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

                                    FORM 10-Q
(Mark One)

|X|   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934
                                  For the quarterly period ended March 31, 2006.

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
      EXCHANGE ACT OF 1934.
                                    For the transition period from ____ to ____.

Commission file number 1-15117.


                             ON2 TECHNOLOGIES, INC.
--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)


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

21 Corporate Drive, Suite 103, Clifton Park, New York                 12065
--------------------------------------------------------------------------------
(Address of principal executive offices)                            (Zip Code)

                                 (518) 348-0099
--------------------------------------------------------------------------------
              (Registrant's telephone number, including area code)


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



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


      Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
                                                                  |_| Yes |X| No


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


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


                                      -1-
<PAGE>

--------------------------------------------------------------------------------

                      APPLICABLE ONLY TO CORPORATE ISSUERS:


      Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest applicable date:


The number of shares of the Registrant's Common Stock, par value $0.01 ("Common
Stock"), outstanding, as of May 5, 2006, was 95,389,522.



                                      -2-
<PAGE>


                               TABLE OF CONTENTS


<TABLE>
<CAPTION>

PART I -- FINANCIAL INFORMATION
                                                                                                             Page

Item 1.  Consolidated Financial Statements.

<S>                                                                                                            <C>
Condensed Consolidated Balance Sheets at March 31, 2006 (unaudited) and December 31, 2005......................  5
Unaudited Condensed Consolidated Statements of Operations,
  Three Months Ended March 31, 2006 and 2005...................................................................  6
Unaudited Condensed Consolidated Statements of Comprehensive loss,
  Three Months Ended March 31, 2006 and 2005...................................................................  7
Unaudited Condensed Consolidated Statements of Cash Flows
  Three Months Ended March 31, 2006 and 2005...................................................................  8
Notes to Unaudited Condensed Consolidated Financial Statements................................................. 10

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations................. 15

Item 3.  Quantitative and Qualitative Disclosures About Market Risk............................................ 24

Item 4.  Controls and Procedures............................................................................... 24

PART II -- OTHER INFORMATION

Item 1.  Legal Proceedings..................................................................................... 25

Item 6.  Exhibits and Reports on Form 8-K...................................................................... 26

Signatures..................................................................................................... 27

Certifications................................................................................................. 28


</TABLE>


                                      -3-
<PAGE>



                         PART I -- FINANCIAL INFORMATION

Item 1.  Consolidated Financial Statements






















                                      -4-
<PAGE>





                             ON2 TECHNOLOGIES, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                                  March 31,        December 31,
                                                                                    2006               2005
                                                                               ----------------    -----------------
                                                                                 (unaudited)
                                     ASSETS
<S>                                                                            <C>                 <C>
   Current assets:
     Cash and cash equivalents................................................ $    3,287,000      $     3,976,000
     Marketable securities, at market.........................................         68,000              181,000
     Accounts receivable......................................................        790,000              746,000
     Prepaid expenses and other current assets................................        148,000              186,000

        Total current assets..................................................      4,293,000            5,089,000
                                                                               ----------------    -----------------

   Acquired software, net.....................................................        616,000              667,000
   Other acquired intangibles, net............................................        143,000              154,000
   Goodwill...................................................................        244,000              244,000
   Property and equipment, net................................................        137,000              131,000
   Other assets...............................................................         63,000               29,000
                                                                               ----------------    -----------------
        Total assets.......................................................... $    5,496,000      $     6,314,000
                                                                               ================    =================

                      LIABILITIES AND STOCKHOLDERS' EQUITY

   Current liabilities:
     Accounts payable......................................................... $      272,000      $        41,000
     Accrued expenses.........................................................        509,000              608,000
     Deferred revenue.........................................................        142,000              241,000
     Capital lease obligation.................................................         21,000               20,000
                                                                               -------------------------------------
        Total current liabilities.............................................        944,000              910,000

   Capital lease obligation, excluding current portion........................                               6,000
   Convertible debentures.....................................................                             244,000
                                                                               ----------------    -----------------

         Total liabilities                                                            944,000            1,160,000

   Series D redeemable convertible preferred stock                                  3,615,000            3,790,000

   Commitments and contingencies..............................................

   Stockholders' equity:
     Preferred stock..........................................................         19,000               19,000
     Common stock.............................................................        951,000              923,000
     Additional paid-in capital...............................................    120,970,000          119,772,000
     Unearned compensation....................................................       (400,000)
     Accumulated other comprehensive loss.....................................        (44,000)             (43,000)
     Accumulated deficit......................................................   (120,559,000)        (119,307,000)
                                                                               ----------------    -----------------
       Total stockholders' equity.............................................        937,000            1,364,000
                                                                               ----------------    -----------------
       Total liabilities and stockholders' equity............................. $    5,496,000      $     6,314,000

                                                                               ================    =================
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements


                                      -5-
<PAGE>


                             ON2 TECHNOLOGIES, INC.
            UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                                                       Three Months Ended March 31,
                                                                                   ------------------------------------
                                                                                         2006                2005
                                                                                   ----------------    ----------------

<S>                                                                                <C>                 <C>
Revenue.........................................................................   $     1,217,000     $       353,000

Operating expenses:
     Cost of revenue (1)........................................................           583,000             369,000
     Research and development (2)...............................................           225,000             258,000
     Sales and marketing (2)....................................................           188,000             111,000
     General and administrative (2).............................................         1,260,000             717,000
     Equity-based compensation:
        Research and development................................................            27,000
        Sales and marketing.....................................................            35,000
        General and administrative..............................................            48,000
                                                                                   ----------------    ----------------
Total operating expenses........................................................         2,366,000           1,455,000
                                                                                   ----------------    ----------------
Loss from operations............................................................        (1,149,000)         (1,102,000)

Interest and other expense, net.................................................           (27,000)           (200,000)
                                                                                   ----------------    ----------------
Loss before provision for income taxes..........................................        (1,176,000)         (1,302,000)

Provision for income taxes......................................................             3,000
                                                                                   ----------------    ----------------
Net loss........................................................................   $    (1,179,000)    $    (1,302,000)

Convertible preferred stock deemed dividend.....................................                               180,000
Convertible preferred stock 8% dividend.........................................            73,000              81,000
Accretion of costs associated with the Series D Preferred Stock.................                                21,000
                                                                                   ----------------    ----------------
Net loss attributable to common stockholders....................................   $    (1,252,000)    $    (1,584,000)
                                                                                   ================    ================

Basic and diluted net loss attributable to common stockholders per common share.   $         (0.01)    $         (0.02)
                                                                                   ================    ================

Weighted average basic and diluted common
  shares outstanding............................................................        92,919,000          85,755,000
                                                                                   ================    ================
</TABLE>

(1)   Includes equity-based compensation of $57,000 for the three months ended
      March 31, 2006.

