ORTHOLOGIC CORP (Form: 10-Q, Received: 08/08/2006 17:28:02)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended June 30, 2006


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

For the transition period from to

Commission File Number: 0-21214

ORTHOLOGIC CORP.

(Exact name of registrant as specified in its charter)


Delaware		86-0585310

(State of other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)


1275 W. Washington Street, Tempe, Arizona		85281

(Address of principal executive offices)		(Zip Code)

(602) 286-5520

(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. þ Yes o No

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

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 practicable date.

41,564,291 shares of common stock outstanding as of July 28, 2006

ORTHOLOGIC CORP.
(A Development Stage Company)
INDEX


			Page
			No.
Part I Financial Information

Item 1. Financial Statements (Unaudited)

Condensed Balance Sheets as of June 30, 2006 and December 31, 2005			3

Condensed Statements of Operations for the three and six months ended June 30, 2006 and 2005			4

Condensed Statements of Cash Flows for the six months ended June 30, 2006 and 2005			5

Notes to Unaudited Condensed Financial Statements			6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14

Item 3. Quantitative and Qualitative Disclosures about Market Risk			20

Item 4. Controls and Procedures			20

Part II Other Information

Item 1A. Risk Factors			21

Item 4. Submission of Matters to a Vote of Security Holders			23

Item 6. Exhibits			23
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 10.7
Exhibit 10.8
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I – Financial Information

Item 1. Financial Statements

ORTHOLOGIC CORP.
(A Development Stage Company)

CONDENSED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)


	June 30,			December 31,
	2006			2005

ASSETS
Current assets
Cash and cash equivalents	$	36,992		$	35,111
Short-term investments		28,425			46,437
Prepaids and other current assets		546			857

Total current assets		65,963			82,405

Furniture and equipment, net		512			525
Long-term investments		10,182			2,084
Deferred income taxes		—			1,106
Patents, net		2,170			2,223


Total assets	$	78,827		$	88,343


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities
Accounts payable	$	785		$	1,036
Accrued compensation		448			711
Accrued clinical		557			544
Accrued severance and restructuring costs		349			602
Other accrued liabilities		829			1,089

Total current liabilities		2,968			3,982

Deferred rent and other non-current liabilities		412			183

Total liabilities		3,380			4,165

Stockholders’ Equity
Common Stock $.0005 par value; 100,000,000 shares authorized; 40,661,039 and 38,124,742 shares issued and outstanding at 2006 and 2005, respectively		20			19
Additional paid-in capital		185,646			171,355
Accumulated deficit		(110,219	)		(87,196	)

Total stockholders’ equity		75,447			84,178


Total liabilities and stockholders’ equity	$	78,827		$	88,343

See notes to unaudited condensed financial statements

ORTHOLOGIC CORP.
(A Development Stage Company)

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)


													As a Development
	Three months ended June 30,						Six months ended June 30,						Stage Company
	2006			2005			2006			2005			8/5/2004 - 6/30/2006

OPERATING EXPENSES
General and administrative	$	2,061		$	1,273		$	4,153		$	2,183		$	10,941
Research and development		4,208			5,991			10,924			11,394			44,448
Other divestiture and related gains		—			—			—			(250	)		(375	)
Purchased in-process research and development		34			—			8,469			—			34,309

Total operating expenses		6,303			7,264			23,546			13,327			89,323

Interest income, net		(867	)		(654	)		(1,629	)		(1,206	)		(5,020	)

Loss from continuing operations before taxes		5,436			6,610			21,917			12,121			84,303
Income tax expense (benefit)		1,106			—			1,106			(12	)		356


Loss from continuing operations		6,542			6,610			23,023			12,109			84,659

Discontinued operations — net gain on the sale of the bone device business, net of taxes ($267)		—			—			—			—			(2,202	)


NET LOSS	$	6,542		$	6,610		$	23,023		$	12,109		$	82,457


Per Share Information:
Net loss, basic and diluted	$	0.16		$	0.17		$	0.58		$	0.32


Basic and diluted shares outstanding		40,622			38,220			39,962			38,134

See notes to unaudited condensed financial statements

ORTHOLOGIC CORP.
(A Development Stage Company)

