemented on DSPs, and VP7 currently operates on a number of chips across a range of resolutions.

TrueMotion Encoder Products

Our Encoder enables content owners to re-master and compress their assets efficiently into the VP6 or VP7 format at their own convenience. The Encoder is a key tool for users looking to develop content for our TrueMobile video products. Beginning with capturing uncompressed video through high quality SDI inputs, users can create an optimized digital file using our proprietary re-mastering tools. These tools are geared toward the video professional who wants exact control over the optimization process. Once the raw file has been optimized, our compression software has the capability to create multiple data rate compressed files.

TrueMobile Mobile Video Products

On2’s partnership in late 2005 with China Transport Telecommunications Broadband Network Service Co., Ltd. (CTTnet) of Beijing, China to jointly develop mobile video products marked the launch of On2’s TrueMobile mobile video platform. Research and development that On2 did in the Symbian and Smartphone Mobile environments formed the foundation of the first commercial TrueMobile products, which are based on On2’s VP7 TrueMotion technology.

TrueCast® Server Software

TrueCast Server Software is designed to take full advantage of our industry-leading TrueMotion line of codecs and to guarantee the smoothest delivery of compelling multi-media presentations over private networks (e.g., set-top boxes), embedded platforms or the Internet.

TrueCast comes optimized in two manners: one for transport using our own proprietary protocol, TrueCast Transport Protocol (TTP), and one for RTSP/RTP to various set-top box platforms. TrueCast and VP6/VP7 are an ideal combination for low-bit-rate Video-On-Demand systems. Our TrueCast Servers and our encoder provide the necessary tools for high-quality video over low speed IP connections.

In 2005, we released TrueCast version 8.0. This version of TrueCast provides support for multicast presentations and can simultaneously stream a single audio and video stream from a server, including HTTP-based Web servers, to thousands of users. It also permits local playback of AVI files from a user’s hard disk, and set-top box/DSP platforms from Texas Instruments, Equator Technologies and others.

In addition, TrueCast 8.0 is able to stream content that is captured and encoded directly from “live” video sources using our pioneering VP6, VP7 and earlier-generation On2 real-time encoders. This feature is ideal for time-critical applications, such as streaming live events, video conferencing, Digital Television over DSL and personal video recorders.

Integrations on Chips

VP6, VP7 and earlier generations of On2’s TrueMotion codecs have been ported onto a variety of digital signal processing chips (DSPs) and other integrated circuits. DSPs, video chips (video ICs), and systems-on-a chip (SOCs) are the computer processing chips and components frequently used in consumer products such as DVDs, portable media players, cell phones, and personal digital assistants. The VP6 and VP7 decoders currently run on a wide range ofDSPs at various resolutions, and the VP6 encoder operates on several DSPs as well. We and several third parties are also working to port the VP6 and VP7 decoders and encoders to a number of DSPs and other chips. Our recent high-profile implementations by Adobe/Macromedia, Skype and others have greatly increased the incentive for chip manufacturers to quickly implement our codecs on their chips. We believe that by porting to these platforms, we will facilitate the use of On2’s codec in mobile phones, portable media players and other consumer device deployments where the availability of low-cost chips is important.

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Encoding Tools for Customer Formats

In 2005, we entered the business of selling video encoding software that allows users to encode video in formats used by two of our customers, Adobe and AOL. Both Adobe’s Flash 8 multimedia player and AOL’s Nullsoft video (NSV) player use On2’s TrueMotion VP6 technology. Although we continue to offer Nullsoft encoding tools, that business constitutes a small fraction of our third-party encoding tool business. The licensing of our Flash encoding tools accounted for 64%, 59%, and 0% of our revenue for the three fiscals years ended December 31, 2006, 2005 and 2004, respectively. In 2004, we did license our VP6 technology to Adobe/Macromedia for use in its Flash multimedia player product.

We launched our encoding software business as part of our strategy to capitalize on our customers’ successful deployments of products that incorporate our technology. In particular, we believed that the inclusion of our technology in the widely-distributed Adobe Flash player represented a significant opportunity for us. We acquired the Flix® line of Flash encoding software from Wildform, Inc. to further our plan for rapidly establishing a significant business of marketing Flash encoding tools.

We sell two types of Flash encoding tools. We distribute end-user software, such as our desktop Flix encoding tools (Flix Pro and Flix Standard) and our Flix Engine software, which can operate in desktop or server environments. These products allow users to convert and/or encode video in Flash 6, 7 and 8 formats. We also sell Flash encoder software development kits that allow customers to enable their products to encode in the Flash format. These products range from low-level tools, such as our Flix 8 SDK for DirectShow®, to relatively high-level, more fully-featured tools, such our Flix Engine. The Flix Engine can be integrated with our customers’ applications, as well as being used as an off-the-shelf end user software product.

Our marketing efforts for our encoding tools for Flash are generally directed at three groups of customers. First, we offer our desktop Flix encoding tools (Flix Pro and Flix Standard) for purchase online by end users, both professional and non-professional. Second, we market our desktop and server products directly to enterprise customers, such as content providers and Internet advertising firms. Finally, we promote our Flix SDKs for Flash to software developers. Some developers use our SDKs to integrate our Flash encoder with their software products for sale to end users. Other developers will incorporate our Flash encoder into products that they will use in their own services (e.g., an online video search service might develop a Flash encoding tool for use internally or by its customers).

We believe that the prospects for our Flash encoding business are closely related to the success of Adobe’s Flash player and Flash authoring business. Although the increasing worldwide adoption of Flash players may not ensure the success of our Flash encoder business, the failure of Adobe’s Flash 8 and Flash 9 initiatives would almost certainly have a serious, negative impact on our sales of Flash encoding software.

Services

In addition to licensing our software, we offer a variety of custom engineering and consulting services to our customers. Fees derived from engineering, consulting and support services accounted for 8%, 4% and 14% of our revenue for the years ended December 31, 2006, 2005 and 2004, respectively. In particular, we offer the following services:

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Custom Engineering and Consulting Services

We provide custom engineering and consulting services designed to support customers or assist prospective customers in evaluating our software. Our engineering and consulting services generally consist of:

· customizing our software to add a feature, user interface or other function requested by a customer;

· porting and optimizing our technology platform and algorithm libraries onto chips and embedded devices, such as set-top boxes, mobile phones and other portable devices;

· evaluating potential customer implementations of our software; and

· providing technical support for existing customers.

Encoding

We provide encoding services for customers, although this business has significantly contracted as a component of our total revenue. These services consist of the conversion of archival video and audio content into formats for delivery to end-users.

Research and Development

We primary focus of our research and development activities is to advance and expand upon our core codec technology, which improves the video experience for end users. In addition, we devote significant research and development time to exploring new uses of our codecs, such as implementing our software on mobile platforms or in new operating environments. Our research and development efforts have enabled us to provide quality video compression and decompression at lower broadband data rates (e.g., DSL) and certain narrowband data rates (e.g., dial-up and cell phone). Our research in new platforms or operating environments also regularly results in commercial products that may become a significant source of revenue. We believe that continued advances in our technology are key to the success of our business. Consequently, we devote a substantial portion of our resources to our research and development efforts. Research and development expenses, excluding equity-based compensation, for the years ended December 31, 2006, 2005 and 2004 were $972,000, $1,035,000 and $884,000, respectively.

Distribution Methods

Our business consists of developing and marketing our software-based technology products and related services. Because we generally sell our software to companies that will integrate the software with their products or distribute the software themselves in connection with their services, and until recently have not regularly attempted to sell products directly to end users, we do not distribute a high volume of individual copies of software. Our customers usually download copies of software that they have purchased by online file transfer, although we will send them a CD-ROM containing the software at their request. Other than temporary interruptions to Internet service, we do not generally suffer from delays in our distribution network. We usually provide our engineering and consulting services and our product support from our own facilities.

Sales and Business Development

Our sales and business development departments aim to build relationships that fall into two basic categories: product licensing and professional services. These departments focus on engaging chip-set manufacturers, cable andtelecommunication companies, manufacturers of hardware platforms for consumer electronic and wireless devices and manufacturers of video-enabled products targeted at commercial and government users. We seek to license our compression software to manufacturers of video or video-enabled equipment and providers of video services, and we seek to encourage developers of chip-sets and software platforms to integrate our codecs within their products. Additionally, our teams focus on selling licenses for our encoding and streaming software to content providers who are delivering video over proprietary networks and to IP-based end users. Our professional services are usually incident to our product licensing and primarily focus on porting or optimizing our compression technologies to multiple hardware platforms used in video delivery solutions by manufacturers who have licensed our compression technology.

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International

We believe that we are well positioned to selectively expand our business internationally. We have focused in particular on identifying and capitalizing on opportunities in Asia and Europe. To that end, in the past year we have engaged a number of overseas sales consultants, support contractors and resellers and have thus significantly increased the number of staff focused on sales in Europe and Asia. In addition, we have dramatically increased our participation at international tradeshows and conferences.

For the years ended December 31, 2006, 2005 and 2004, foreign customers accounted for approximately 40%, 27%, and 20% respectively, of total revenue. These customers are primarily located in Asia.

Asia

We believe that Asia, with its numerous broadband networks and high penetration for mobile devices, is one of the strongest markets for our products. Our international sales and business development efforts have been primarily focused in this region to date. Our subsidiary, The Duck Corporation, has significant name recognition in Asia, especially among video game developers, and we continue to enjoy a favorable reputation in Asia based on our history in that market. We have recently significantly expanded the resources we are devoting to sales and marketing in Asia, particularly in Japan, Korea and China, by engaging regional marketing specialists and sales and support consultants and by seeking to increase the number of resellers we have operating in those territories. To date, we have signed reseller agreements for a number of Asian markets, including China, Japan, Korea, Hong Kong, Taiwan and Singapore. For the year ended December 31, 2006, revenue generated from customers located in Asia was $1,868,000, with 31% from Japan, 42% from Korea and 27% from China. For the year ended December 31, 2005, revenue generated from customers located in Asia was $551,000, with 48% from Japan, 23 % from Korea, 21 % from China and 9% from Singapore. For the year ended December 31, 2004, revenue generated from customers located in Asia was $518,000, with 49% from Japan, 29% from Korea and 23% from China.

CTTNet

In January 2006, On2 and CTTnet entered into an agreement to jointly develop and distribute On2 TrueMobile mobile video software in China and the Asian markets. Under the terms of the Agreement, On2 granted CTTNet a license to On2’s VP6 and VP7 software as well as certain reseller rights for China and other Asian markets. On2’s TrueMobile implementation continues to be evaluated by Chinese mobile carriers as part of a lengthy trial process.

Europe

As part of our efforts to expand international sales, we have recently increased the number of sales and marketing resources focused on European customers. Historically we have not had the same success in Europe that we have had in Asia. We nevertheless believe that we have made strides in meeting our goal of increasing the visibility of our compression products in Europe and, specifically, in increasing name recognition and demand for our products in that region. For the year ended December 31, 2006, revenue generated from customers located in Europe was $266,000 with 80% from the Netherlands, 12% from Italy and 8% from the UK. For the year ended December 31, 2005, revenue generated from customers located in Europe was $25,000 all of which was from the Netherlands. For the year ended December 31, 2004, revenue generated from customers located in Europe was $22,000, with 45% from the Finland and 55% from the UK.

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Location of Assets and Operations

All of the Company’s assets and operations have been and are currently based within the United States, except for two research and development employees located in the United Kingdom. We did not generate any revenue from our United Kingdom operations for the years ended December 31, 2006, 2005 and 2004.