(2)   Excludes equity-based compensation, which is presented separately.



See accompanying notes to unaudited condensed consolidated financial statements


                                      -6-
<PAGE>



                             ON2 TECHNOLOGIES, INC.
        UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

<TABLE>
<CAPTION>

                                                                      Three Months Ended
                                                            ---------------------------------------
                                                                           March 31,
                                                                   2006                 2005
                                                            -----------------    -----------------
<S>                                                         <C>                  <C>
Net loss....................................                $     (1,179,000)    $     (1,302,000)

Other Comprehensive income:

     Foreign currency translation adjustment                          (1,000)               7,000
                                                            -----------------    -----------------
Comprehensive loss  .................................       $     (1,180,000)    $     (1,295,000)
                                                            =================    =================

</TABLE>



See accompanying notes to unaudited condensed consolidated financial statements






                                      -7-
<PAGE>



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

<TABLE>
<CAPTION>


                                                                           Three Months Ended March 31,
                                                                      ---------------------------------------
                                                                            2006                   2005
                                                                      ----------------       ----------------
<S>                                                                   <C>                    <C>
 Cash flows from operating activities:

   Net loss.........................................................  $    (1,179,000)       $    (1,302,000)
     Adjustments to reconcile net loss to net cash
     used in operating activities:
         Equity based compensation..................................          167,000
      Depreciation and                                                         80,000                 19,000
      amortization..................................................
      Amortization of debt discount.................................            6,000                  3,000
      Unrealized loss on marketable equity securities...............           38,000                212,000
    Changes in operating assets and liabilities:
      Accounts receivable, net......................................          (44,000)              (112,000)
      Prepaid expenses and other current assets.....................           38,000                (15,000)
      Other assets..................................................          (34,000)                27,000
      Accounts payable and accrued expenses.........................          135,000               (283,000)
      Deferred revenue..............................................          (99,000)                (7,000)
                                                                      ----------------       ----------------
 Net cash used in operating activities..............................         (892,000)            (1,458,000)
                                                                      ================       ================
 Cash flows from investing activities:

   Proceeds from the sale of marketable securities..................           75,000

   Purchases of property and equipment..............................          (24,000)               (52,000)
                                                                      ----------------       ----------------
 Net cash provided by (used in) investing activities................           51,000                (52,000)
                                                                      ================       ================
 Cash flows from financing activities:

   Principal payments on capital lease obligations..................           (5,000)                (4,000)
   Principal payments on term-loan..................................                                 (62,000)
   Proceeds from exercise of common stock options and warrants......          158,000              4,158,000
                                                                      ----------------       ----------------
 Net cash provided by financing activities..........................          153,000              4,092,000
                                                                      ----------------       ----------------
 Net change in cash and cash equivalents............................         (688,000)             2,582,000

 Effect of exchange rate changes on cash and cash equivalents.......           (1,000)                 7,000

 Cash and cash equivalents, beginning of period.....................        3,976,000              5,418,000
                                                                      ----------------       ----------------
 Cash and cash equivalents, end of period...........................  $     3,287,000        $     8,007,000
                                                                      ================       ================
</TABLE>


                                      -8-
<PAGE>


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


SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH INVESTING AND
FINANCING ACTIVITIES:

<TABLE>
<CAPTION>

                                                                                Three Months Ended March 31,
                                                                           ---------------------------------------
                                                                                   2006               2005
                                                                           ---------------------------------------
<S>                                                                         <C>                    <C>

Cash paid during the period for:
  Interest............................................................      $        1,000         $     1,000
                                                                         ========================================
  Taxes...............................................................      $        6,000
                                                                         ==================
Non-cash transactions:
 Unearned Compensation from the issuance of common stock options......      $      567,000
                                                                         ==================
 Common stock issued for dividends on Series D Preferred Stock........      $       75,000         $    80,000
                                                                         ========================================
 Conversion of Series A Secured Debentures into common stock..........      $      250,000
                                                                         ==================
 Conversion of Series D Convertible Preferred stock...................      $      175,000
                                                                         ==================
 (Decrease) increase in accrued dividend on Series D Preferred Stock..      $       (2,000)        $     1,000
                                                                         ========================================
 Accretion of costs  associated  with the issuance
 of Series D Preferred Stock..........................................                             $  21,000
                                                                                                =================
     Convertible Preferred Stock deemed dividend......................                             $ 180,000
                                                                                                =================
</TABLE>


See accompanying notes to unaudited condensed consolidated financial statements



                                      -9-
<PAGE>


                             ON2 TECHNOLOGIES, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(1) Description of On2 Technologies, Inc.

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

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

(2) Basis of Presentation

      The unaudited  condensed  consolidated  financial  statements  include the
accounts of the  Company  and its wholly  owned  subsidiaries.  All  significant
intercompany balances and transactions have been eliminated in consolidation.