CONDENSED STATEMENTS OF CASH FLOW

(in thousands)

(Unaudited)


							As a Development
	For six months ended June 30,						Stage Company
	2006			2005			8/5/2004 – 6/30/2006

OPERATING ACTIVITIES
Net loss	$	(23,023	)	$	(12,109	)	$	(82,457	)
Non-cash items:
Depreciation and amortization		507			231			939
Deferred tax expense		1,106			—			770
Non-cash stock compensation		1,652			—			1,814
Gain on sale of bone device business		—			—			(2,298	)
In-process research and development		8,469			—			34,309
Change in other operating items:
Prepaids and other current assets		310			(425	)		1,163
Accounts payable		(251	)		410			65
Accrued liabilities		(1,105	)		(161	)		(616	)

Cash flows used in operating activities		(12,335	)		(12,054	)		(46,311	)

INVESTING ACTIVITIES
Expenditures for equipment and furniture		(83	)		(87	)		(402	)
Proceeds from sale of assets		—			—			7,000
Cash paid for assets of AzERx/CBI		(390	)		—			(4,058	)
Cash paid for patent assignment rights		(100	)		(400	)		(500	)
Purchases of investments		(24,463	)		(29,891	)		(113,848	)
Maturities of investments		34,377			38,744			133,179

Cash flows provided by investing activities		9,341			8,366			21,371

FINANCING ACTIVITIES
Net proceeds from stock option exercises		2,962			44			4,612
Net proceeds from sale of stock		1,913			—			1,913

Cash flows provided by financing activities		4,875			44			6,525


NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		1,881			(3,644	)		(18,415	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		35,111			38,377			55,407

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	36,992		$	34,733		$	36,992


Supplemental Disclosure of Non-Cash Investing Activities	AzERx						AzERx and CBI
AzERx/CBI Acquisitions
Current assets acquired	$	—					$	29
Patents acquired		—						2,142
Liabilities acquired, and accrued acquisition costs		(315	)					(455	)
Original investment reversal		—						(750	)
In-process research and development acquired		8,469						34,309
Common stock issued for acquisition		(7,764	)					(31,217	)

Cash paid for acquisition	$	390					$	4,058

See notes to unaudited condensed financial statements

ORTHOLOGIC CORP.
(A Development Stage Company)

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2006

OVERVIEW OF BUSINESS

Description of the business

OrthoLogic is a biotechnology company committed to developing a pipeline of novel peptides and other molecules aimed at helping patients with under-served conditions. We are focused on the development and commercialization of two product platforms: Chrysalin® (TP508) and AZX100.

Chrysalin, the Company’s first novel synthetic peptide, is being studied in two lead indications, both of which represent areas of significant unmet medical need – fracture repair and diabetic foot ulcer healing. Based on the Company’s pioneering scientific research of the natural healing cascade, OrthoLogic has become a leading company focused on bone and tissue repair. The Company owns exclusive worldwide rights to Chrysalin.

AZX100, the Company’s second peptide, is a novel synthetic pre-clinical 24-amino acid peptide, one of a new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™. AZX100 is currently being evaluated for medically and commercially significant applications, such as the treatment of vasospasm associated with subarachnoid hemorrhage, the prevention of keloid scarring, pulmonary fibrosis, and the treatment of asthma. OrthoLogic has an exclusive worldwide license to AZX100.

We continue to explore other biopharmaceutical compounds that can complement our research activity internally and broaden our potential pipeline for successful products.

Company History

Prior to November 26, 2003, we developed, manufactured and marketed proprietary, technologically advanced orthopedic products designed to promote the healing of musculoskeletal bone and tissue, with particular emphasis on fracture healing and spine repair. Our product lines included bone growth stimulation and fracture fixation devices including the OL1000 product line, SpinaLogic® and OrthoFrame/Mayo, which we sometimes refer to as our “Bone Device Business.”

On November 26, 2003, we sold our Bone Device Business. Our principal business remains focused on tissue repair, although through biopharmaceutical approaches rather than through the use of medical devices.