Competition

We believe that our principal competitive advantage is our ability to deliver video that is comparable or superior in quality to other compression technologies at significantly lower data rates. In the streaming video market, this attribute significantly reduces the amount of bandwidth necessary to deliver video of similar quality and allows our customers to realize a greater profit on their video delivery initiatives by either:

· lowering the amount of bandwidth that customers need to deliver video,

· allowing customers to deliver video to more users without increasing bandwidth, or

· permitting customers to deliver good-quality video at lower data rates than those at which other video codecs can operate effectively.

Increased compression offers similar advantages in storage of video files, enabling customers to:

· store video at a set resolution using less storage capacity than required by competitive compression software;

· store more video at a set resolution in a given storage space than competitive compression software; and

· store more video of a higher quality in a given storage space than competitive compression software.

Our position as a developer of proprietary video codecs also offers several significant pricing advantages. First, because we are not bound by the pricing constraints placed on the standards bodies, we are able to vary our business terms to respond to our customers’ requests. Second, because we can offer both a license to the intellectual property underlying our technology as well as a codec that implements that technology, our customers do not have to pay multiple layers of licensing fees. In contrast, licensees of MPEG compression technology generally must acquire a license to patents from the MPEG consortium and then either acquire a separate license to or develop at their own cost a codec implementation based on the intellectual property they have licensed.

Our business is highly competitive and affected by rapid change. We believe that the principal competitive factors in our business include technological innovation, versatility of products, pricing, availability of content, ease of integration with and availability of use on low-cost processors, customer service, service offerings and the flexibility to adapt to changing market conditions. Our video compression technology competes with that of companies such as Microsoft and RealNetworks and with standards-based codecs such as MPEG-2, H.264, MPEG-4 and several codecs that position themselves as “MPEG-4-based”. Companies such as Apple, Inc. and DivX, Inc. also have popular players that they have derived from standards-based technology; Apple’s QuickTime® player is based on H.264, and DivX® uses a variant of MPEG-4. In the market for mobile video players, our newly-developed On2 TrueMobile products compete with products from companies such as MobiTV, Inc., GoTV, PacketVideo and SmartVideo. Our server technology faces competition from products marketed by RealNetworks, Microsoft and other companies and various open source server technology.

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The size of our company and the fact that we have developed a proprietary, non-standards-based video codec both help and hinder our ability to compete. Companies such as Microsoft and RealNetworks benefit from name recognition that we do not enjoy. Microsoft is also able to use its market power to support aggressive pricing on its products that compete with ours. There are three major standards-based codecs - MPEG-2, H.264 and the less widely-adopted MPEG-4; in addition, Microsoft was instrumental in establishing a standard, named VC1, based on its Window Media 9 technology. With respect to standards-based codecs, there are numerous developers programming to those standards, and there are certain customers that prefer to license standards-based codecs. In addition, because of significant adoption of standards-based codecs and Windows Media 9, there are a number of chip manufacturers that have designed low-cost chips designed to operate with those codecs. The availability of a range of chips means that potential customers of standards-based codecs or Windows Media 9 may not have to incur added cost or experience delays if they choose to use those codecs in their products.Nevertheless, we believe that our small size and proprietary products frequently are attractive to customers, especially overseas, that will seek to license our products not only because of their superior performance, but also because:

· our products do not come from Microsoft or a consortium of conglomerates (such as those that own the core intellectual property used in the proprietary codecs), and we offer highly responsive, customized service befitting a company of our size and culture;

· we offer flexible licensing terms that do not involve burdensome standards-based licenses and fee structures;

· we license both the intellectual property underlying our compression technology and a full-featured codec implementing that technology, which means that customers do not have to incur additional development and/or licensing costs to produce a working codec; and

· we are able to upgrade our technology regularly, because we do not have to submit proposed revisions to slow-acting standards committees.

Customers

Our customers, and the potential customers of our resellers, fall into several categories. The customers for our TrueMotion video compression technology and Flash encoding software development kits typically are either software or hardware developers who want to enable their products to store or transmit digital video, or providers of online services that want to add video capabilities to their services. The customers for our engineering services are generally customers of our video compression technology who need assistance customizing our software to work on a certain platform or need us to modify our software to work with their software. In addition, we have begun to provide a growing range of engineering services to customers who have requested customization of our Flash encoding software. Finally, the customers who purchase our Flix Flash encoding tools span the spectrum from individual users to business users, who range from small businesses to large enterprises, such as content providers, operators of UGC sites, and Internet advertising firms who may license single or multiple units of our end user products or copies of our SDKs for use in large-scale deployments.

For the year ended December 31, 2006, our Korean reseller, Ninelanes, Inc. accounted for 10% of the Company’s total revenue. For the year ended December 31, 2005, VideoEgg, Inc and our Japanese reseller, MCS KK, accounted for 20% and 11%, respectively, of the Company’s total revenue. For the year ended December 31, 2004, Macromedia (Adobe) accounted for 47% of the Company’s total revenue.

As of December 31, 2006, four customers accounted for 13%, 12%, 11% and 10% of total accounts receivable. As of December 31, 2005, four customers accounted for 18%, 20%, 11% and 11% of total accounts receivable.

Intellectual Property

We regard much of our technology as proprietary and try to protect it by relying on trademarks, copyrights, patents, trade secret laws and confidentiality agreements. We view our copyrights, service marks, trademarks, trade secrets, proprietary technology and similar intellectual property as critical to our success. We currently hold several U.S. patents and have several U.S. and international patent applicationspending. We believe that the patents that are currently issued are material to our business and anticipate that our pending patents will also be of importance to us. While we try to ensure that the security of On2’s intellectual property is maintained through these measures, there can be no assurance that steps we have taken and continue to take to protect our proprietary rights will be adequate or that third parties will not infringe on our intellectual property. In addition, there can be no assurance that third parties will not assert infringement claims against us which, even if not meritorious, could result in the expenditure of substantial resources and management effort.

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In connection with our software license agreements with third parties, we seek to control access to and distribution of our technology, documentation and other proprietary information. Even with all of these precautions, someone else could conceivably copy or otherwise obtain and use our proprietary information without our authorization, or could develop similar technology independently. Effective trademark, copyright and trade secret protection may not be available in every country in which our services are made available through the Internet, and policing unauthorized use of our proprietary information is difficult and expensive. In addition, some of our technology is protected as trade secrets for which government registration is not available. Our only means of protecting our trade secrets is to restrict scrupulously the disclosure of that information.

Within the last year, we have faced several efforts to produce open source versions of our software. These efforts involve attempts to evade our copyright and other intellectual property protection by developing software that works with our codec but that purports not to rely on our software code. The newly-developed software is then generally distributed under one of the common open source licenses, such as the GNU General Public License or Lesser Public License. Although open source software that has been reverse engineered from proprietary software in a clean room environment (i.e., without reference to the proprietary source code) may avoid violation of copyright protection, it nevertheless is generally viewed as not avoiding patent protection for techniques used in the software. In the face of these efforts, it has therefore become increasingly important for us to pursue patent protection for our technology, since we could demand that users of open source versions of our software acquire patent licenses from us.

We cannot be certain that the steps we have taken will prevent misappropriation of our proprietary information. Any misappropriation could have a material adverse effect on our business. In the future, we may need to initiate and maintain legal proceedings to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. That litigation might result in substantial costs and diversion of resources and management attention.

From time to time, we license from third parties technologies that are to be incorporated into some of our products and services. Historically, we have not required any material third party technology licenses. As we have entered into the Flash encoding business, however, we have found it necessary to license third-party software to allow us to decode and encode video and audio files in a variety of formats. We cannot be certain that these third-party technology licenses will continue to be available on commercially reasonable terms, if at all.

Government Regulation

We are not currently subject to direct regulation by any governmental agency other than rules and regulations that apply to businesses and publicly-traded companies generally, except that certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Laws and regulations specifically pertaining to the Internet are new and developing. These laws or regulations govern matters such as intellectual property, user privacy, e-commerce, information security and taxation. In addition, the applicability of existing laws to the Internet is uncertain and evolving. As a result of this uncertainty, it is difficult to predict the impact, if any, that future regulation or changes in regulation may have on our operations.

Employees

As of December 31, 2006, we had 37 full-time employees. Of the total employees, 24 were engineering and product development personnel, 4 were sales and marketing personnel and 9 were general and administrative personnel.

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None of our employees is represented by a labor union, and we consider our relationships with our employees to be good. We supplement our work force from time to time with contractors, administrative personnel through employment agencies and part time employees.

PART II

Item 5.Market for Common Equity and Related Stockholder Matters

Our common stock is traded on the American Stock Exchange under the symbol “ONT”. The following table sets forth for the fiscal periods indicated the high and low bid prices of our common stock, as reported on the American Stock Exchange, since January 1, 2005: 

	High		Low
Fiscal Year 2007
First Quarter (through March, 2007)	$	1.55	$	1.02
Fiscal Year 2006
First Quarter	$	1.48	$	0.70
Second Quarter	$	1.08	$	0.65
Third Quarter	$	0.86	$	0.55
Fourth Quarter	$	1.26	$	0.65
Fiscal Year 2005
First Quarter	$	1.28	$	0.62
Second Quarter	$	0.70	$	0.52
Third Quarter	$	0.94	$	0.52
Fourth Quarter	$	1.20	$	0.55

There were approximately 266 stockholders of record of our common stock as of March 22, 2007.

It is our current policy not to pay cash dividends and to retain future earnings to support our growth. Since our inception, we have not paid any cash dividends and we do not anticipate paying any cash dividends in the foreseeable future.

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Equity Compensation Plan Information December 31, 2006
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted- average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		16,926,000	$	1.01		1,012,000
Equity compensation plans not approved by security holders		0		0		0
Total		16,926,000	$	1.01		1,012,000

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Performance Graph

The following graph compares the cumulative 5-year total return provided shareholders on On2 Technologies, Inc.'s common stock relative to the cumulative total returns of the AMEX Composite index and the RDG Software Composite index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/2001 to 12/31/2006.

	12/01		12/02		12/03		12/04		12/05		12/06
On2 Technologies, Inc.		100.00		88.24		385.29		185.29		311.76		352.94
AMEX Composite		100.00		100.08		144.57		178.46		220.35		262.17
RDG Software Composite		100.00		69.77		86.91		97.48		97.30		107.31

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

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Recent Issuances of Unregistered Securities and Use of Proceeds from Unregistered Securities

Series D Convertible Preferred Stock

On October 28, 2004, we completed a private placement of its convertible securities (the “MidSummer Transaction”) to MidSummer Investment Ltd. and Islandia L.P (the “Series D Investors”). The Company received gross proceeds of $4,000,000 and net proceeds of approximately $3,699,000. We paid a fee of $240,000 to H.C. Wainwright & Co., Inc. (“Wainwright”), and issued certain common stock warrants described below, for Wainwright’s services as placement agent in the MidSummer Transaction. In addition, we paid approximately $61,000 in additional fees relating to the MidSummer Transaction and registration for resale of the common stock issuable upon conversion of the securities issued in connection with the MidSummer Transaction. In exchange for the proceeds, the Company issued 4,000 shares of a new Series D convertible preferred stock (the “Series D Preferred Stock”), which are convertible into an aggregate of 5,714,286 shares (at an initial conversion price of $0.70 per share) of our common stock, par value $0.01. The Series D Preferred Stock is subject to a guaranteed 8% annual dividend, payable quarterly, and is mandatorily redeemable by the Company over an eighteen-month period starting in October 2006. Such redemptions can be made in cash or shares of our common stock, at our option. If redemptions are made in common stock, the shares are valued at the average of the volume weighted average trading price of our common stock for the twenty trading days immediately prior to the redemption date. In addition, we granted the Investors a Series A Warrant and Series B Warrant, each of which is exercisable for 2,994,011 shares of our common stock. The Series A Warrant, which has been exercised as described below, bore an exercise price of $0.65 and could be redeemed by us for $0.01 if our common stock trades at or above $0.845 for 10 consecutive trading days at any point after the shares of common stock underlying the Series A Warrant had been registered for resale. The Series B Warrant bears an exercise price of $0.76 and expires on October 27, 2009. The Series D Preferred Stock and warrants are subject to weighted-average anti-dilution protection for issuances of securities below the exercise price. We relied on Section (4)(2) of the Securities Act in issuing the debentures and warrants without registration.