      The interim  condensed  consolidated  financial  statements are unaudited.
However,  in the opinion of management,  such financial  statements  contain all
adjustments  necessary to present  fairly the financial  position of the Company
and its results of operations and cash flows for the interim periods  presented.
The  condensed  consolidated  financial  statements  included  herein  have been
prepared  pursuant to the rules and  regulations  of the Securities and Exchange
Commission  ("SEC").  Certain  information  and  footnote  disclosures  normally
included  in  consolidated  financial  statements  prepared in  accordance  with
accounting  principals  generally  accepted in the United States of America have
been condensed or omitted  pursuant to such rules and  regulations.  The Company
believes  that  the  disclosures  included  herein  are  adequate  to  make  the
information  presented not misleading.  These condensed  consolidated  financial
statements  should be read in conjunction with the annual  financial  statements
and notes thereto  included in the Company's Form 10-K Report filed with the SEC
on March 15, 2006.

(3) Stock-Based Compensation

      In December 2004, the Financial Accounting Standards Board ("FASB") issued
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 the
Company  accounted for stock based  compensation  using the intrinsic value , if
any. The Company  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.  The Company
recognizes  share-based  compensation  costs on a  straight-line  basis over the
requisite  service  periods of awards.  That cost is recognized as  compensation
expense over the service  period,  which would normally be the vesting period of
the options.

                                      -10-
<PAGE>

      Pursuant  to  the  Company's  1999  Amended  and  Restated  Incentive  and
Nonqualified  Stock Option Plan (the "1999  Plan"),  5,500,000  shares of Common
Stock are  reserved  for  issuance.  The 1999 Plan  provides for the issuance of
incentive stock options,  which are intended to qualify under Section 422 of the
Internal Revenue Code,  non-qualified stock options and restricted stock grants.
The granting of incentive  stock  options is subject to the  limitations  as set
forth in the 1999 Plan.  Directors,  officers,  employees  and  consultants  are
eligible to receive  grants  under the 1999 Plan.  A  committee  selected by the
Company's  Board of Directors has the authority to approve option grants and the
terms,  which include the option price and the vesting  terms.  Options  granted
under  the  1999  Plan  expire  after  a  ten-year  period  and are  subject  to
acceleration upon the occurrence of certain events.

      Pursuant to the Company's 2000  Nonqualified  Stock Option Plan (the "2000
Plan"),  5,000,000  shares  of the  Company's  Common  Stock  are  reserved  for
issuance.  The 2000 Plan authorizes the Board of Directors to issue nonqualified
stock  options  as  provided  in  Section  422 of  the  Internal  Revenue  Code,
restricted  stock and  stock  appreciation  rights.  Only  employees,  including
officers,  of the Company and its  subsidiaries  are eligible to receive  grants
under the 2000 Plan. A committee  selected by the  Company's  Board of Directors
has the  authority to approve  option  grants and the terms,  which  include the
option price and the vesting terms.  Options  granted under the 2000 Plan expire
after a ten-year period and are subject to  acceleration  upon the occurrence of
certain events.

      In May 2005,  the Company's  stockholders  approved the On2  Technologies,
Inc.  2005  Incentive  Compensation  Plan (the  "2005  Plan").  Pursuant  to the
Company's 2005 Plan, 7,000,000 shares of the Company's Common Stock are reserved
for issuance, as Performance Grants, Restricted Stock, Goal-Based Stock options,
or Stock  Appreciation  rights.  Options  granted  under  the  2005  Plan may be
incentive  Stock Options or  Nonstatutory  Stock Options.  Employees,  including
officers,  of the Company and its  subsidiaries  are eligible to receive  grants
under the 2005 Plan.  The 2005 Plan also permits the award of only  Nonstatutory
Stock  Options  and  Restricted  Stock to  directors  on the On2 Board,  if such
directors  are not  employees  of On2 and  individuals  who are  consultants  or
advisors to On2. The 2005 Plan is administered by the Compensation Committee, of
the  Board  for  all  present  and  future  employees  of the  Company  and  its
subsidiaries.  The Board will administer the 2005 Plan for outside directors and
consultants,  based upon  recommendations  by the  Compensation  Committee.  The
Compensation Committee has the authority to approve option grants and the terms,
which include the option price and the vesting terms.  Options granted under the
2005 Plan expire after an eight-year period.




                                      -11-
<PAGE>

The following table  illustrates the effect on net income and earnings per share
if the fair value based method had been applied to the prior period.

<TABLE>
<CAPTION>

                                                                              Three months
                                                                            ended, March 31,
                                                                                  2005
                                                                           --------------------

<S>                                                                              <C>
     Reported net loss attributable to common stockholders                       $ (1,584,000)
     Stock-based employee compensation determined under
     the fair value-based method, prior to the adoption of SFAS 123R                 (309,000)
                                                                                 ------------

     Pro forma net loss attributable to common stockholders                      $ (1,893,000)
                                                                                 ============

     Loss per common share (basic and diluted):
         As reported                                                                 $  (0.02)
                                                                                     ========
         Pro forma                                                                   $  (0.02)
                                                                                     ========


Stock based  compensation  expense recognized in the Statement of Operations was
$167,000   and  $0  for  the  three  months  ended  March  31,  2006  and  2005,
respectively.

The following  table  summarizes the activity of the Company's stock options for
the three months ended March 31, 2006:

<CAPTION>

                                                                                          Weighted
                                                                          Weighted         Average
                                                                          Average         Remaining       Aggregate
                                                                       Exercise Price    Contractual      Intrinsic
                                                          Shares                            Life            Value
                                                      ---------------- --------------- ---------------- --------------
<S>                                                         <C>                 <C>               <C>     <C>
Number of shares under option:

Outstanding at January 1, 2006                             10,299,000           $0.98
Granted                                                         5,000            0.82
Exercised                                                    (46,000)            0.68
Canceled or expired                                         (860,000)            0.67
                                                      ---------------- ---------------

Outstanding at March 31, 2006                               9,398,000           $1.01             7.15    $ 1,560,000
                                                      ================================================================

Exercisable at March 31, 2006                               8,358,000           $1.04              7.0    $ 1,497,000
                                                      ================================================================
</TABLE>


      The aggregate intrinsic value of options exercised during the three months
ended March 31, 2006 was $33,000.