On August 5, 2004, we purchased substantially all of the assets and intellectual property of Chrysalis Biotechnology, Inc. (“CBI”), including its exclusive worldwide license for Chrysalin for all medical indications, for $2.5 million in cash and $25.0 million in OrthoLogic common stock plus an additional $7.0 million in OrthoLogic common stock upon the occurrence of certain triggering events. We became a development stage entity commensurate with the acquisition. Subsequently, all of our collective efforts were focused on research and development of our Chrysalin Product Platform, with the goal of commercializing our products.

On February 23, 2006 the Company entered into an agreement to purchase certain assets and assume certain liabilities of AzERx, Inc. The transaction was completed (closed) on February 27, 2006. Under the terms of the transaction, OrthoLogic acquired an exclusive license for the core intellectual property relating to AZX100, and will continue to develop the new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™, based on the unique technology developed by AzERx. The acquisition provides the Company with a new technology platform that diversifies the portfolio, and may provide more than one potential product. AzERx’s lead compound is AZX100, a 24-amino acid synthetic peptide. AZX100 is currently being evaluated for medically important and commercially significant applications such as the treatment of vasospasm associated with subarachnoid hemorrhage (SAH), prevention of keloid scarring, pulmonary fibrosis and the treatment of asthma. Preclinical and human in vitro studies have shown that this novel compound has the ability to relax smooth muscle in multiple tissue types. The Company will continue pre-clinical activities on AZX100 in 2006.

Our development activities for the Chrysalin Product Platform and AZX100 represent a single operating segment as they share the same product development path and utilize the same Company resources. As a result, we have determined that it is appropriate to reflect our operations as one reportable segment. Through June 30, 2006, we have incurred $82 million in net losses as a development stage company.

In these notes, references to “we”, “our” and the “Company” refer to OrthoLogic Corp. References to our Bone Device Business refer to our former business line of bone growth stimulation and fracture fixation devices, including the OL1000 product line, SpinaLogic®, OrthoFrame® and OrthoFrame/Mayo.

Financial Statement Presentation

In the opinion of management, the unaudited condensed interim financial statements include all adjustments necessary for the fair presentation of our financial position, results of operations, and cash flows. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the complete fiscal year.

Use of estimates: The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that management make a number of assumptions and estimates that affect the reported amounts of assets, liabilities, and expenses in our financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s assumptions regarding current events and actions that may impact the Company in the future, actual results may differ from these estimates and assumptions. Our critical accounting policies are those that affect, or could affect, our financial statements materially and involve a significant level of judgment by management. The accounting policies and related risks described in our Annual Report for the year ended December 31, 2005 are those that depend most heavily on these judgments and estimates. As of June 30, 2006, there have been no material changes to any of the critical accounting policies contained therein, except for the adoption of SFAS No. 123(R) as disclosed in Note A.

As discussed in the following section of this report, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the results of the Company’s Phase 3 Chrysalin fracture repair human clinical trial will result in a change in our planned clinical pathway and timeline for our Chrysalin fracture repair indication. This potential change, when factored with

our current significant net operating loss carryovers and current period net loss, has resulted in a revision of our estimate of the need for a valuation allowance for the previously recorded deferred tax asset related to a Alternative Minimum Tax credit carryover. Due to the uncertainty that the deferred tax asset will be realized, we have recorded a valuation allowance for the full amount of the deferred tax asset ($1,106,000) at June 30, 2006.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to Securities and Exchange Commission rules and regulations, although the Company believes that the disclosures herein are adequate to make the information presented not misleading. These unaudited condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

New Accounting Pronouncements. In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109), (“FIN 48”), which clarifies the relevant criteria and approach for the recognition, de-recognition and measurement of uncertain tax positions. FIN 48 will be effective for the Company beginning January 1, 2007. We are currently in the process of assessing the provisions of FIN 48, but do not expect the adoption of FIN 48 to have a material impact on our financial statements.