On October 28, 2004, we issued to Wainwright 285,714 warrants (the “Wainwright Warrants”). These warrants were further payment, in addition to the $240,000 cash fee described above, for Wainwright’s services as placement agent in connection with the MidSummer Transaction. Warrants in this series are exercisable for shares of our common stock at an exercise price of $0.70 per share, expire on October 27, 2009 and are subject to weighted-average anti-dilution protection for issuances of securities below the exercise price.

The Company has filed a registration statement with the SEC for resale of the common stock issuable upon conversion of the Series D Preferred Stock, Series A Warrants, Series B Warrants, and Wainwright Warrants. The Series D Investors have since exercised all of the Series A Warrants and have paid the exercise price of $1,946,000 to the Company. In addition, the Series D Investors have also converted 917 shares of the Series D Preferred Stock into 1,317,000 shares of our common stock. Upon receipt of the Series A Warrant exercise fee, we paid Wainwright a cash fee of $60,000 as further compensation for acting as placement agent on the MidSummer Transaction. In January 2006 Wainwright exercised 202,000 warrants, and we received $127,000 in cash for the exercise.

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Issuance of Common Stock in Connection with the Acquisition of the Flix Business

On April 29, 2005, we completed the acquisition of certain assets related to the “Flix” software line of business of Wildform, Inc. (“Wildform”). In connection with the acquisition, On2 and Wildform entered a Support and Maintenance Agreement, dated as of April 29, 2005, under which Wildform agreed to perform certain software integration, technical support and marketing services. In consideration for the services, we agreed to pay Wildform $160,000 and 280,000 shares of common stock, issuable upon the anniversary of the closing date. Accordingly, we have issued the 280,000 shares to Wildform on April 28, 2006. We relied on Section (4)(2) of the Securities Act in agreeing to issue the Stock without registration. We have agreed to file a registration statement to register the shares of common stock issuable to Wildform.

Issuance of Common Stock in August 2006

In August 2006, we completed the sale of 3,070,175 shares of our common stock at $0.57 per share. The sale of common stock raised gross proceeds for us of $1,750,000. The purchasers of these shares also received a warrant to purchase an aggregate of 2,302,632 additional shares of our common stock exercisable for a period of five years at an exercise price of $0.77 per share. The offering was exempt from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The common stock and warrants were offered and sold to Midsummer Investment and Rockmore Investment , both of which are two “accredited investors,” as that term is defined in Rule 501 of Regulation D, both of which are institutional investors, in compliance with Rule 506.

Kuhns Brothers, Inc. acted as private placement agent in the offering to Midsummer Investment and Rockmore Investment and earned commissions of $87,500. We also granted a warrant to Kuhns Brothers, Inc. to purchase 42,982 shares of our common stock at an exercise price of $0.57 per share. The offering was exempt from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 of Regulation D promulgated thereunder. In connection with the offering, we also granted Gregory Dryer, a registered employee of Kuhns Brothers, Inc., a warrant to purchase 79,825 shares of our common stock at an exercise price of $0.57 per share. The offering was exempt from registration under Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. Both Kuhns Brothers and Mr. Dryer are “accredited investors,” as that term is defined in Rule 501 of Regulation D. We have filed a registration statement with the SEC for the resale of the Common Stock issued or issuable in connection with this private placement.

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Item 6.Selected Financial Data

	For the years ended December 31,
Statements of Operations Data	2006			2005			2004			2003			2002
Revenue	$	6,572,000		$	2,208,000		$	3,028,000		$	3,302,000		$	3,353,000
Total operating expenses		10,162,000			6,497,000			6,518,000			5,665,000			8,621,000
Loss from operations		(3,590,000	)		(4,289,000	)		(3,490,000	)		(2,363,000	)		(5,268,000	)
Interest and other income (expense), net		(1,226,000	)		(284,000	)		47,000			(2,000	)		(5,000	)
Provision for income taxes		30,000			32,000			2,000			10,000			28,000
Net loss		(4,846,000	)		(4,605,000	)		(3,445,000	)		(2,375,000	)		(5,301,000	)
Convertible preferred stock deemed dividend		68,000			2,844,000			120,000			228,000			668,000
Convertible preferred stock 8% dividend		285,000			325,000			57,000
Accretion of costs associated with the Series D Preferred stock					175,000			14,000
Net loss attributable to common stockholders	$	(5,199,000	)	$	(7,949,000	)	$	(3,636,000	)	$	(2,603,000	)	$	(5,969,000	)
Basic and diluted net loss attributable to common stockholders per common share	$	(0.05	)	$	(0.09	)	$	(0.05	)	$$	(0.04	)		(0.11	)

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	December 31,
Balance Sheet Data	2006			2005			2004			2003			2002
Cash and cash equivalents	$	4,961,000		$	3,976,000		$	5,418,000		$	2,963,000		$	553,000
Working capital		5,268,000			4,179,000			5,466,000			3,520,000			731,000
Total assets		7,887,000			6,314,000			6,610,000			4,128,000			2,080,000
Convertible debentures					244,000			330,000			409,000			569,000
Capital lease obligations		53,000			26,000			43,000						9,000
Series D redeemable convertible preferred stock		3,083,000			3,790,000			1,156,000
Convertible preferred stock		19,000			19,000			33,000			56,000			99,000
Common stock and APIC		125,566,000			120,695,000			115,663,000			110,970,000			106,018,000
Accumulated deficit and other comprehensive loss		(124,522,000	)		(119,350,000	)		(111,400,000	)		(107,740,000	)		(105,135,000	)
Total stockholders’ equity		1,033,000			1,364,000			4,296,000			3,286,000			982,000

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements, including the notes thereto, appearing elsewhere 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 allow the efficient storage of high-quality video and delivery of that video at the lowest possible data rates over proprietary networks and the Internet to personal computers, wireless devices and set-top boxes. We offer a suite of products and services based on our proprietary compression technology and multimedia server software. Our service offerings include customized engineering, consulting services, technical supportand 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. We have also recently begun to license software that encodes video in the Adobe/Macromedia Flash 8 format; the Flash 8 format uses our VP6 video codec.

Company History

Founded in 1992 as The Duck Corporation, a privately owned entity, we originally developed and marketed compression technology that enabled developers of computer video games, video games for dedicated video game consoles and multi-media presentations on computers to convert an analog video signal to a digital video signal, and to compress the signal for storage and playback on the required device.

In June of 1999, The Duck Corporation was merged with and into a wholly-owned subsidiary of Applied Capital Funding, Inc., a public company whose name was concurrently changed to On2.com Inc. and subsequently changed to On2 Technologies, Inc. At that time, we had developed proprietary technology that enabled the compression, storage and streaming of high quality video signals over high bandwidth networks (i.e. broadband). We adopted a business model in which we would develop our own broadband content network powered by our proprietary technology. We intended to generate revenue through advertising sales and electronic commerce. From June of 1999, through the first quarter of 2000, we made three acquisitions: MetaVisual Creations Limited (“Metavisual”), Celebrity Interviews (“CII”) and Quickband Networks, Inc. (“Quickband”). Metavisual was a compression technology firm located in the United Kingdom and had developed its own video compression technology. That technology is instrumental in the compression technology we offer today.

By the second quarter of 2000, with the rapid decline in the Internet industry and the lack of interest in content networks, we determined that operating a content network would not be profitable for the foreseeable future. Based on market conditions, we decided to cease production on our content network and developed a strategic business model to distribute our video compression technology to IP-based clients as well as those offering video through proprietary networks, consumer electronics and wireless devices. This is the business model under which we currently operate.

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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 December 31, 2006, we had an accumulated deficit of $124.5 million. We will continue to incur costs to develop, introduce and enhance products and services, build brand awareness and expand our business. We may also incur significant additional costs related to technology, marketing or acquisitions of businesses 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, and may therefore result in negative operating cash flows until such time as we generate sufficient revenues to offset such costs.

Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements that have been prepared under accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent 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. We have disclosed all significant accounting policies in note 1 to the consolidated financial statements included in this Form 10-K. The consolidated financial statements and the related notes thereto should be read in conjunction with the following discussion of our critical accounting policies. Our critical accounting policies and estimates are:

•  Revenue recognition

•  Equity-based compensation

•  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.

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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). Most of our license agreements offer 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 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.

Equity-Based Compensation   In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment” (“SFAS 123R”), which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations as an operating expense, based on their fair values on grant date. Prior to the adoption of SFAS 123R, we accounted for stock based compensation using the intrinsic value method. We adopted the provisions of SFAS No. 123R effective January 1, 2006, using the modified prospective transition method. Under the modified prospective method, non-cash compensation expense is recognized under the fair value method for the portion of outstanding share based awards granted prior to the adoption of SFAS 123R for which service has not been rendered, and for any future share based awards granted or modified after adoption. Accordingly, periods prior to adoption have not been restated. We recognize share-based compensation cost associated with awards subject to graded vesting in accordance with the accelerated method specified in FASB Interpretation No. 28 pursuant to which each vesting tranche is treated as a separate award. The compensation cost associated with each vesting tranche is recognized as expense evenly over the vesting period of that tranche.

Valuation of Goodwill, Intangible Assets and Other Long-Lived Assets. In June 2001, the FASB issued 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.

Long-lived assets and identifiable intangibles with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. As of December 31, 2005, we believe that no such impairment has occurred.

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Results of Operations

Revenue. Our revenue for the years ended December 31, 2006, 2005 and 2004 was $6,572,000, $2,208,000 and $3,028,000, respectively, and was derived from the sale of software licenses, engineering and consulting services and license royalties. Our revenue increased $4,364,000 for the year ended December 31, 2006 as compared with 2005. The increase is primarily attributable to an increase in license sales of our Flix product line and license royalties. As a percent of total sales, license revenue decreased to 83% in 2006 from 84% in 2005, while engineering services and support decreased to 8% in 2006 from 11% in 2005. Royalties increased to 9% of sales in 2006 from 5% in 2005.

For the year ended December 31, 2006, license revenue was $5,472,000 of which our VPx licenses were $1,266,000 and Flix licenses were $4,206,000. For the year ended December 31, 2005, license revenue was $1,858,000, of which the Company’s VPx licenses were $597,000 and Flix licenses were $1,261,000. For the year ended December 31, 2004 license revenue was $2,571,000.

The following table sets forth the allocation of revenues, in terms of percentages, for the years ended December 31, 2006, 2005 and 2004:

	2006			2005			2004
Licenses		83	%		84	%		85	%
Engineering services and support		8			11			14
Royalties		9			5			1
Total		100	%		100	%		100	%

For the years ended December 31, 2006, 2005 and 2004, software licenses were the significant revenue stream and are expected to be the significant future revenue stream as we continue to provide these services and products to clients who deliver high quality video to proprietary networks, consumer electronic devices, wireless applications and IP-based end users.

OPERATING EXPENSES

Year ended December 2006 versus 2005:

Our operating expenses consist of cost of revenues, research and development, sales and marketing and general and administrative expenses. Our operating expenses for the year ended December 31, 2006 were $10,162,000 compared with $6,497,000 for the year ended December 31, 2005.

Cost of Revenue. Cost of revenue includes personnel and related overhead expenses, rent and related energy costs, consulting costs, fees paid for licensed technology, depreciation, amortization of purchased technology and certain other operating expenses. Cost of revenue was $2,328,000 for the year ended December 31, 2006, compared with $1,919,000 for the year ended December 31, 2005. Cost of revenue increased $409,000 for the year ended December 31, 2006 compared with 2005. The increase is primarily attributable to an increase of approximately $80,000 in personnel and related overhead allocated to cost of revenue from the addition of one software engineer, an increase of $172,000 in equity-based compensation and an increase of $82,000 in amortization of the acquired Flix software assets.