                                      -12-
<PAGE>


The following  summarizes the activity of the Company's non-vested stock options
for the three months ended March 31, 2006:

                                                         Weighted Average
                                                          Grant Date Fair
                                           Shares              Value
                                     ------------------- ------------------

Non-vested at January 1, 2006                 2,035,000             $ 0.69
Granted                                           5,000               0.82
Cancelled or expired                          (850,000)               0.68
Vested during the period                      (150,000)               0.46
                                     ------------------- ------------------

Non-vested at March 31, 2006                  1,040,000              $0.75
                                     =================== ==================


      As  of  March  31,  2006,   there  was  $400,000  of  total   unrecognized
compensation cost related to non-vested  share-based  compensation  arrangements
granted  under  existing  stock  option  plans.  This  cost  is  expected  to be
recognized over a  weighted-average  period of 0.83 years.  The total grant date
fair value of shares  vested  during the  three-months  ended March 31, 2006 was
$69,000.


      The Company uses the Black-Scholes  option-pricing  model to determine the
weighted  average  fair value of  options.  The fair value of options at date of
grant and the assumptions utilized to determine such values are indicated in the
following table:

<TABLE>
<CAPTION>

                                                                                         Three months
                                                                                             ended
                                                                                        March 31, 2006
                                                                                       ------------------

<S>                                                                                           <C>
Weighted average fair value at date of grant for options granted during the period            $    0.68

Expected stock price volatility                                                                     116%
Expected life of options                                                                         5 years
Risk free interest rates                                                                            4.7%
Expected dividend yield                                                                               0%

</TABLE>



(4) Marketable Securities

      As of December 31, 2005 the Company held 2,119,000  shares of a customer's
common stock with a market value of $106,000,  which were received as payment of
license fees in 2004.  During the quarter ended March 31, 2006, there was a 1:50
reverse  stock split and the number of shares was reduced to 42,000.  The market
value of these  shares  decreased  to $69,000  ($1.62 per share) as of March 31,
2006.  The market value of these shares was $81,000  ($1.90 per share) as of May
2, 2006. The Company  classifies these shares as trading securities and pursuant
to SFAS  No.  115,  "Accounting  for  Certain  Investments  in Debt  and  Equity
Securities",  unrealized  gains and losses are included in the  determination of
net income (loss).  Other income includes $38,000 and $212,000 of net unrealized
loss for the three months ended March 31, 2006 and 2005, respectively,  on these
securities. The Company's former Chief Executive Officer (who was a director and
shareholder  of the Company) was a director of this  customer.  During the three
months ended March 31, 2006, the Company sold securities with for $75,000.

                                      -13-
<PAGE>

(5) Series A Secured Convertible Debentures

      During the three months ended March 31, 2006 a debenture  holder converted
$250,000  face value  Series A Secured  Convertible  Debentures  into  2,232,000
shares of the  Company's  common  stock.  As of March 31,  2006 all the Series A
Secured  Convertible  Debentures  have been converted into the Companies  common
stock. The Company recognized $6,000 of interest expense upon the conversion for
the unamortized balance of the debt discount.

(6) Series D Redeemable, Convertible Preferred Stock

      During the three months ended March 31, 2006 Midsummer  Capital  converted
175  shares of their  Series D  redeemable,  convertible  preferred  stock  into
250,000 shares of the Company's common stock.

(7) Common Stock Warrants

      During the three  months  ended March 31,  2006  certain  warrant  holders
exercised  their  warrants  and the Company  received  proceeds of $127,000  and
issued 232,000 shares of Common Stock.


(8) Customer Concentration

      For the three months ended March 31, 2006,  three customers  accounted for
16%, 16% and 14% of revenues.  For the three months ended March 31, 2005,  three
customers accounted for 35%, 34% and 17% of the revenues.

(9) Flix Acquisition

      On April 29, 2005 the Company  acquired certain assets related to the Flix
software  line of  Wildform,  pursuant  to the terms of the Asset  Purchase  And
Software License Agreement.  Pursuant to the terms of the agreement, the Company
acquired  certain  assets related to the Flix software and received a perpetual,
irrevocable,   royalty-free,   sub-licensable   license  to  use  certain  other
intellectual property (the "Licensed Flix IP") related to the Flix software. The
Company also  received a  perpetual,  irrevocable,  royalty-free  license to use
certain web sales software  ("E-Commerce  Software").  In addition,  the Company
granted  Wildform a perpetual  license to use the purchased  Flix assets and new
versions of the Flix software in certain new software  products being  developed
by Wildform in exchange for a payment of a royalty to the Company by Wildform.

      Had the Company acquired the Flix assets as of January 1, 2005 there would
have been a nominal  effect on revenue and  expenses  for the three months ended
March 31, 2005.


                                      -14-
<PAGE>


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

FORWARD-LOOKING STATEMENT

      This document  contains  forward-looking  statements within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934.  These  statements  relate to future  events or our future
financial  performance and are not statements of historical fact. In some cases,
you can  identify  forward-looking  statements  by  terminology  such as  "may,"
"will,"  "should,"   "expect,"  "plan,"   "anticipate,"   "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.  Although we believe that the expectations  reflected in
the  forward-looking  statements  are  reasonable,  we cannot  guarantee  future
results, levels of activity, performance or achievements, and in all cases, such
statements are subject to the Company's ability to secure  additional  financing
or to  increase  revenues  to support its  operations.  We believe  that we have
sufficient  funds and will generate  sufficient  funds to finance our operations
for the next 12 months.  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-Q.  You
should  consider the material  presented in this Form 10-Q in  conjunction  with
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations  - Risk  Factors  That May Affect  Future  Operating  Results" in the
Company's Form 10-K for the year ended December 31, 2005

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

OVERVIEW

      On2 Technologies is a leading video  compression  technology firm. 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 software is based solely on intellectual  property that we developed
and own ourselves.