A. STOCK BASED COMPENSATION . SFAS No. 123(R) supersedes APB No. 25 and revises guidance in SFAS No. 123. Effective January 1, 2006 we adopted SFAS No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)). SFAS 123(R) requires all share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. Under this standard, the fair value of each employee stock option and employee stock purchase right is estimated on the date of grant using an option pricing model that meets certain requirements. We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payments. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We use the historical volatility adjusted for future expectations. The expected life of the stock options is based on historical data and future expectations. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our stock options and stock purchase rights. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock units is based on the fair market value of our common stock on the date of grant. Stock-based compensation expense recognized in our financial statements in 2006 and thereafter is based on awards that are ultimately expected to vest. The amount of stock-based compensation expense in 2006 and thereafter will be reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We will evaluate the assumptions used to value stock awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. To the extent that we grant additional equity securities to employees, our stock-based compensation expense will be increased by the additional compensation resulting from those additional grants. The Company chose the modified-prospective transition alternatives in adopting SFAS 123(R). Under the modified-prospective transition method, compensation cost is recognized in financial statements issued subsequent to the date of adoption for all stock-based payments granted, modified or settled after the date of adoption, as well as for any unvested awards that were granted prior to the date of adoption. Because the Company previously adopted only the pro

forma disclosure provisions of SFAS 123, we will recognize compensation cost relating to the unvested portion of awards granted prior to the date of adoption using the same estimate of the grant-date fair value and the same attribution method used to determine the pro forma disclosure under SFAS 123, except that a forfeiture rate will be estimated for all options, as required by SFAS 123(R).

Unrecognized non-cash stock compensation expense related to unvested options outstanding as of December 31, 2005 was approximately $1 million ( includes 328,124 shares valued at $500,000 unvested and cancelled on April 5, 2006 upon the resignation of James M. Pusey, MD). Because of the significant expected forfeiture rate caused by the options cancelled at the time of Dr. Pusey’s resignation, the expected compensation cost for unvested options at December 31, 2005, was approximately $400,000. Compensation costs recorded for the six months ended June 30, 2006, for the options outstanding and unvested at December 31, 2005 was $118,000. At June 30, 2006 the remaining compensation cost related to unvested options outstanding at December 31, 2005, is approximately $300,000, which will be recognized over the remaining vesting period of approximately three years, with an estimated weighted average period of 1.2 years.

We have provided the required additional disclosures below which illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123(R), “Accounting for Stock-based Compensation,” to stock-based employee compensation (in thousands except per share data) prior to the actual date of adoption of SFAS No. 123 (R), January 1, 2006.


	Three months ended			Six months ended
	June 30, 2005			June 30, 2005

Estimated weighted-average fair value of options granted during the period	$	2.66		$	3.78


Net loss attributable to common stockholders:
As reported	$	(6,610	)	$	(12,109	)
Stock based compensation expense (included in net loss)		—			—
Stock based compensation expense, net of tax		(315	)		(580	)


Pro forma	$	(6,925	)	$	(12,689	)


Basic and diluted net loss per share:
As reported	$	(0.17	)	$	(0.32	)
Pro forma	$	(0.18	)	$	(0.33	)

Black-Scholes model assumptions:
Risk free interest rate		3.7	%		3.7	%
Expected volatility		79	%		63	%
Expected term	2.6 Years			2.6 Years
Dividend yield		0	%		0	%

2006 Stock Options

On June 2, 2006, the Board of Directors granted options to purchase 800,000 shares of the Company’s common stock, at an exercise price of $1.70 per share, to certain Company employees. These options vest pro rata over a two-year period.

On May 12, 2006, The Board of Directors of the Company granted each Director a fully vested option to purchase 25,000 shares of the Company’s common stock at an exercise price of $1.75.

As part of their service agreements, on May 12, 2006, the Board granted options to John M. Holliman, III, Executive Chairman, and Randolph C. Steer, MD, Ph.D., President, to each purchase 200,000 shares of the Company’s common stock, at an exercise price of $1.75 per share. The options vest pro rata over a two-year period.

During the three months ended March 31, 2006, the Board granted employees options to purchase 584,000 shares of the Company’s common stock at exercise prices ranging from $4.73 to $5.39 per share. These options vest over a four-year period. On January 1, 2006, the Board also granted each Director a fully vested option to purchase 10,000 shares of the Company’s common stock at an exercise price of $4.90 per share.

The Company used the Black-Scholes model with the following assumptions, to determine the total fair market value of $3,350,000 for options to purchase 1,994,000 shares of the Company’s common stock issued during the six months ended June 30, 2006.