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Research and Development. Research and development expenses (excluding equity-based compensation), includes personnel and related overhead expenses, rent and related energy costs and depreciation, associated with the development and pre-production of our products and services. Research and development expenses were $972,000 and $1,035,000 for the years ended December 31, 2006 and 2005, respectively. The decrease of $63,000 is primarily attributed to a higher percentage of our engineers working on customer projects. We believe that continued investments in research and development are necessary to improve our competitive advantage, and we will continue to invest in such costs as considered necessary.

Sales and Marketing. Sales and marketing expenses (excluding equity-based compensation), consist primarily of salaries and related overhead costs and increases in year end bonuses, commissions, tradeshow costs, marketing and promotional costs incurred to create brand awareness and public relations expenses. Our sales and marketing expenses for the year ended December 31, 2006 were $1,093,000 compared with $794,000 for the year ended December 31, 2005. The increase of $299,000 is primarily attributable to an increase in personnel and related overhead expenses from the addition of two sales and two marketing people and an increase in tradeshow, advertising and promotional costs. We intend to continue to recruit and hire experienced personnel, as necessary, to sell and market our products and services.

General and Administrative. General and administrative expenses (excluding equity-based compensation), consist primarily of salaries and related overhead costs for general corporate functions including legal, finance, human resources and management information systems. Also included are outside legal and professional fees, stock-listing fees, reserve for uncollectible accounts receivable and general liability and directors and offices’ liability insurance. Our general and administrative costs for the year ended December 31, 2006 were $4,384,000, compared with $2,749,000 for the year ended December 31, 2005. The increase of $1,635,000 is attributable to an increase in outside legal fees of $1,069,000 (including $1,010,000 associated with the investigation relating to the Company’s former President, Chief Executive Officer and Chairman), recruiting fees of $216,000 associated with the selection, recruitment and relocation of the Company’s new CEO, increase in consulting fees increased $163,000 (including $107,000 associated with our preparation for Sarbanes-Oxley Section 404), an increase in our bad debt provision of $117,000 and an increase in stock listing fees of $55,000.

Equity-Based Compensation. In December 2004, FASB issued SFAS 123R, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations as an operating expense, based on their fair values on grant date. Prior to the adoption of SFAS 123R we had accounted for stock based compensation using the intrinsic value, if any. We adopted the provision of SFAS No. 123R effective January 1, 2006, using the modified prospective transition method. Under the modified prospective method, non-cash compensation expense is recognized for the portion of outstanding stock option awards granted prior to the adoption of SFAS 123R for which service has not been rendered, and for any future stock option grants. Accordingly, periods prior to adoption have not been restated. We recognize share-based compensation cost associated with awards subject to graded vesting in accordance with the accelerated method specified in FASB Interpretation No. 28 pursuant to which each vesting tranche is treated as a separate award. The compensation cost associated with each vesting tranche is recognized as expense evenly over the vesting period of that tranche. Equity-based compensation costs for the year ended December 31, 2006 was $1,554,000, of which $169,000 is included in cost of revenue, $98,000 is classified as research and development, $103,000 is classified as sales and marketing and $1,184,000 is classified as general and administrative. During the year ended December 31, 2006, we recognized expense of $1,389,000 related to stock options issued to employees and $37,000 related to 110,000 shares of restricted stock issued to an employee and certain consultants. Additionally, for the year ended December 31, 2006 our former President, Chief Executive Officer and Chairman was granted extensions on stock options, and we recorded $128,000 of compensation expense related to those extensions. There was no equity-based compensation for the year ended December 31, 2005. During 2004, we had granted restricted stock to its employees and directors as compensation. We issued 870,000 shares of our common stock, with a fair value of $835,000, which was recognized as compensation expense in 2004.

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Interest and Other Income (Expense), Net. Interest and other income (expense) was $(1,226,000) for the year ended December 31, 2006, compared with $(284,000) for the year ended December 31, 2005. Interest and other income (expense) primarily consist of net gains (losses) on marketable securities, interest earned on our cash and cash equivalent balances, interest on capital lease obligations and indebtedness, the amortization of debt discounts and for 2006, the increase in the increase in the incremental fair value of the warrant derivative liability. The $1,226,000 in interest and other expense, net for the year ended December 31, 2006 consists primarily of other expense of $1,304,000, interest income of $95,000 and interest expense of $17,000.

Other expense of $1,304,000 consists primarily of $1,078,000 associated with the increase in the fair value of the warrant derivative liability at December 31, 2006 resulting from the increase in our stock price of $1.20 on December 31, 2006, compared with $0.70 on September 30, 2006, and financing costs of $186,000, of which $135,000 is associated with the expiration of a warrant extension granted in January 2006.

Interest income of $95,000 was derived primarily from interest earned on our excess cash balances. The cash was invested in both a money market account and short term fixed income securities.

Interest expense of $17,000 is primarily interest paid on capital leases, the term loan used to finance our directors and officers liability insurance, interest paid in shares of our common stock to a holder of Series A Secured Convertible Debentures and amortization of debt discount.

Income Taxes. Income taxes reflect state and local franchise taxes and foreign withholding taxes. Income taxes were $30,000 and $32,000 for the years ended December 31, 2006 and 2005, respectively.

Year ended December 31, 2005 versus 2004:

Cost of Revenue. Our cost of revenue includes personnel and related overhead expenses, rent and related energy costs, fees paid for licensed technology, depreciation, amortization of purchased intangible assets and certain other operating expenses. Our cost of revenue was $1,919,000 for the year ended December 31, 2005, compared with $1,437,000 for the year ended December 31, 2004. Cost of revenue increased $482,000 for the year ended December 31, 2005, compared with 2004. The increase is primarily attributable to an increase of approximately $124,000 in personnel and related overhead, $203,000 associated with the support of the Flix product line by Wildform in 2005 and $164,000 in amortization of the Flix software assets.

Research and Development. Our research and development expenses, excluding equity based compensation, includes personnel and related overhead expenses, rent and related energy costs and depreciation, associated with the development and pre-production of our products and services. Our research and development expenses were $1,035,000 and $884,000 for the years ended December 31, 2005 and 2004, respectively. The increase of $151,000 is primarily from an increase of approximately $156,000 in personnel and related overhead attributed to research and development.

Sales and Marketing. Our sales and marketing expenses, excluding equity based compensation, consist primarily of salaries and related overhead costs, tradeshow costs, marketing and promotional costs incurred to create brand awareness and public relations expenses. Our sales and marketing expenses for the year ended December 31, 2005 were $794,000, compared with $459,000 for the year ended December 31, 2004. The increase of $335,000 is primarily attributable to an increase in personnel and related overhead expenses and an increase in tradeshow and promotional costs.

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General and Administrative. Our general and administrative expenses, excluding equity based compensation, consist primarily of salaries and related overhead costs for general corporate functions including legal, finance, human resources and management information systems. Also included are outside legal and professional fees, stock-listing fees, reserves for uncollectible accounts receivable and costs of liability and directors and offices’ insurance. General and administrative costs for the year ended December 31, 2005 were $2,749,000, compared with $3,068,000 for the year ended December 31, 2004. The decrease of $319,000 is attributable to a decrease in outside legal fees, stock listing fees and a decrease in the reserve for uncollectible accounts receivable partially offset by an increase in personnel and related overhead expenses as a result of increases in labor and related overhead rates.

Equity-Based Compensation. The Company had no equity based compensation expense in 2005. During 2004 we granted restricted stock to its employees and directors as compensation. We issued 870,000 shares of our common stock, with a fair value of $835,000. The related compensation expense of $835,000 was recognized in 2004, including $165,000 included in cost of revenue.

Interest and Other Income (Expense), Net. Interest and other income (expense) was $(284,000) for the year ended December 31, 2005 as compared with $47,000 for the year ended December 31, 2004. The $284,000 in interest and other expense, net for the year ended December 31, 2005 is primarily a result of a $339,000 unrealized loss on marketable equity securities, interest paid on debt of $39,000 partially offset by interest earned on our cash balances of $89,000 and $5,000 in other income.

At December 31, 2006, we had approximately 37 full-time employees. We expect to hire employees as necessary in order to attain our strategic objectives.

Liquidity and Capital Resources

At December 31, 2006, we had cash and cash equivalents of $4,961,000, compared with $3,976,000 at December 31, 2005. At December 31, 2006 we had working capital of $5,268,000, compared with $4,179,000 at December 31, 2005.

Net cash used in operating activities was $1,590,000 and $4,307,000 for the years ended December 31, 2006 and 2005, respectively. The net cash used in operating activities during 2006 consisted principally of a net loss of $4,846,000 and an increase in accounts receivable, net of $589,000, partially offset by equity-based compensation of $1,554,000, an expense of $1,078,000 associated with an increase in the estimated fair value of the warrant derivative liability, an increase in accounts payable and accrued expenses of $136,000, an increase in deferred revenue of $467,000, depreciation and amortization of $336,000 and other equity-based charges of $261,000. The net cash used in operating activities during 2005 consisted principally of a net loss of $4,605,000 and an increase in accounts receivable, net of $497,000, partially offset by an unrealized loss on marketable equity securities of $339,000 and depreciation and amortization of $236,000.

Net cash used in investing activities was $76,000 and $1,420,000 for the years ended December 31, 2006 and 2005, respectively. The decrease in 2006 is primarily due to $1,229,000 of cash used in connection with the purchase of the Flix software line during 2005.

Net cash provided by financing activities was $2,654,000 and $4,286,000 for the years ended December 31, 2006 and 2005, respectively. The decrease is attributable a decrease in the proceeds from the exercise of common stock options and warrants, net, partially offset by an increase in proceeds attributed to the warrant derivative liability and the issuance of common stock.

The Company currently has no material commitments for the next 12 months other than those under operating lease arrangements. These arrangements consist primarily of lease arrangements for our office space in Clifton Park and Tarrytown, New York, and Cambridge, UK. The aggregate required payments for the next 12 months under these arrangements are $165,000. Additionally, 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 2007, we anticipate incurring approximately $750,000 per month in cash operating costs.

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We believe that existing funds are sufficient to fund our operations through 2007. We plan to increase cash flows from operations principally from increases in revenue generated from its compression technology services and products. We may also pursue additional financings. See Item 1A “Risk Factors” above.

In August 2006, we completed the sale of 3,070,000 shares of its common stock with detachable five-year warrants to purchase 2,303,000 shares of our common stock at an exercise price of $0.77 per share, to two institutional investors, led by Midsummer Investments Ltd., and received net proceeds of $1,628,000.

The warrants contain certain anti-dilution provisions and, accordingly, we accounted for the fair value of the warrants as a derivative liability (warrant derivative liability) subject to SFAS No. 133. The fair value of the warrants issued, as calculated using the Black Scholes pricing model, was $1,251,000 and represents the portion of the proceeds from the financing that was attributed to the warrant derivative liability. The warrant fair value will be revalued at each balance sheet date, using the Black Scholes pricing model, with changes in value recorded in the statement of operations as income or expense. On December 31, 2006 the warrant derivative fair value was $2,329,000 and the increase in value of $1,078,000 is included as an expense in interest and other income (expense), net. We paid financing costs in the amount of $122,000 of which $52,000 is associated with the warrants, and is included in interest and other income (expense), net in our consolidated financial statements for the twelve months ended December 31, 2006.

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 compression technology services and products. However, there are no assurances that we will be successful in effecting such increases. The market for distribution of compression 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.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. 