                                      -15-
<PAGE>

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


PRODUCTS                     o        Video codecs;
                             o        Audio codecs; and
                             o        encoding and server software, for
                                      use with video delivery platforms

SERVICES                     o        Customized engineering and
                                      consulting services;
                             o        Technical support; and
                             o        High-level video encoding


      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:

<TABLE>
<CAPTION>

       TYPE OF CUSTOMER APPLICATION                           EXAMPLES
       ----------------------------                           --------

<S>                                        <C>       <C>
Video and Audio Distribution over           o        Providing video-on-demand services to
Proprietary Networks                                 residents in multi-dwelling units (MDUs)
                                            o        Video surveillance

Consumer Electronic Devices                 o        Digital video players
                                            o        Digital video recorders

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

Video and Audio Distribution over           o        Video-on-demand
IP-based Networks (Internet)                o        Teleconferencing services
                                            o        Video instant messaging
                                            o        Video for Voice-over-IP (VOIP) services
</TABLE>


      In addition,  as discussed at greater length below, 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.

      As  covered in greater  detail  below,  we earn  revenue  chiefly  through
licensing  our software  and  providing  specialized  software  engineering  and
consulting services to customers. In addition to license fees, we often charge a
royalty  fee  based on the  number  of  units  of some or all of the  customer's
products  that  contain the  relevant  On2  software  products  that are sold or
distributed.  Some of our  agreements  with  customers  also  require  that  the
customers  pay us a percentage  of the revenues that they earn from any of their
products  or  services  that  use our  software.  Royalties  may be  subject  to
guaranteed minimum amounts and/or maximum amounts (e.g., annual caps).

                                      -16-
<PAGE>

      We have recently begun selling  products and services that extend from 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 encode video and other multimedia  content for playback
on Adobe(R) Flash(R) player,  which is a widely  distributed  multimedia player.
The Flix  brand  has  existed  since the  advent of Flash  video and has a loyal
following  among its users.  Because Adobe has integrated our VP6 codec software
into its Flash 8 player,  we 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  wide  distribution of the Flash 8
player.

      In addition to licensing our software to software developers and end users
for their own use, we sell licenses to certain  third-party  resellers.  We also
generally  require that  customers pay us if they desire to receive any upgrades
to our software  (e.g.,  from VP6 to VP7). We charge a fee for  engineering  and
consulting services,  based on an estimate of the time it will take our software
engineers to provide the services, or an hourly fee for ongoing services such as
product support.

      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,  as 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 with greater
complexity.   Increased   compression   rates  frequently  result  in  increased
complexity.  While  customers  want software that produces the highest  possible
compression  rates and the best possible  decompressed  image, they also want to
keep production  costs low by using the  lowest-powered  and  accordingly  least
expensive chips that still perform the processing they require. In addition,  in
some embedded applications,  such as mobile devices, size and power constraints,
in addition to price issues,  can limit the capability of the chips.  Of course,
in  devices in which 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).

                                      -17-
<PAGE>

      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  mentioned  above,  an  increasing  number  of our  license  agreements  with
customers  provide  for the  payment  of fees that are  dependent  either on the
number of units of a customer's product incorporating our software that are sold
or on the amount of revenue generated by a customer from the sale of products or
services that  incorporate  our software.  We have chosen this  licensing  model
because,  as a company of only  approximately  35 employees,  we do not have the
product  development  or marketing  resources  to develop and market  end-to-end
video  solutions.  Instead,  our software is primarily  intended to be used as a
building  block for companies  that are  developing  end-to-end  video  products
and/or services.

      As addressed above, 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'
often  superior  ability to produce and market  end-to-end  video  products  and
services,   while   offering   those   customers   the   benefit  of   including
technologically-advanced software in their applications. As with arrangements in
which  we  receive   royalties  or  revenue   shares,   the  ability  to  market
complementary  products  can  yield  total  revenues  over  time in excess of an
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 of
significant  value. But unlike royalties and revenue shares,  which we generally
expect to receive  without any  significant  additional  effort on our part, the
successful sale of complementary  products requires that we effectively  execute
an end-user product development and marketing program.  Developing and marketing
products aimed at end users is a relatively new business for us. Until recently,
we had generally  produced  software  targeted at developers,  who integrate our
software into their products.

      Although  we  believe  that we  have  adopted  the  licensing  model  most
appropriate  for a business of our size and expertise,  a natural result of this
licensing  model is that the  revenue we  generate  is highly  dependent  on the
success of our customers' product deployments. 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, the revenues we earn from that relationship are likely not to
attain  significant  levels.  Conversely,  if one or  more  of  such  customers'
products is widely adopted, our revenues will likely be enhanced.

      Another significant trend in our business is the emergence of Microsoft 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's  commitment  to and  presence  in the media
delivery industry has increased.  Microsoft  distributes its competing streaming
encoder,  media server,  player,  tools and digital  rights  management  ("DRM")
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 third parties with whom we have relationships. Finally,
Microsoft's DRM 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 DRM does not  integrate  well with
non-Microsoft  video and audio software.  Many companies that want to distribute
copy-protected content are therefore forced to choose Microsoft video technology
to be able to use Microsoft's DRM technology.

                                      -18-
<PAGE>

      Another  trend is the  emergence  of H.264 as 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  get when
licensing H.264.  H.264 has  nevertheless  started to gain 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 such standard.  In addition, at least several manufacturers of
multimedia  processors  have done the work  necessary  to have H.264  operate on
their  chips.  These  advantages  may allow  potential  customers to implement a
solution  based on H.264 with less initial  development  time and expense than a
solution using On2 Video might require,  even though the H.264 solution could be
less efficient and more expensive than On2 Video solution in the final analysis.
In addition,  there are certain customers that prefer to license standards-based
codecs.

      We are also watching with interest and  participating in the trend towards
the proliferation of consumer-created  video content on the web. As Internet use
has grown worldwide and Internet  connection  speeds have  increased,  there has
been a marked  increase  in  consumer-created  content  on the web.  While  that
content initially 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  groundswell  in
consumer-created  video  content.  Weblogs  (blogs) and podcasts  (broadcasts of
audio content to iPod(R) and MP3 devices) are evolving to include video content.
A number of services are being offered to host consumer-created  video, and many
commercial sites now also feature amateur videos. The continued proliferation of
consumer-created  video  on the  Internet  may  have a  positive  effect  on our
business. The Adobe(R) Flash(R) video is a popular format for Web video. Because
Flash 8 uses  On2's VP6 codec,  On2 may have the  opportunity  to license  Flash
encoding tools for use in video blogs, video podcasts,  and to  consumer-created
video services or to individual users of those services.