	Three months ended			Three months ended
	March 31, 2006			June 30, 2006

Risk free interest rate		4.8	%		5.2	%
Volatility		73	%		70	%
Expected term from vesting	2.9 years			2.9 years
Dividend yield		0	%		0	%

Using an estimated forfeiture rate of 5%, compensation cost recorded for the six months ended June 30, 2006, for options issued in that period, was $932,000. The options granted generally vest over a two to four-year period from the date of grant and, accordingly, the remaining unamortized cost at June 30, 2006 of approximately $2,400,000 will be amortized ratably over the period ending December 31, 2009, with an estimated weighted average period of 1.2 years.

2006 Restricted Stock

On May 12, 2006, the Shareholders of the Company approved the 2005 Equity Incentive Plan, which reserves an additional 2,000,000 of the Company’s common stock for equity incentive awards. In conjunction with the approval, on May 12, 2006, the Board of Directors of the Company awarded 117,750 shares of restricted stock, of which 87,550 shares are fully vested at June 30, 2006, and 30,200 shares will vest December 31, 2006. All of the restricted stock awards had been conditionally awarded in 2005, subject to shareholder approval of the 2005 Equity Incentive Plan. Of the restricted shares awarded, 62,750 shares related to annual awards to the Board of Directors, and 55,000 shares were performance based awards to officers of the Company. The total fair market value of the grants, determined using the closing price of the Company’s common stock on the date of grant, was $206,000, of which $176,000 has been recognized as compensation cost in the six months ended June 30, 2006.

In connection with the employment of James M. Pusey, MD, President and CEO, in March 2005, the Company granted Dr. Pusey 200,000 shares of restricted stock, which vested if certain

milestones were reached. In March 2006, 100,000 shares of restricted stock vested resulting in total compensation expense of $588,000, of which $426,000 was recorded in the quarter ended March 31, 2006 and $162,000 in fiscal year 2005, as general and administrative expenses. The compensation cost was determined using the closing price of the Company’s common stock on March 3, 2005, the date of grant. The remaining unvested 100,000 shares of restricted stock were cancelled upon Dr. Pusey’s resignation on April 5, 2006 of his employment with the Company.

Non-cash stock compensation cost for the six months ended June 30, 2006 totaled $1,652,000 of which $602,000 related to restricted stock, as described above. In the condensed Statements of Operations for the six months ended June 30, 2006, non-cash stock compensation expense of $1,310,000 was recorded as a general and administrative expense and $342,000 was recorded as a research and development expense.

During the six months ended June 30, 3006, options to purchase 670,400 shares of the Company’s common stock were exercised resulting in the receipt by the Company of net cash proceeds of $2,962,000.

A summary of option activity under our stock option plans for the six months ended June 30, 2006, is as follows:


						Weighted
				Weighted		average remaining
	Number of			average exercise		contractual term
	options			price		(years)

Options outstanding at December 31, 2005		3,135,575		$	5.28
Plus: Options granted		1,994,000		$	2.85

Less:
Options exercised		(670,400	)	$	4.42
Options expired/forfeited		(855,662	)	$	6.92

Options outstanding at June 30, 2006		3,603,513		$	3.70		7.87

Options exercisable at June 30, 2006		1,822,839		$	4.62		6.02

Options vested and expected to vest at June 30, 2006		3,499,226		$	3.72

A summary of the status of the Company’s unvested shares as of June 30, 2006, and changes during the six months ended June 30, 2006, is presented below:


				Weighted
				average
	Number of			Grant date
Unvested Shares	Options			Fair Value

Unvested shares at December 31, 2005		200,000		$	5.88
Granted		117,750		$	1.75
Vested		(187,550	)	$	3.95
Canceled/forfeited		(100,000	)	$	5.88

Unvested shares at June 30, 2006		30,200		$	1.75

It is the Company’s policy to issue options from shareholder approved incentive plans. However, if the options are issued as an inducement for an individual to join the Company, the Company may issue stock options outside of shareholder approved plans. The options granted under shareholder approved incentive plans have a ten-year term and vest over a two to four-year period of service. All options and stock purchase rights are granted with an exercise price equal to the current market value on the date of grant and, accordingly, options or stock purchase rights have no intrinsic value.