Tabular Disclosure of Contractual Obligations

	Payments due by period
Contractual Obligations	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Capital lease obligation	$	61,000	$	28,000	$	33,000
Operating lease for office space		497,000	$	165,000		275,000	$	53,000	$	4,000
Total	$	558,000	$	193,000	$	308,000	$	53,000	$	4,000

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Impact of Recently Issued Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, (“FIN48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. We must determine whether it is “more-likely-than-not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions related to income taxes subject to FASB Statement No. 109, Accounting for Income Taxes. We will adopt the provisions of this statement beginning in the first quarter of 2007. The cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings on January 1, 2007. We do not anticipate that the adoption of this statement will have a material effect on our financial position or results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires employers to: (a) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under-funded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income of a business entity. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, for entities with publicly traded equity securities. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We currently have no Post Retirement Benefit Plan.

Also in September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements’” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosuresabout fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Earlier application is encouraged provided that the reporting entity has not yet issued financial statements for that fiscal year including financial statements for an interim period within that fiscal year. We believe that several accounts will be affected on the adoption of SFAS No. 157 statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which provides companies with an option to report selected financial assets and liabilities at their fair values. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with FASB’s long-term measurement objectives for accounting for financial instruments. We are currently evaluating the effects of the adoption of SFAS No. 159.

Limitation on Use of Net Operating Loss and Other Tax Credit Carry-Forwards

At December 31, 2006, we had available net operating loss carry-forwards of approximately $90,083,000. The net operating loss carry-forwards expire at various dates through 2026.

Section 382 of the Internal Revenue Code provides that when a corporation undergoes an “ownership change,” the corporation’s use of its net operating losses is limited in each subsequent year. An “ownership change” occurs when, as of any testing date, the sum of the increases in ownership of each shareholder that owns five percent or more of the value of a company’s stock as compared to that shareholder’s lowest percentage ownership during the preceding three-year period exceeds fifty percentage points. For purposes of this rule, certain shareholders who own less than five percent of a company’s stock are aggregated and treated as a single five-percent stockholder.

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The merger of The Duck Corporation with and into a wholly-owned subsidiary of Applied Capital Funding, Inc. in 1999 may have involved an “ownership change,” and thus we may be unable to use a material portion of our available net operating loss carry-forwards. Furthermore, in the ordinary course of our business operations we have and may continue to issue shares in conjunction with acquisitions or additional financing, to meet our growth objectives and liquidity constraints. In addition, the exercise of outstanding warrants and certain options to purchase shares of our common stock may require us to issue additional shares of common stock. Past and future issuances of shares of common stock may limit our ability to use a substantial amount of our available net operating loss carry-forwards to reduce future taxable income.

The extent of the actual future use of our net operating loss carry-forwards is subject to inherent uncertainty because it depends on the amount of otherwise taxable income we may earn. We cannot be certain that we will have sufficient taxable income in future years to use any of our net operating loss carry-forwards before they would otherwise expire.

Item 11.    Executive Compensation 

EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

Overview of our Compensation Program

The Compensation Committee oversees our executive compensation plans and general compensation and employee benefit plans, including incentive and equity-based plans. Information concerning the Compensation Committee, the scope of its authority and responsibilities, and its processes and procedures are described in the “Compensation Committee” section of the corporate governance discussion.

The individuals who served as our chief executive officer and our chief financial officer during fiscal year ended December 31, 2006, as well as the other individuals included in the Summary Compensation Table, are referred to in this proxy statement as the “Named Executive Officers.”

Compensation Philosophy and Objectives

Our compensation program for the Named Executive Officers is intended to attract, retain, motivate and appropriately reward talented executives who can contribute significantly to our financial growth and success, and thereby build value for our stockholders over the long term. The program has the following specific goals:

· To offer a total compensation package to the Named Executive Officers that is competitive in the marketplace for executive talent.

· To motivate the Named Executive Officers to achieve our business objectives by providing incentive compensation awards that take into account our overall performance and that measure performance against those business objectives.

· To provide equity-based, long-term compensation arrangements that create meaningful incentives for the Named Executive Officers to maximize our near and long-term future performance, that align their interests with our shareholders', and encourage the Named Executive Officers to remain with the Company.

To achieve these objectives, the Compensation Committee is developing certain processes for setting Named Executive Officer compensation and is constructing an overall compensation program that consists of a number of elements, as described below.

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Setting Executive Compensation

General Processes

In establishing compensation of Named Executives, the Compensation Committee has relied heavily on the terms of existing employment agreements with executive officers to establish executive compensation. Those agreements were entered into before the Company had articulated its current compensation philosophy, and thus, do not fully reflect the compensation principles that the Committee has since established. As we renew our executives’ employment agreements, we will work to ensure that the terms of the agreements dovetail with our compensation philosophy.

The Compensation Committee intends to use certain performance measures as the bases for determining annual cash incentive compensation. The Compensation Committee intends for annual cash incentive compensation to be linked to attainment of specific target performance measures. The specific target performance measure for 2007 will be cash flow. Further, the Named Executive Officers will not receive a bonus unless we have positive cash flow, and the payment of bonuses may not result in negative cash flow for us.

Generally, the bonus for each Named Executive Officer will be based on a percentage of his salary. The minimum amount of cash incentive compensation that Named Executive Officer can achieve will be $0 and will increase up to 20% of the Named Executive Officer’s salary on a schedule as our cash flow increases up to a pre-determined target amount. Thereafter, the cash incentive compensation will be based on performance toward a second, higher target amount, up to a maximum amount of cash incentive compensation equal to 50% of the Named Executive Officer’s salary, again on a schedule that links actual cash flow achieved with percentage of salary payable as bonus. The Compensation Committee will make subjective determinations as to the cash flow performance targets that must be attained for the Named Executive Officers to earn each of the two tiers of cash incentive compensation. In addition to this programmatic approach, the committee retains the discretion to grant cash bonuses as necessary to account for special circumstances or extraordinary individual or company performance.

The Compensation Committee intends annually to review and benchmark the total compensation program for the Named Executive Officers against relevant market data. The Compensation Committee anticipates retaining James Reda to assist in the benchmarking process, which will involve a comparison of various components of total compensation against a peer group of publicly traded companies (the “Peer Group”). The Compensation Committee has selected the Peer Group companies based on their similarities to us in revenue, earnings and capital and management structures, and the Board has adopted the Peer Group based on the Compensation Committee’s recommendation. The Compensation Committee included in the Peer Group some companies that, because of their recent acquisition or changes in ownership structure, have recently ceased to be publicly traded. The Peer Group will be reviewed periodically by the Compensation Committee and Board and updated as necessary to maintain comparability, including to remove those companies that have recently ceased to be publicly traded. The companies currently composing the Peer Group are:

· Audible Inc.

· Broadcaster Inc.

· CaminoSoft Corp.

· DG FastChannel Inc.

· DivX, Inc.

· eGames Inc.

· Global Entertainment Holdings/Equities

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· Loudeye Corp.

· OpenTV Corp.

· SmartVideo Technologies, Inc.

· Sonic Foundry, Inc.

· SRS Labs, Inc.

· TouchStone Software Corp.

· VitalStream Holdings, Inc.

· Wizzard Software Corp.

The Compensation Committee will compare its executive compensation programs as a whole to those maintained by the members of the Peer Group to determine whether our programs are reasonable in the aggregate. In addition, the Compensation Committee will compare the pay of its individual Named Executive Officers with that of executives of the Peer Group companies who hold functionally comparable positions.

Allocating Between Different Types of Compensation

The Compensation Committee believes that executive compensation should include a mix of different types of compensation and takes this consideration into account when structuring the total compensation for each Named Executive Officer. The allocation among different types of compensation is based on the employment agreement with the Named Executive Officer, where such agreements exist. Within the parameters set by the employment agreements, if any, the Compensation Committee intends to reward recent performance and create incentives for long-term enhancements in shareholder value. For example, the Compensation Committee allocates a portion of each Named Executive Officer’s total compensation to an annual variable compensation program that links the amount of bonus pay directly to the annual performance of On2. This is achieved through our annual cash incentive plan, which is further described below. In setting the amounts potentially payable under the annual cash incentive plan, the Compensation Committee takes into account other annual cash compensation payable to each Named Executive Officer and how that compensation compares to the amount of annual cash compensation paid by companies in the Peer Group. In setting the terms of the future employment agreements and when setting future compensation, the Compensation Committee anticipates setting total annual cash compensation in the middle percentile of the Peer Group for performance that meets our annual business objectives and between the 50^th and 80^th percentile of the Peer Group for performance that substantially exceeds annual business objectives.

The Compensation Committee also seeks to allocate a portion of total compensation to long-term, equity-based compensation. Equity-based compensation is designed to motivate the creation of long-term shareholder value and simultaneously enhance executive retention. The Compensation Committee typically uses stock options because this form of equity compensation provides the executive with value only if the price of our stock when the option is exercised exceeds the option’s exercise price. This provides an incentive to increase stock price over the term of the option. To enhance retention goals and provide balance with stock options, the Compensation Committee may also grant restricted stock. The Compensation Committee anticipates that long-term, equity based compensation will constitute a larger percentage of each Named Executive Officer’s total compensation in future years as the Compensation Committee has additional opportunity to structure appropriately targeted awards of this type.

Role of Executive Officers in Compensation Decisions

Decisions on the compensation of the chief executive officer are made by the Compensation Committee. Compensation decisions on the other Named Executive Officers are made by the chief executive officer, pursuant to guidelines established by the Compensation Committee. Decisions regarding non-equity compensation of employees who are not Named Executive Officers are made by our chief executive officer in consultation with other members of management and the Compensation Committee. The chief executive officer, in consultation with the Compensation Committee, annually reviews the performance of the other Named Executive Officers. The Compensation Committee may exercise discretion to modify any recommended salary adjustment or award as it deems appropriate under the circumstances.

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2006 Executive Compensation Components

For the 2006 fiscal year, the principal components of compensation for the Named Executive Officers were:

· base salary;

· performance-based incentive compensation; and

· long-term equity incentive compensation.

In addition, employment agreements with three of our Named Executive Officers provide for certain potential payments upon termination of employment for a variety of reasons, as well as certain payments and benefits during the executive’s employment. The Compensation Committee does not currently believe that perquisites, such as club memberships or automobile allowances, have a significant role to play in executive compensation. Each of the elements of the executive compensation program is discussed in the following paragraphs.

Base Salary

Base salaries are designed to compensate the Named Executive Officers for faithful execution of their individual responsibilities. The base salaries of the chief executive officer, executive vice president and chief technology officer, and the executive vice president and general counsel are set forth in the applicable employment agreement with the executive. The employment agreement of the chief executive officer will expire on May 1, 2008. The employment agreement of the executive vice president and general counsel will expire on February 8, 2008. The employment agreement of the executive vice president and chief technology officer will expire on September 15, 2009. When we enter into new or amended employment agreements with such Named Executive Officers, or if we enter into an employment agreement with another executive officer, the Compensation Committee will review the base salaries and adjust them based on a number of relevant factors. During its review of base salaries, the Compensation Committee primarily considers the following:

· relevant market data developed in connection with the benchmarking process described above;

· the executive’s role and responsibilities;

· and, in cases of renewal, the past performance of the executive.

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Of the factors described above, primary consideration will be given to relevant market data in setting base salaries because the Compensation Committee believes that base compensation for executives should be close to the fiftieth percentile of the peer group and that upside potential in total compensation is achieved through the performance-based and long-term incentive compensation programs. Factors, other than those listed above, that may cause the Compensation Committee to deviate from the benchmarking salary data include an executive’s experience in a particular role, retention concerns, and the Compensation Committee’s judgment based on an executive’s leadership qualities, career with us, and long-term potential to enhance shareholder value.

Base salaries for other Named Executive Officers are set by the chief executive officer, within the guidelines established by the Compensation Committee. Those guidelines are based on the salaries set by the Compensation Committee for those Named Executive Officers that have employment agreements with us.