      The  market  for  digital  media  creation  and  delivery   technology  is
constantly  changing and has become intensely and increasingly  competitive.  We
have and continue to take a number of steps to address this  competition.  First
and   foremost,    we   focus   on   providing   our   customers    with   video
compression/decompression  technology  that delivers the highest  possible video
quality at the lowest  possible  data  rates.  In order to do this,  we devote a
significant  portion of our  engineering  capacity to research and  development.
Although we expect that competition from Microsoft, H.264 developers, and others
will -  intensify,  we also 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
address  the  competitive  threats  that  we  face  by  focusing  on  developing
relationships  with  customers  who do not want to do  business  with  Microsoft
and/or  do not find the  complex  and  rigid  standards-based  licenses  and fee
structures appealing.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

      This  discussion  and analysis of our  financial  condition and results of
operations are based on our condensed  consolidated  financial  statements  that
have been prepared  pursuant to the rules and  regulations of the Securities and
Exchange  Commission  ("SEC").  The  preparation  of our condensed  consolidated
financial  statements requires management to make estimates and assumptions that
affect  the  reported  amounts  of  assets  and  liabilities  at the date of the
financial statements and the reported amounts of revenue and expenses during the
reporting  period.  Actual results could materially differ from those estimates.
The condensed  consolidated  financial  statements and the related notes thereto
should be read in  conjunction  with the  following  discussion  of our critical
accounting  policies and our Form 10-K filed with the SEC on March 15, 2006. Our
critical accounting policies and estimates are:

                                      -19-
<PAGE>

o        Revenue recognition
o        Equity-based compensation
o        Valuation of goodwill, intangible assets and other long-lived assets

      Revenue  recognition.  We  currently  recognize  revenue  from the sale of
software  licenses and professional  services.  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  Statement of Position  ("SOP")
97-2, "Software Revenue  Recognition",  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".  Under each
arrangement,  revenues are recognized when a  non-cancelable  agreement has been
signed and the customer  acknowledges  an  unconditional  obligation to pay, the
products  or  applications  have  been  delivered,  there  are no  uncertainties
surrounding  customer  acceptance,  the fees are  fixed  and  determinable,  and
collection is considered  probable.  Revenues  recognized from  multiple-element
software  arrangements are allocated to each element of the arrangement based on
the  fair  values  of the  elements,  such as  product  licenses,  post-contract
customer support,  or training.  The determination of the fair value is based on
the vendor specific  objective evidence available to us. If such evidence of the
fair value of each  element  of the  arrangement  does not  exist,  we defer all
revenue  from the  arrangement  until such time that  evidence of the fair value
does exist or until all elements of the arrangement are delivered.

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

      When engineering and consulting services are sold together with a software
license,  the  arrangement  typically  requires  customization  and  integration
(porting)  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  generally  require 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".  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.

                                      -20-
<PAGE>

      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 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.  Pro  forma
disclosure  is no longer an  alternative.  The Company  adopted the provision of
SFAS No.  123R  effective  January  1,  2006,  using  the  modified  prospective
transition method.  Under the modified  prospective method,  equity 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 and  modifications.  The Company  recognizes
share-based  compensation  costs on a  straight-line  basis  over the  requisite
service  periods of awards  which would  normally  be the vesting  period of the
options.

      Valuation of goodwill and  intangible  assets.  We evaluate our long-lived
assets in accordance with Statement of Financial  Accounting  Standards ("SFAS")
No. 121,  "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of. Long-lived assets are reviewed for impairment whenever
events or changes in  circumstances  indicate that the net carrying value of the
asset may not be recoverable.  In such circumstances,  the net carrying value of
the asset is compared to the undiscounted  future cash flows which that asset is
expected to generate.

      SFAS No. 142, "Goodwill and Other Intangible Assets" requires goodwill and
other  intangible  assets with  indefinite  lives to be tested for impairment at
least  annually,  and written off when impaired,  rather than being amortized as
previously required.


RESULTS OF OPERATIONS

      Revenue.

      Revenue  for the three  months  ended  March 31,  2006 was  $1,217,000  as
compared to $353,000  for the three  months  ended  March 31,  2005.  Revenue is
derived primarily from the sale of software licenses and engineering and support
services.  For the three  months  ended  March 31,  2006,  46% of the  Company's
revenue was  generated  from 3  customers.  For the three months ended March 31,
2005, 86% of the Company's revenue was generated from 3 customers.

      Operating expenses

      The Company's operating expenses consist of cost of revenue,  research and
development,  sales and  marketing  and  general  and  administrative  expenses.
Operating expenses for the three months ended March 31, 2006, were $2,366,000 as
compared to $1,455,000 for the three months ended March 31, 2005.

      Cost of Revenue.  Cost of revenue includes  personnel and related overhead
expenses,  consulting compensation costs, operating lease costs and depreciation
and amortization  costs. Cost of revenue was $583,000 for the three months ended
March 31,  2006 as compared to  $369,000  for the three  months  ended March 31,
2005.  The  increase of $214,000  for the three  months  ended March 31, 2006 as
compared  with the three months ended March 31, 2005 is  principally a result of
increases in amortization of the acquired intangibles related to the purchase of
the Flix product line, costs  associated with the support  services  provided by
Wildform  in  connection  with  support  of  the  Flix  software,   equity-based
compensation  and the increased use of resources in connection  with an increase
in engineering service related projects for customers.