B. Acquisition of New Class of Molecules, ICARMs™

On February 23, 2006, the Company entered into an agreement to purchase certain assets and assume certain liabilities of AzERx, Inc. for $390,000 in cash and the issuance of 1,355,000 shares of the Company’s common stock. The transaction was completed (closed) on February 27, 2006. Under the terms of the transaction, OrthoLogic acquired an exclusive license for the core intellectual property relating to AZX100, and will continue to develop the new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™, based on the unique technology developed by AzERx.

The acquisition provides the Company with a new technology platform that diversifies the portfolio, and may provide more than one potential product. AzERx’s lead compound is AZX100, a 24-amino acid synthetic peptide. AZX100 is currently being evaluated for medically important and commercially significant applications such as the treatment of vasospasm associated with subarachnoid hemorrhage, prevention of keloid scarring, pulmonary fibrosis and the treatment of asthma. Preclinical and human in vitro studies have shown that this novel compound has the ability to relax smooth muscle in multiple tissue types.

The Company deemed the cost of the acquisition to be in-process research and development costs and, accordingly, charged the acquisition costs to research and development expense in the six month period ended June 30, 2006.

The costs associated with the acquisition were as follows:


Cash	$	390,000
Fair Market Value of the Company’s common stock issued (1)		7,764,000
Transaction costs		240,000
Liabilities assumed		75,000

In-process research and development costs	$	8,469,000


(1)		The fair market value of the Company’s common stock ($5.73) was determined by reference to the closing market price of the Company’s common stock for a reasonable period before and after February 24, 2006.

Valley Ventures III, L.P., an investment fund affiliated with the Chairman of the OrthoLogic Board of Directors, John M. Holliman, III, is a minority stockholder of AzERx. Mr. Holliman did not participate in the evaluation or approval of this transaction on behalf of OrthoLogic.

C. Sale of Shares of Company Stock, Issuance of Warrants and Entry into Master Services Agreement

On February 24, 2006 the Company entered into agreements with PharmaBio Development Inc., (dba NovaQuest), an affiliate of Quintiles, Inc., and Quintiles, Inc. (hereafter “Quintiles”), which provided for the purchase of $2,000,000 of the Company’s common stock, with the number of shares (359,279) determined by the 15-day average closing stock price prior to February 24, 2006 ($5.56). The transaction was completed (closed) on February 27, 2006. Additionally, at the election of the Company, Quintiles will purchase $1,500,000 of the Company’s common stock on June 30, 2006, (Second Closing) with the number of shares determined by the 15-day average closing stock price prior to June 30, 2006, and will purchase $1,500,000 of the Company’s common stock on September 29, 2006, with the number of shares determined by the 15-day average closing stock price prior to September 29, 2006 (Third Closing). Each stock purchase will include the issuance of fully vested warrants, exercisable for a ten-year period from the date of issuance, for an amount of shares equal to 13% of the shares purchased and with the exercise price set at 115% of the share price of each respective share purchase. (For the February 27, 2006 investment, warrants to purchase 46,706 shares at $6.39 were issued).

Summary of the February 27, 2006 stock sale transaction:


Capital stock and additional paid-in capital	$	1,913,000
Accrued transaction costs		87,000

Cash proceeds	$	2,000,000

Accrued transaction costs represent direct costs of the transaction (legal and accounting fees) and are treated as reduction of additional paid-in capital.

On July 3, 2006, the Company closed the transaction contemplated by the agreements on the Second Closing Date. Pursuant to the agreements, on July 3, 2006, the Company issued a total of 903,252 shares of its common stock to NovaQuest for a purchase price of $1,500,000 and issued a fully vested warrant to purchase 117,423 shares of the Company’s common stock at $1.91 a share.

As part of the transaction, the Company and Quintiles also entered into a Master Services Agreement whereby Quintiles agreed to become the Company’s exclusive contract research organization service provider for the Company’s Chrysalin Product Platform and to provide certain other technical assistance. The Company anticipates entering into a variety of contracts over the five-year term of the agreement as determined by the development and clinical progress of its Chrysalin products. In return for this agreement, the Company has granted Quintiles the right of first negotiation to promote Chrysalin with a specialty sales force under a fee-for-service or risk-based structure. Additionally, the Company has granted Quintiles warrants to purchase up to 240,000 shares of the Company’s common stock, with the exercise price set at 115% of the Second Closing stock price ($1.91). The shares will be exercisable for a ten-year period from February 27, 2006 and the warrants will vest based on the achievement of certain milestones (milestone warrants).