In setting base salaries for the chief executive officer in 2006, the Compensation Committee primarily relied upon the assistance of the executive search firm that assisted us in locating a suitable replacement for the chief executive officer who resigned in 2006. The data relied upon included the base salaries and total compensation for recently placed chief executive officers in technology business of similar size and lifestage.

Annual Cash Incentive Compensation

Our annual cash incentive plan is designed to reinforce the importance of both teamwork and individual initiative and effort, and to provide an incentive for employees to achieve and surpass targeted performance goals. As described below, bonuses to officers are based on a percentage of salary and are linked to metrics established by the Board. Bonuses to other employees are payable from a bonus pool that is budgeted for at the beginning of the fiscal year and are based on individual performance or achievement of technical goals.

For 2007, the annual bonus amount for Named Executive Officers will be based on one or more Company-wide performance measures. The specific target performance measure for 2007 will be cash flow, that is, revenue minus operating expenses. Under the plan, Named Executive Officers will not receive a bonus unless we have positive cash flow, and the payment of bonuses may not result in negative cash flow for us.

Generally, the bonus for each Named Executive Officer will be based on a percentage of the participant’s base salary. This year, the minimum threshold for cash incentive compensation will be $0 and will increase up to 20% of the Employee/Named Executive Officer’s salary as our cash flow increases up to a pre-determined target amount. Thereafter, the cash incentive compensation will be based on performance toward a second, higher target amount, up to a maximum amount of cash incentive compensation equal to 50% of the Employee/Named Executive Officer’s salary.

Each year, the Compensation Committee will consider how to structure performance measures to ensure that the amount of the cash incentive potentially payable under the plan is properly aligned with our business objectives and strategic initiatives. As noted above, for 2007, the Compensation Committee has determined that cash flow is the primary financial measure that should be used to measure performance with regard to the annual cash incentive compensation plan.

The annual bonus amount paid in 2006 was for the 2005 year. Eric Ameres received a discretionary bonus of $9,000 and Tim Reusing received a discretionary bonus of $10,000. None of our other Named Executive Officers received annual cash incentive compensation during 2006 for their performance during the 2005 year. The amounts of the cash incentive compensation paid for the 2005 year reflected the Company’s continued negative cash flow situation.

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Company-wide performance measures for the 2006 cash incentive plan were not defined prior to the end of 2006. The Compensation Committee intended to establish the target performance levels for 2006 based on a budget target. The 2006 plan funding was based on base salaries for all eligible employees as of December 31, 2006. The level of total funding for the plan for 2006 was determined during conversations between the Board and the Chief Executive Officer regarding the Company's performance in 2006.

Long-Term Equity Incentive Compensation

Consistent with our compensation philosophy, long-term equity incentives are an important component of each Named Executive Officer’s total compensation package. We have generally awarded stock options to the Named Executive Officers and other key management employees. These stock option awards are designed to:

· reward and encourage long-term contribution to the Company

· align executives' interests with the interests of shareholders;

· help achieve competitive levels of total compensation.

During 2006, the Company only awarded long-term equity compensation only to Mr. Joll and Mr. Frost. Mr. Joll was awarded options to purchase 1,350,000 shares of common stock at an exercise price of $.90 per share. The options were issued to Mr. Joll in connection with the commencement of his employment with the Company. The options vested in one installment of 333, 334 shares on May 1, 2006, one installment of 333,333 shares on November 8, 2006, with the remainder to vest in one installment of 333,333 shares on May 8, 2007 and one installment of 500,000 shares on May 8, 2008.

Mr. Frost was awarded options to purchase 75,000 shares of common stock at an exercise price of $0.82 per share. The options were issued to Mr. Frost in connection with his promotion to General Counsel. The options vested in one installment of 37,500 shares on April 3, 2006 and one installment of 37,500 shares on February 28, 2007.

The Compensation Committee intends to determine stock option award levels based on consideration of a number of factors, including discussions with the chief executive officer and other executives. For 2006, stock option awards were approved in the first quarter of 2007 and will be granted in the second quarter of 2007. However, newly appointed or promoted executives or management personnel may receive an additional stock grant at other times during the year.

Grants are not directly connected to an executive’s salary or bonus. Grants of stock options or restricted stock awards will usually be subject to less dramatic variation than cash incentive compensation. For instance, in a year when an executive’s performance evaluation was good, he might receive an equity award that is slightly larger than that received by other executives. But if, in that same year, our financial performance did not meet targets, then the executive would not receive a bonus. If, however, in the following year, the executive’s performance evaluation was again good and our financial performance exceeded targets, then the executive would receive an equity award that, while higher than other executives’, was approximately the same as in the previous year. On account of our financial performance in that year, however, he would also receive a bonus; like the award of equity, that bonus would also be adjusted upward because of the employee’s exceptional performance.

Grants will generally be awarded during the first quarter of the fiscal year in order to coincide with the timing of annual reviews and compensation determinations, and because our fiscal year-end results have generally been announced by this time. Equity awards are awarded under our 2005 Incentive Compensation Plan, which requires that the option exercise price be based on the average of the high and low price of our common stock on the trading day preceding the date the option is granted. The Compensation Committee does not grant options with an exercise price that is less than the fair market value of our common stock, as determined according to the 2005 Incentive Compensation Plan, or grant options which are priced on a date other than the grant date, unless for some reason the date proceeding the date is not a trading date, in which case the average of the high and low price of our common stock on the preceeding trading day is used.

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Retirement and Other Benefits

We maintain a tax-qualified Section 401(k) savings plan available to all of our employees, including the Named Executive Officers. The plan provides a matching contribution equal to 100% of an employee’s contributions, up to a maximum contribution of $1,000. All contributions to the Section 401(k) savings plan, including the matching contributions, are fully-vested upon contribution.

Our other benefit plans primarily include medical and other health care benefits, group life insurance, disability and tuition assistance. The Compensation Committee has reviewed these other components of compensation in relation to the total compensation of the Named Executive Officers, and determined that they are reasonable and appropriate.

We do not maintain any defined benefit pension plans or any nonqualified deferred compensation arrangements.

Perquisites and Other Personal Benefits

We do not provide the Named Executive Officers with any perquisites or other similar personal benefits and the Compensation Committee does not currently believe that perquisites, such as club memberships or automobile allowances, have a significant role to play in executive compensation.

Employment Agreements

Mr. Joll, Mr. Ameres and Mr. Frost are parties to employment agreements with us. Each of these agreements provides for certain payments and other benefits if the executive’s employment terminates under specified circumstances, as well as certain payments and benefits during the executive’s employment. The Compensation Committee believed that these employment arrangements were an important part of our overall executive compensation program at that time because they served as a recruitment and retention device. However, the Compensation Committee has not determined that it is necessary to enter into employment agreements with other executives at this time. More information concerning these employment agreements is contained in the “Employment Agreements” section and in the “Potential Payments Upon Termination” section.

COMPENSATION COMMITTEE REPORT

The Compensation Committee oversees On2’s executive compensation program on behalf of the Board. In fulfilling its oversight responsibilities, the Compensation Committee reviewed and discussed with On2 management the Compensation Discussion and Analysis set forth in this proxy statement. Based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this proxy statement.

James Meyer, Chairman

Michael Alfant

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SUMMARY COMPENSATION TABLE

The following table provides summary information regarding compensation earned by the Named Executive Officers during the fiscal year ended December 31, 2006.  

Name and Principal Position	Year		Salary		Bonus		Option Awards2		All Other Compensation3		Total
Douglas A. McIntyre Chief Executive Officer, President and Chairman, Former		2006	$	36,000	$	175,000			$	56,0005	$	267,000
James Meyer Interim Chief Executive Officer, Former4		2006	$	109,000								109,000
Bill Joll Chief Executive Officer and President1		2006	$	211,000			$	784,000				995,000
Anthony Principe Executive Vice President and Chief Financial Officer		2006	$	120,000				35,000		1,000		156,000
Eric L. Ameres Executive Vice Presidentand Chief Technology Officer		2006	$	190,000	$	9,000		63,000		1,000		263,000
Matthew Frost Executive Vice President and General Counsel		2006	$	179,000				76,000		1,000		256,000
Timothy C. Reusing Executive Vice President - Legal and Business Affairs, Former		2006	$	233,000	$	10,000		62,000		1,000		306,000

¹ Mr. Joll commenced employment on May 8, 2006 at an annual base salary of $325,000. His salary for 2006 was prorated to reflect his employment for only the relevant portion of the year.

² This column represents the dollar amount recognized for financial statement reporting purposes with respect to the 2006 fiscal year for the fair value of stock options granted to each of the Named Executive Officers in 2006 as well as prior fiscal years, determined in accordance with SFAS 123R. The amounts shown exclude the impact of estimated forfeitures related to service-based vesting conditions. For additional information on the valuation assumptions with respect to the 2006 grants, refer to note 1(k) of our financial statements in the Form 10-K for the year ended December 31, 2006, as filed with the SEC. See the Grants of Plan-Based Awards Table at page 12 for information on options granted in 2006. These amounts reflect our accounting expense for these awards, and do not correspond to the actual value that may be recognized by the Named Executive Officers. Options awarded to Mr. Joll during the 2006 fiscal year were granted on May 1, 2006. Options awarded to Mr. Frost during the 2006 fiscal year were granted on April 3, 2006.

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³ See the All Other Compensation Table for additional information.

⁴ Mr. Meyer also received compensation in 2006 for his service on On2’s Board of Directors. See page 19.

⁵ Mr. McIntyre received this compensation for consulting services provided after termination of his employment as President, Chairman and Chief Executive Officer.

All Other Compensation Table

The All Other Compensation in the Summary Compensation Table reports the company matching contributions to the named executive’s section 401(k) savings plan account of up to $1,000 (subject to the limitations imposed by law).

GRANTS OF PLAN-BASED AWARDS IN 2006

The following table provides information about equity and non-equity awards granted to the Named Executive Officers in 2006. This information includes (1) the grant date of the award; (2) the estimated payouts under non-equity incentive plan awards, which consist of the potential payout levels under the 2006 annual performance-based incentive plan; (3) the number of shares underlying restricted stock awards; (4) the number of shares underlying stock option awards; (5) the exercise price of the stock option awards, based on closing price of our common stock on the date of grant and (6) the grant date fair value of each equity award, computed under SFAS 123R.

Name	Grant Date		All Option Awards: Number of Securities Underlying Options1		Exercise or Base Price of Option Awards)2		Grant Date Fair Value of Stock and Option Awards3
Douglas A. McIntyre				—
James Meyer				—
Bill Joll		May 9, 2006		1,500,000	$	0.90	$	1,114,000
Anthony Principe				—
Eric L. Ameres				—
Matthew Frost		April 3, 2006		75,000	$	0.82	$	51,000
Timothy Reusing				—

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¹ This column shows the number of stock options granted in 2006 to the Named Executive Officers. The 1,500,000 options issued to Mr. Joll vested in one installment of 333, 334 shares on May 1, 2006, one installment of 333,333 shares on November 8, 2006, with the remainder to vest in one installment of 333,333 shares on May 8, 2007 and one installment of 500,000 shares on May 8, 2008. The options issued to Mr. Frost vested in one installment of 37,500 shares on April 3, 2006 and one installment of 37,500 shares on February 28, 2007.

² This column shows the exercise price (per share) for the stock options granted, which was the average of the high and low prices of a share of our common stockon the last date on which our stock was traded prior to the date on which the Compensation Committee granted the options.