                                      -21-
<PAGE>

      Research and  Development.  Research and  development  expenses  primarily
consist of personnel and related overhead  expenses and consulting  compensation
costs  associated  with the  development  and  production  of our  products  and
services, operating lease costs and depreciation costs. Research and development
expenses  for the three  months  ended March 31, 2006 were  $225,000,  excluding
equity-based compensation,  which is shown separately, as compared with $258,000
for the three months ended March 31, 2005.  The decrease of $33,000 is primarily
a result of the  increased  use of resources in  connection  with an increase in
engineering  service related  projects for customers.  We believe that continued
investments  in  research  and   development   are  necessary  to  maintain  our
competitive advantage and we will continue to invest in such costs as considered
necessary.

      Sales and Marketing.  Sales and marketing  expenses  consist  primarily of
salaries and related overhead costs of sales, business development and marketing
personnel,  tradeshow costs,  marketing and promotional costs incurred to create
brand awareness and public relations expenses.  Sales and marketing expenses for
the three months ended March 31, 2006,  were  $188,000,  excluding  equity-based
compensation,  which is shown separately,  as compared to $111,000 for the three
months  ended March 31,  2005.  The increase of $77,000 is primarily a result of
increases  in  personnel  and related  overhead  from the  addition of two sales
people in the second  quarter of 2005. We intend to continue to recruit and hire
experienced  personnel  or  consultants,  as  necessary,  to sell and market our
products and services.

      General and  Administrative.  General and administrative  expenses consist
primarily  of  salaries  and  related  personnel  costs  for  general  corporate
functions,  professional  fees,  insurance,  rent and depreciation.  General and
administrative costs for the three months ended March 31, 2006, were $1,260,000,
excluding equity-based compensation, which is shown separately, as compared with
$717,000 for the three months  ended March 31,  2005.  The $543,000  increase is
principally  attributable to an increase in professional fees in connection with
the Company's  internal  investigation  into facts and circumstances  concerning
investor and other  communications made by the Company's former Chairman,  Chief
Executive Officer and President.  On May 4, 2006, the Company's outside law firm
submitted  its final  report to the Board of Directors  in  connection  with the
investigation,  and the Board will review the report and determine what, if any,
further action to take in connection with the investigation. The Company has not
uncovered any evidence of financial impropriety,  and thus the Company continues
to  believe  that the  investigation  will have no effect  on  previously  filed
financial statements or lead to any restatement of reported financial results.

      Interest  and other  expense,  net.  Interest and other  expense,  net was
$27,000 for the three  months  ended March 31, 2006 as compared to $200,000  for
the three months ended March 31, 2005. Interest and other expense, net primarily
consists of interest paid for capital  lease  obligations  and  long-term  debt,
amortization of debt discount and unrealized loss on marketable securities.  The
$173,000 decrease for the three months ended March 31, 2006 as compared with the
three months ended March 31, 2005 is principally  attributable  to a decrease in
the net loss on marketable securities.

      Equity-based  compensation,  In December  2004,  the Financial  Accounting
Standards  Board  ("FASB")  issued 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.  Pro  forma
disclosure  is no longer an  alternative.  The Company  adopted the provision of
SFAS No. 123R effective January 1, 2006. The equity-based  compensation  expense
represents  the fair value of non-cash  compensation  expense 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. The
equity-based  compensation expense for the three months ended March 31, 2006 was
$167,000 of which  $57,000 is included in cost of revenue and  $110,000 is shown
separately.

                                      -22-
<PAGE>

      At March 31, 2005, we had approximately 36 full-time employees.  We expect
to hire employees as necessary in order to attain our strategic objectives.


LIQUIDITY AND CAPITAL RESOURCES

      At March 31,  2006,  we had cash and cash  equivalents  of  $3,287,000  as
compared to  $3,976,000  at December 31, 2005. At March 31, 2006 the Company had
working capital of $3,349,000 as compared with $4,179,000 at December 31, 2005.

      Net cash used in operating  activities was $892,000 and $1,458,000 for the
three  months ended March 31, 2006 and 2005,  respectively.  The decrease in net
cash used in operating activities is primarily attributable to a decrease in the
net loss, an increase in equity-based  compensation  and the changes in accounts
payable and accrued  expenses  partially  offset by a decrease in the unrealized
loss on marketable securities.

      Net cash  provided  by (used in)  investing  activities  was  $51,000  and
($52,000) for the three months ended March 31, 2006 and 2005, respectively.  The
increase  of $103,000 is a result of $75,000  from the sale of  investments  and
$28,000 decrease from the purchase of property and equipment.

      Net cash provided by financing  activities was $153,000 and $4,092,000 for
the three  months ended March 31, 2006 and 2005,  respectively.  The decrease is
principally attributable to $4,000,000 decrease in proceeds from the exercise of
common stock options and warrants.

      We  currently  have no material  commitments  for the next 12 months other
than those under our operating lease  arrangements.  These arrangements  consist
primarily of lease  arrangements  for our office space in Clifton Park, New York
and New York City. The aggregate  required payments for the next 12 months under
these arrangements are $154,000. Notwithstanding the above, our most significant
non-contractual  operating  costs for the next 12 months  are  compensation  and
benefit costs,  insurance costs and general overhead costs such as telephone and
utilities.  During the next 12 months,  we  anticipate  incurring  approximately
$600,000 per month in cash operating costs.

      The  Company  believes  that  existing  funds are  sufficient  to fund its
operations  through at least March 31, 2007.  The Company plans to increase cash
flows from operations  principally from increases in revenue  generated from its
compression  technology  services  and  products.  The  Company  may also pursue
additional  financings.  See "Management's  Discussion and Analysis of Financial
Condition  and  Results of  Operations  - Risk  Factors  That May Affect  Future
Operating  Results" in the Company's  10-K for the year ended December 31, 2005,
filed on March 15, 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
technology services and products.  However, there are no assurances that we will
be  successful  in effecting  such  increases.  The market for  distribution  of
broadband technology services is highly competitive.  Additionally,  our capital
requirements  depend on numerous  factors,  including  market  acceptance of our
technology  and services,  research and  development  costs and the resources we
spend on  marketing  and selling our  products and  services.  Additionally,  we
continue to evaluate  investments  in  complementary  businesses,  products  and
services, some of which may be significant.