The total cost of the milestone warrants will be charged to expense over the period of performance. The costs will be determined based on the fair market value of the milestone warrants determined by using the Black-Scholes model, revalued at each Company reporting date until fully vested. The fair market value of the milestone warrants using the Black-Scholes model, 70% volatility, 0% dividend yield, expected term of 9.7 years, and 4.8% interest rate was $306,000 at June

30, 2006. No costs were charged to expense at June 30, 2006 as it is not yet probable that any milestone warrants will vest.

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

The following is management’s discussion of significant events in the three and six month periods ended June 30, 2006 and factors that affected OrthoLogic’s interim financial condition and results of operations. This should be read in conjunction with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2005 and Item 1A. Risk Factors included in Part II of this quarterly report.

Overview of the Business

OrthoLogic is a biotechnology company focused on the development and commercialization of the novel synthetic peptides Chrysalin ^® (TP508) and AZX100.

CHRYSALIN ®

Chrysalin (TP508) is being developed in two lead indications, both of which represent areas of significant unmet medical need – fracture repair and diabetic foot ulcer healing. Chrysalin, or TP508, is a 23-amino acid synthetic peptide representing a receptor-binding domain of the human thrombin molecule, a naturally occurring agent responsible for blood clotting and initiating the natural healing cascade of cellular events responsible for tissue repair in both bone and soft tissue.

On March 15, 2006, the Company reported results of an analysis of topline data from its Phase 3 clinical trial of the novel synthetic peptide Chrysalin (TP508) in subjects who sustained unstable, displaced distal radius (wrist) fractures. Treatment with 10 µg Chrysalin did not demonstrate a statistically significant benefit compared to placebo in the primary efficacy endpoint of time to removal of immobilization.

Within the secondary endpoints, radiographic evidence of time to radial cortical bridging, showed a statistically significant benefit for Chrysalin–treated subjects (p = 0.046). This benefit mirrored findings from the Phase 1/2 clinical trial that provided part of the foundation for the Phase 3 study. A statistically significant difference between Chrysalin treatment and placebo in the functional secondary endpoints was not observed. From a safety perspective, there were no adverse events related to Chrysalin reported in this Phase 3 trial, nor were there any differences in adverse event rates observed between the Chrysalin and placebo treated subject.

The Company is currently assessing Chrysalin in a Phase 2b human clinical trial in distal radius fracture, which is a double-blind, randomized placebo controlled trial that explores a wider dose range of Chrysalin, including 1 µg, 3 µg, 10 µg, or 30 µg doses. At March 15, 2006, the Company temporarily interrupted enrollment in its Phase 2b fracture repair dosing human clinical trial to perform an interim analysis of the subjects enrolled up to that date. The Company plans to announce the results of the interim analysis of the Phase 2b fracture repair human clinical trial in the 3 ^rd Quarter of 2006.

AZX100 — ICARMs™

On February 23, 2006, the Company entered into an agreement to purchase certain assets and assume certain liabilities of AzERx, Inc. The transaction was completed (closed) on February 27, 2006. Under the terms of the transaction, OrthoLogic acquired an exclusive license for the core intellectual property relating to AZX100, and will continue to develop the new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™, based on the unique technology developed by AzERx. The acquisition provides the Company with a new technology platform that diversifies the portfolio, and may provide more than one potential product. AzERx’s lead compound is AZX100, a 24-amino acid synthetic peptide. AZX100 is currently being evaluated for medically important and commercially significant applications such as the treatment of vasospasm associated with subarachnoid hemorrhage (SAH), prevention of keloid scarring, pulmonary fibrosis and the treatment of asthma. Preclinical and human in vitro studies have shown that this novel compound has the ability to relax smooth muscle in multiple tissue types. The Company will continue pre-clinical activities on AZX100 in 2006.

We continue to evaluate other biopharmaceutical compounds that can complement our research activity internally and broaden our potential pipeline for successful products.