³ This column shows the full grant date fair value of stock options under SFAS 123R granted to each of the Named Executive Officers in 2006. Generally, the full grant date fair value is the amount that we would expense in our financial statements over the award’s vesting schedule. For stock options, fair value is calculated using the Black-Scholes option-pricing model which takes into account volatility in the price of our stock, the risk-free interest rate, the estimated life of the award, the closing market price of our stock on the date of grant and the exercise price. For additional information on the valuation assumptions, refer to note 1(k) of our financial statements in the Form 10-K for the year ended December 31, 2006, as filed with the SEC. These amounts reflect our accounting expense, and do not correspond to the actual value that may be recognized by the Named Executive Officers.

Narrative to Summary Compensation Table and Plan-Based Awards Table

Employment Agreements. During 2006, Mr. Joll, Mr. Ameres and Mr. Frost were employed pursuant to employment agreements with us. Each agreement specifies the Named Executive Officer’s base salary, annual bonus opportunity, benefits during employment and post-termination benefits. The employment agreements also impose on each Named Executive Officer certain obligations following termination of their employment.

Mr. Joll’s employment agreement has an initial term that ends on May 7, 2008. The term will be automatically extended thereafter for a one-year term unless either party provides notice of non-extension at least ninety days prior to the expiration of the original term. Mr. Joll’s agreement provides for an initial base salary of $325,000. The agreement provides for a discretionary bonus for the fiscal year ending December 31, 2006, ranging from 33% of base salary based on attainment of an agreed-upon budget to 67% of base salary. A threshold budget was adopted by the Compensation Committee after the end of the 2006 fiscal year; the target budget specified under the Agreement that would have entitled Mr. Joll to receive the 67% bonus was achievement of positive earnings before interest, taxes, depreciation and amortization. We did not achieve positive earnings before interest, taxes, depreciation and amortization in fiscal 2006, so the discretionary bonus of 33% of base salary, $107,250, will be paid to Bill Joll based upon the budget adopted by the Compensation Committee at the end of the 2006 fiscal year.

Pursuant to the agreement with Mr. Joll, we granted to him options to purchase 1,500,000 shares of our common stock at an exercise price of $.90 per share. The options vested in one installment of 333,334 shares on May 1, 2006, one installment of 333,333 shares on November 8, 2006, with the remainder to vest in one installment of 333,333 shares on May 8, 2007 and one installment of 500,000 shares on May 8, 2008. The exercise price of $0.90 for the stock options granted was the average of the high and low price of our common stock on April 28, 2006, the trading day preceeding the date on which the Compensation Committee approved the grant of the options.

In addition, the agreement also entitles Mr. Joll to participate in employee benefit plans which are available to our other senior executives, annual vacation and reimbursement of reasonable travel and other business expenses.

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Mr. Frost’s employment agreement has an initial term that ends on February 28, 2008. The term may be extended upon our agreement with Mr. Frost. Mr. Frost’s agreement provides for an annual base salary of $182,500 per year and an annual discretionary bonus pursuant to the bonus plan available to the most senior members of our management. Mr. Frost also received stock options to purchase 75,000 shares of our common stock, to be granted under our 2005 Incentive Compensation Plan. One-half of the options vested on March 8, 2006, the date of grant, and the other half of the options vested on February 28, 2007. The exercise price was $0.82, which was the average of the high and low price of our common stock on March 31, 2006, the trading day preceeding the date on which the Compensation Committee granted the options. The agreement also provides that Mr. Frost is entitled to participate in employee benefit plans which are available to our other senior executives, annual vacation and reimbursement of reasonable business expenses.

Mr. Joll, Mr. Ameres and Mr. Frost are entitled to certain payments and benefits under their employment agreements if they are terminated by us without cause. For additional information concerning these payments and benefits, see Potential Payments Upon Termination on page 46.

Salary and Cash Incentive Awards in Proportion to Total Compensation. As noted in the Compensation Discussion and Analysis, the Compensation Committee believes that a portion of each Named Executive Officer’s compensation should be in the form of equity awards; however, the Compensation Committee awarded very little cash incentive compensation and long-term equity incentive compensation as a result of the Company’s continued negative cash flow in 2005. The following table sets forth the percentage of each Named Executive Officer’s total compensation that was paid in the form of base salary and cash incentive award under the 2006 performance-based incentive plan. The Compensation Committee anticipates that salary and cash incentive awards will constitute a smaller percentage of each Named Executive Officer’s total compensation in future years as the Compensation Committee has additional opportunity to structure appropriately targeted long-term equity-based incentive awards, such as stock options and restricted stock and the Company achieves profitability.

Name	Percentage of Total Compensation
Douglas A. McIntyre		100	%
James Meyer		100	%
Bill Joll		21	%
Anthony Principe		100	%
Eric Ameres		100	%
Matthew Frost		80	%
Timothy C. Reusing		100	%

As described above, we have moved from a practice of awarding cash bonuses and equity compensation at the end of a fiscal year to a practice of making such awards at the beginning of a fiscal year, based upon the previous year’s performance. Accordingly, the amount of equity compensation awarded to Named Executive Officers in 2006, other than to those officers who received promotions or were newly hired, is significantly lower than it has been in past years, or will likely be in the future.

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OUTSTANDING EQUITY AWARDS AT 2006 FISCAL YEAR-END

The following table provides information about the stock option awards held by the Named Executive Officers as of December 31, 2006. This information includes unexercised and unvested stock options. Each equity award is separately shown for each Named Executive Officer. The vesting schedule for each stock option award is shown immediately following the table based on the date on which the stock option award was granted.

	Option Awards
Name	Option Grant Date	Number of Securities Underlying Unexercised Options Exercisable		Number of Securities Underlying Unexercised Options Unexercisable		Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options	Option Exercise Price		Option Expiration Date		Option Awards Vesting Schedule
Bill Joll	5/1/2006		666,667		333,333		$	0.90		5/1/2014	33.34% vests on 5/1/06; 33.33% vests on 11/8/06; 33.33% vests on 5/8/07
	5/1/2006				500,000		$	0.90		5/1/2014	100% vests on 5/8/08
Anthony Principe	8/26/2002		12,500				$	0.14		8/26/2012	25% immediately; 25% 1 year after grant; 25% 2 years after grant; 25% 3 years after grant
	10/1/2002		10,000				$	0.32		10/1/2012	50% in 6 months; 50% 1 year after grant
	11/15/2003		50,000				$	1.25		11/15/2013	50% immediately; 50% 1 year after grant

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	5/13/2004	35,000	$	0.66	5/13/2014	50% immediately; 50% 1 year after grant
	12/3/2004	40.000	$	0.57	12/3/2014	100% 1 year after grant
	6/27/2005	40,000	$	0.59	6/27/2013	50% immediately; 50% 1 year after grant
	11/18/2005	100,000	$	0.79	11/18/2013	50% immediately; 50% 1 year after grant
Eric Ameres	7/27/1999	50,000	$	16.63	7/27/2009	33% 1 year after grant; 33.33% 2 years after grant; 33.34% 3 years after grant
	5/17/2000	100,000	$	11.81	5/17/2010	33% 1 year after grant; 33.33% 2 years after grant; 33.34% 3 years after grant
	4/1/2003	100.000	$	0.40	4/1/2013	33% 1 year after grant; 33.33% 2 years after grant; 33.34% 3 years after grant
	8/9/2001	50,000	$	0.80	8/9/2011	50% immediately; 50% 1 year after grant
	7/2/2004	200,000	$	0.68	7/2/2014	50% immediately; 50% 1 year after grant
	5/5/2005	200,000	$	0.57	5/5/2013	100% on 12/3/05
	11/18/2007	200,000	$	0.79	11/18/2013	50% immediately; 50% 1 year after grant

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Matthew Frost	12/15/2003	75,000		$	1.36	12/15/2013	33.33% immediately; 33.33% 1 year after grant; 33.34% 2 years after grant
	5/13/2004	35,000		$	0.66	5/13/2014	50% immediately; 50% 1 year after grant
	12/3/2004	140,000		$	0.57	12/3/2014	100% 1 year after grant
	11/18/2005	100,000		$	0.79	11/18/2013	50% immediately; 50% 1 year after grant
	4/3/2006	37,500	37,500	$	0.81	4/3/2014
Douglas A. McIntyre
James Meyer	5/11/2005						100% immediately
	11/18/2005						100% immediately
Timothy Reusing	4/1/2003	33,334		$	0.40	4/1/2013	33% 1 year after grant; 33.33% 2 years after grant; 33.34% in 3 years
	11/5/2003	84,000		$	1.25	11/5/2013	50% immediately; 50% 1 year after grant
	7/2/2004	200,000		$	0.68	7/2/2014	50% immediately; 50% 1 year after grant
	6/15/2005	200,000		$	0.57	5/5/2013	100% on 12/3/05
	11/18/2005	100,000		$	0.79	11/18/2013	100% 1 year after grant

OPTION EXERCISES AND STOCK VESTED IN FISCAL 2006

The following table provides information for the Named Executive Officers regarding stock options that were exercised during fiscal 2006.

	Option Awards				Stock Awards
Name	Number of Shares Acquired on Exercise		Value Realized on Exercise		Number of Shares Acquired on Vesting	Value Realized on Vesting
Bill Joll
Anthony Principe
Eric Ameres
Matthew Frost
Douglas A. McIntyre 1		1,475,000	$	1,138,433
James Meyer
Timothy C. Reusing 2		193,332	$	210,332

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¹ Douglas A. McIntyre exercised the following stock options in 2006:

· 125,000 stock options on May 16, 2006. The stock options had an exercise price of $28,250 and a market price of $98,750 on the date of exercise.

· 500,000 stock options on May 26, 2006. The stock options had an exercise price of $165,000 and a market price of $385,000 on the date of exercise.

· 356,700 stock options on September 28, 2006. The stock options had an exercise price of $228,288 and a market price of $246,123 on the date of exercise.

· 243,300 stock options on September 20, 2006. The stock options had an exercise price of $155,712 and a market price of $177,609 on the date of exercise.

· 100,000 stock options on November 2, 2006. The stock options had an exercise price of $64,000 and a market price of $86,000 on the date of exercise.

· 81,700 stock options on December 15, 2006. The stock options had an exercise price of $64,543 and a market price of $80,066 on the date of exercise.

· 68,300 stock options on December 18, 2006. The stock options had an exercise price of $53,957 and a market price of $64,885 on the date of exercise.

² Timothy C. Reusing exercised the following options in 2006:

· 93,332 stock options on December 14, 2006. The stock options had an exercise price of $47,533 and a market price of $93,332 on the date of exercise.

· 100,000 stock options on December 21, 2006. The stock options had an exercise price of $79,000 and a market price of $117,000 on the date of exercise.

POTENTIAL PAYMENTS UPON TERMINATION

Employment Agreements. As explained in the Narrative to the Summary Compensation Table and Plan-Based Award Table on pages 11 and 12, we have entered into employment agreements with Mr. Joll, Mr. Ameres and Mr. Frost. The agreements provide for certain payments and other benefits if their employment with us is terminated under circumstances described in the agreements. The specific payments and benefits depend on the type of termination event. The standard definitions for the various types of termination events covered under the agreements are described below, although the exact definitions may vary by agreement and by Named Executive Officer.

· “Resignation for Good Reason” means a termination that the executive initiates if we, without the executive’s consent, fail to continue to employ him in his position; there is a material diminution in the nature or scope of his responsibilities, duties or authority; or we fail to make any payment or provide any benefit due under the agreement 15 days after notice of such has been made to us.

· “Resignation without Good Reason” means a termination initiated by the Named Executive Officer that is not a Resignation for Good Reason.

· “Termination for Cause” means termination of the Named Executive Officer’s employment by us due to his failure to satisfactorily perform material services required by the Board; conviction of a felony or any act of material fraud or dishonesty; willful misconduct or gross negligence in the performance of his duties; disregard or violation of the legal rights of our employees or of our written policy regarding harassment or discrimination; or a breach of any material provision of the executive’s employment agreement.