                                      -23-
<PAGE>


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  is
material to investors.


IMPACT OF RECENTLY-ISSUED ACCOUNTING PRONOUNCEMENTS

      None


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK

      The Company does not currently have any material exposure to interest rate
risk, foreign currency risk,  exchange rate risk,  commodity price risk or other
relevant  market  rate or price  risks.  However,  the  Company  does  have some
exposure to foreign  currency  rate  fluctuations  arising from  maintaining  an
office for the Company's U.K.  based,  wholly-owned  subsidiary  which transacts
business in the local  functional  currency.  The U.K. based subsidiary does not
conduct any sales and all their costs are funded in United  States  dollars.  To
date,  the Company has not entered into any derivative  financial  instrument to
manage foreign  currency risk and is not currently  evaluating the future use of
any such financial instruments.



ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures:

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

                                      -24-
<PAGE>

(b) Changes in Internal Controls:

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













                                      -25-
<PAGE>

                          PART II -- OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS

INTERNAL INVESTIGATION

      On March 2, 2006,  the Company filed a Form 8-K,  which  disclosed that it
had voluntarily  reported to the Securities and Exchange Commission ("SEC") that
the  Company  had   undertaken   an  internal   investigation   into  facts  and
circumstances concerning investor and other communications made by the Company's
former  Chairman,   Chief  Executive  Officer  and  President.  The  Company  is
voluntarily  working  with  the SEC to  complete  the  investigation,  which  is
ongoing.  On May 4, 2006,  the  Company's  outside law firm  submitted its final
report to the Board of Directors in connection with the  investigation,  and the
Board will review the report and determine what, if any,  further action to take
in connection with the investigation. The Company has not uncovered any evidence
of  financial  impropriety,  and thus the Company  continues to believe that the
investigation  will have no effect on previously  filed financial  statements or
lead to any restatement of reported financial results.

BEIJING E-WORLD

On March 31, 2006,  On2  commenced  arbitration  against its  customer,  Beijing
E-World  relating to a dispute arising from two license  agreements that On2 and
E-World entered into in June 2003.

Under those  agreements,  On2 licensed the source code to its video  compression
(codec)  technology  to E-World for use in  E-World's  video disk (EVD) and high
definition  television  (HDTV)  products  as  well  as  for  other  non-EVD/HDTV
products.  We believe that the license agreements impose a number of obligations
on E-World, including the requirements that:

      o     E-World pay to On2 certain minimum quarterly payments; and

      o     E-World  use best  reasonable  efforts  to have  On2's  video  codec
            "ported"  to  (i.e.,  integrated  with)  a chip  to be  used  in EVD
            players.

On2 has previously commenced  arbitration  regarding the license agreements with
E-World. In March 2005, the London Court of International  Arbitration  tribunal
released the decision of the  arbitrator,  in which he dismissed On2's claims in
the prior  arbitration,  as well as E-World's counter claims, and ruled that the
license  agreements  remained in effect;  and that the parties had a  continuing
obligation to work towards porting On2's software to two  commercially-available
DSPs.

Although a year has passed since the conclusion of the previous arbitration, the
parties have  nevertheless  not completed the required porting of On2's software
to two commercially available DSPs.

On2's current  arbitration claim alleges that, despite its obligations under the
license agreements, E-World has:

      o     Failed to pay On2 the quarterly  payments of  $1,232,000,  which On2
            believes are currently due and owing; and

      o     Failed to use best  reasonable  efforts  to have On2's  video  codec
            ported to a chip.

On2 has requested that the arbitrator  award it  approximately  $5,690,000.00 in
damages  under  the  contract  and  grant it  further  relief as may be just and
equitable. E-World has not yet responded to On2's claims.


                                      -26-
<PAGE>


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

      (a) Exhibits

10.1  Employment Agreement, dated May 1, 2006, by and between the Company and
      Bill Joll

31.1  Certification of Chief Executive Officer Pursuant to Rule
      13a-14(a)/15d-14(a)

31.2  Certification of Chief Financial Officer Pursuant to Rule
      13a-14(a)/15d-14(a)

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

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


      (b) Reports on Form 8-K

      The Company filed Form 8-K on February 8, 2006, announcing:

      o     The resignation of Douglas A. McIntyre from his positions as
            Chairman, President and CEO of the Company and his position as a
            member of the Board of Directors of the Company;
      o     The Termination of the Company's employment agreement with Mr.
            McIntyre;
      o     The entry into a Separation and Consultancy Agreement with Mr.
            McIntyre;
      o     The appointment of James Meyer as Interim CEO of the Company;
      o     The appointment of J. Allen Kosowsky as the non-executive,
            non-employee Chairman of the Board of Directors;
      o     The entry into an employment agreement with Mr. Meyer;
      o     Certain amendments to Articles III and IV of the Company's Bylaws

      The 8-K filed on February 8 also contained a press release  announcing the
      resignation  of Mr.  McIntyre and the  appointments  of Messrs.  Meyer and
      Kosowsky.

      The Company filed Form 8-K on March 2, 2006 announcing:

      o     the termination of its Separation and Consultancy agreement with
            Douglas A. McIntyre
      o     that the Company had voluntarily reported to the U.S. Securities and
            Exchange Commission the preliminary results of an internal
            investigation; and
      o     the reallocation of responsibilities and restructuring of reporting
            responsibilities of certain officers of the Company.

      The 8-K filed on March 2 also contained a press release announcing the
      Company's results of operations for the fiscal quarter ending December 31,
      2005.

      The Company filed Form 8-K/A on March 9, 2006, announcing further
      information regarding the Company's internal investigation.





                                      -27-
<PAGE>



                                   SIGNATURES

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

                                                 On2 Technologies, Inc.
                                         ---------------------------------------
                                                    (Registrant)



May 5, 2006                                /s/ Anthony Principe
--------------------                     ---------------------------------------
(Date)                                                (Signature)
                                           Anthony Principe
                                           Senior Vice President and
                                           Chief Financial Officer
                                               (Principal Financial Officer)


                                      -28-