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· “Termination without Cause” means a termination by us of the Named Executive Officer’s employment that is not a Termination for Cause.

· “Non-extension of Term by the Company” means termination initiated by us by providing notice to the Named Executive Officer that the current term of the agreement will not be automatically extended beyond its scheduled end date.

· “Disability Termination” means termination of the executive’s employment by us because of his failure to perform his material duties for a period of 26 consecutive weeks or an aggregate of 40 weeks during any twelve month period, in the case of Bill Joll, or six consecutive weeks or an aggregate of twelve weeks during any twelve month period, in the case of Matt Frost as a result of disability or incapacity.

· “Death Termination” means the automatic termination of the agreement upon the Named Executive Officer’s death.

Bill Joll is subject to non-competition and non-solicitation restrictions following termination of his employment for any reason. These restrictions apply for 12 months. In addition, Mr. Joll and Mr. Frost are entitled to continue coverage under company-sponsored group health plans following termination of employment for a period of six months.

The following tables describe the potential payments and benefits under each employment agreement. The agreements vary as to whether a particular type of termination event entitles the Named Executive Officer to any benefits or payments.

Bill Joll

Chief Executive Officer

and President

Executive Benefits and Payments Upon Separation1	Resignation for Good Reason		Non-extension of Term by the Executive		Resignation Without Good Reason		Termination for Cause		Termination without Cause		Non-extension of Term by the Company		Disability Termination		Death Termination
Compensation:
Severance2	$	341,700	$	0	$	0	$	0	$	341,700	$	162,500	$	27,083	$	0
Bonus3	$	325,000	$	0	$	0	$	0	$	325,000	$	0	$	0	$	0
Benefits & Perquisites:4
Health Plan Continuation5	$	31,941	$	0	$	0	$	0	$	31,941	$	0	$	0	$	0
Total	$	698,641	$	0	$	0	$	0	$	698,641	$	162,500	$	27,083	$	0

¹ The amounts shown in this table were computed based on the following assumptions: the termination date is December 31, 2006; Mr. Joll’s base salary is $325,000; and Mr. Joll’s target percentage is 100% for purposes of our 2007 Cash Incentive plan.

² For Resignation for Good Reason orTermination without Cause, severance is one year of his base salary at termination and is paid in a single lump. For a Non-extension of Term by the Company, severance is continued payment of base salary for six (6) months following the date on which Mr. Joll receives the notice of non-renewal. For a Disability Termination, severance is continued payment of base salary for thirty (30) days following the notice of termination by us.

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³ The bonus amount shown in the event of a Resignation for Good Reason orTermination without Cause is an amount that the Board determines is their good-faith estimate of the pro rata amount of the bonus that would become payable for that year in which the termination or resignation occurs, based upon the goals agreed to by us and Mr. Joll for that year, payable at the end of the year.

Eric Ameres

Executive Vice President and Chief Technical Officer

Executive Benefits and Payments Upon Separation1	Resignation for Good Reason		Non-extension of Term by the Executive		Resignation without Good Reason		Termination for Cause		Termination without Cause		Non-extension of Term by the Company		Disability Termination		Death Termination
Compensation:
Severance2	$	0	$	0	$	0	$	1,800	$	96,250	$	0	$	1,800	$	1,800
Bonus3	$	0	$	0	$	0	$	0	$	0	$	0	$	0	$	0
Benefits & Perquisites:4
Health Plan Continuation5	$	0	$	0	$	0	$	0	$	7,150	$	0	$	0	$	0
Total	$	0	$	0	$	0	$	1,800	$	103,400	$	0	$	1,800	$	1,800

¹ The amounts shown in the above tables were computed based on the following assumptions: the termination date was December 31, 2006; Mr. Ameres’s base salary was $190,000.

² Severance is continuation of annual base salary for one (1) year from the date of termination in the event of a Termination without Cause.

Matthew Frost

Executive Vice President and General Counsel

Executive Benefits and Payments Upon Separation1	Resignation for Good Reason		Non-extension of Term by the Executive			Resignation without Good Reason			Termination for Cause		Termination without Cause		Non-extension of Term by the Company			Disability Termination		Death Termination
Compensation:
Severance2	$	212,000		$	0		$	0	$	9,600	$	91,250		$	0	$	9,600	$	9,600
Bonus3	$	0		$	0		$	0	$	0	$	0		$	0	$	0	$	0
Benefits & Perquisites:4
Health Plan Continuation5	$	0		$	0		$	0	$	11,650	$	11,650		$	0	$	11,650	$	11,650
Total	$	212,000		$	0		$	0	$	21,250	$	102,900		$	0	$	21,250	$	21,250

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¹ The amounts shown in the above tables were computed based on the following assumptions: the termination date was December 31, 2006; Mr. Frost’s base salary was $182,500.

² Severance is continuation of annual base salary for one (1) year from the date of termination in the event of a Termination without Cause.

Life Insurance Benefit. If Mr. Joll had died on December 31, 2006, his survivor would have received $250,000 under the supplemental term life insurance policy for which we annually reimburse premiums. If Mr. Ameres had died on December 31, 2006, his survivor would have received $190,004.88 under the supplemental term life insurance policy for which we annually reimburse premiums. If Mr. Frost had died on December 31, 2006, his survivor would have received $182,500.08 under the supplemental term life insurance policy for which we annually reimburse premiums. If Mr. Principe had died on December 31, 2006, his survivor would have received $138,450.24 under the supplemental term life insurance policy for which we annually reimburse premiums.

NON-MANAGEMENT DIRECTOR COMPENSATION FOR FISCAL 2006

We use a combination of cash and equity-based incentive compensation to attract and retain qualified candidates to serve as non-management directors on the Board. Director compensation is reviewed annually by the Compensation Committee and changes are made to the total director compensation package when the Board determines that such changes are appropriate. The Compensation Committee may from time to time engage independent compensation consultants to evaluate our director compensation program relative to the same Peer Group of companies that the Compensation Committee will consider in setting executive compensation, as described in the Compensation Discussion and Analysis on page 5. During the fiscal year ended December 31, 2006, each non-management director received an annual retainer fee of $10,000 for service on the Board and $5,000 for each committee on which they serve, except that non-management directors who are chairmen of committees shall $10,000 for their service on each such committee. In addition, a non-management chairman of the Board receives an annual cash retainer fee of $10,000 for service as chairman. All members of the Board are reimbursed for actual expenses incurred in connection with attendance at Board meetings and committee meetings.

Name	Fees Earned or Paid in Cash		Option Awards		Total
James Meyer1	$	14,167.00			$	14,167.00
William Newman		15,000.00			$	15,000.00
Thomas Weigman		15,000.00			$	15,000.00
J. Allen Kosowsky		40,000.00	$	72,000	$	112,000.00
Mike Kopetski		15,000.00			$	15,000.00
Mike Alfant		15,000.00			$	15,000.00
Afsaneh Naimollah		17,917.00			$	17,917.00

¹ Mr. Meyer also received compensation for his service as Interim Chief Executive Officer. See page 11. He did not receive a fee for his service on the Board during the term of his employment as Interim Chief Executive Officer.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ON2 TECHNOLOGIES, INC.
By:	/s/ Bill Joll
	Bill Joll
	Director, President   and Chief Executive Officer   (Principal Executive Officer)

Date:  October 10, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the Company and in the capacities and on the dates indicated.

Signature	Title	Date
	Senior Vice President and Chief Financial Officer (Principal Financial and	October 10, 2007
/s/ Anthony Principe	Accounting Officer)
(Anthony Principe)
/s/ J. Allen Kosowsky	Chairman of the Board and Director	October 10, 2007
(J. Allen Kosowsky)
/s/ William A. Newman	Director	October 10, 2007
(William A. Newman)
/s/ Mike Kopetski	Director	October 10, 2007
(Mike Kopetski)
/s/ Michael J. Alfant	Director	October 10, 2007
(Michael J. Alfant)
/s/ Afsaneh Naimollah	Director	October 10, 2007
(Afsaneh Naimollah)
/s/ James Meyer	Director	October 10, 2007
(James Meyer)

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INDEX TO EXHIBITS

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	Date Filed	Filed Herewith
3.1	Certificate of Incorporation of the Company	10-K	April 2, 2001
3.2	Bylaws of the Company	8-K	Feb. 8, 2006
4.1	Securityholders Agreement, dated as of Dec. 1, 1999, between the Company and thirteen securityholders party thereto	10-K	March 30, 2000
4.2	Form of Investor Rights Agreement, dated as of Dec. 1, 1999,between the Company and each of nine investors	10-K	March 30, 2000
4.3	Form of Warrant issued to the investors party to the Investor Rights Agreement	10-K	March 30, 2000
4.4	Form of Investors’ Rights Agreement between the Company and the holders of Series C Preferred Stock, Series C-II Preferred Stock and Series C-III Preferred Stock	S-3	Dec. 8, 2000
4.5	Certificate of Designations for the Company’s Series C Preferred Stock	10-K	April 2, 2001
4.6	Certificate of Designations for the Company’s Series C-II Preferred Stock	10-K	April 2, 2001
4.7	Certificate of Designations for the Company’s Series C-III Preferred Stock	10-K	April 2, 2001
4.8	Form of Warrant issued to the holders of Series C, Series C-II and Series C-III Preferred Stock	10-K	April 2, 2001
4.9	Common Stock Purchase Agreement, dated as of July 18, 2001 by and between the Company and Real.	SB-2/A	Sept. 13, 2001
4.10	Investor Rights Agreement, dated as of July 18, 2001, between Real and the Company	SB-2/A	Sept. 13, 2001
4.11	Indemnity Agreement, dated as of January 28, 2002, by and among The Travelers Insurance Company, Travelers Indemnity Company, and the Company	S-3	July 11, 2003
4.12	Investor’s Rights Agreement, dated as of January 29, 2001, between the Company and Abanat Limited	S-3	Oct. 1, 2003
4.13	Common Stock Purchase Warrant, dated as of August 24, 2006	10-K	August 25, 2006
10.1	License Agreement by and between the Company and Bevmax Office Centers 1560, LLC	10-K	March 15, 2006
10.2	Restated Lease Agreement by and between the Company and Sitterly Associates II	10-K	March 15, 2006
10.3	Separation and Consultancy Agreement by and between the Company and Douglas A. McIntyre, dated as of February 2, 2006	10-K	March 15, 2006
10.4	Employment Agreement, dated May 1, 2006, by and between the Company and Bill Joll	10-Q	May 5, 2006
10.5	Amended and Restated Employment Agreement, dated May 1, 2006, by and between the Company and Tim Reusing	10-Q	Aug. 2, 2006
10.6	Securities Purchase Agreement, dated as of August 24, 2006	8-K	Aug. 25, 2006
10.7	Registration Rights Agreement, dated as of August 24, 2006	8-K	Aug. 25, 2006
10.8	Stockholder Voting Agreement	8-K	Aug. 25, 2006
10.9	Asset Purchase Agreement (Confidential Treatment Requested as to Redacted Portions)	8-K/A	Nov. 17, 2006
10.10	Exhibit B [sic] to Asset Purchase Agreement (Form of Escrow Agreement)	8-K/A	Nov. 17, 2006
10.11	Exhibit C [sic] to Asset Purchase Agreement (Form of Support and Maintenance Agreement)	8-K/A	Nov. 17, 2006
10.12	Exhibit D [sic] to Asset Purchase Agreement (Form of Registration Rights Agreement)	8-K/A	Nov. 17, 2006

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		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	Date Filed	Filed Herewith
10.13	Employment Agreement, dated as of February 28, 2006, by and between the Company and Matt Frost		*
21	Subsidiaries	10-K	March 31, 2003
23.1	Consent of Eisner LLP		*
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Action of 2002			x
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Action of 2002			x
32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002			x
32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002			x

* Previously Filed.

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