Chrysalin Product Platform

Chrysalin, or TP508, is a 23-amino acid synthetic peptide representing a receptor-binding domain of the human thrombin molecule, a naturally occurring molecule in the body responsible for both blood clotting and initiating many of the cellular events responsible for tissue repair. Chrysalin mimics specific attributes of the thrombin molecule, stimulating the body’s natural healing processes. Drugs based on the Chrysalin peptide can be used to mimic part of the thrombin response without stimulating the events associated with blood clotting and therefore has the potential to accelerate the natural cascade of healing events. The Chrysalin molecule serves as the basis for a group of potential therapeutic products we refer to collectively as the “Chrysalin Product Platform.” We have conducted clinical trials for two potential Chrysalin products, acceleration of fracture repair, and diabetic foot ulcer. We previously conducted a pilot study for spine fusion. We have conducted pre-clinical testing for cartilage defect repair, cardiovascular repair, dental bone repair, and tendon repair (see the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 for additional comments on the Chrysalin Product Platform).

The development of each of our potential product candidates in the Chrysalin Product Platform is based on our collective knowledge and understanding of how the human thrombin molecule contributes to the repair of bone and soft tissue. While there are important differences in each of the product candidates in terms of purpose (fracture repair, diabetic foot ulcer healing, etc.) each product candidate is focused on accelerating and enhancing tissue repair and is based on the ability of Chrysalin to mimic specific attributes of the human thrombin molecule to stimulate the body’s natural healing process.

We are developing the Chrysalin-based product candidates, fracture repair and diabetic foot ulcer healing, in parallel. We expect to learn from the results of each trial and apply the findings to the development of the other product candidates. We believe there are distinct research activities within the product candidates whose outcomes and results will apply across the product platform in terms of safety and efficacy.

Through June 30, 2006, the Company has focused most of its efforts on the development and commercialization of fracture repair and diabetic foot ulcer healing indications. The results of the Company efforts in these two product candidates will affect when and what future actions are taken on the other product candidates described above.

Acceleration of Fracture Repair

Every broken bone is called a fracture and approximately 30 million fractures are treated every year throughout the developed world, as reported by medical reimbursement records in countries with national healthcare systems. The treatment of a fracture depends on the severity of the break. Simple fractures often heal themselves, with more complex closed fractures potentially amenable to treatment by manipulation (also called “reduction”) without requiring surgery. Fractures that break the skin (or “open fractures”) or where the fragments cannot be lined up correctly usually require surgery. Sometimes plates, screws or pins are used for mechanical stabilization, occasionally with the use of bone grafts, all of which are invasive, expensive and time consuming procedures.

Chrysalin is a substance that, when injected through the skin into the fracture site at the time of fracture reduction, was shown in a preliminary clinical trial to accelerate the healing of the fracture. Chrysalin does this by mimicking certain stimulatory aspects of the thrombin molecule. Fractures that heal faster lead to earlier return of function for the patient and potentially improved clinical outcomes.

In pre-clinical animal studies, a single injection of Chrysalin into the fracture gap accelerated fracture healing by up to 50% as measured by mechanical testing. In late 1999, we initiated a combined Phase 1/2 human clinical trial to evaluate the safety of Chrysalin and its effect on the rate of healing in adult subjects with unstable distal radius fractures (fractures around and in the wrist joint). We presented the results of this Phase 1/2 human clinical trial for fracture repair at the 57th Annual Meeting of the American Society for Surgery of the Hand in October 2002. The data from x-ray evaluations revealed that a single injection of Chrysalin into the fracture gap resulted in a trend toward accelerated fracture healing compared with the saline placebo control. There were no reportable adverse events attributable to Chrysalin in the study.

We completed subject enrollment in our pivotal Phase 3 human clinical trial evaluating the efficacy of Chrysalin in subjects with unstable and/or displaced distal radius (wrist) fractures in May 2005. We enrolled a total of 503 study subjects in 27 health centers throughout the United States. The primary efficacy endpoint in the trial was to measure how quickly wrist fractures in subjects injected with Chrysalin heal, as measured by the removal of immobilization. Accelerated removal of immobilization allows patients to initiate hand therapy and regain full function of their wrists and hands sooner. The clinical trial’s secondary efficacy endpoints include radiographic analysis of healing, as well as clinical, functional, and subject outcome parameters. On March 15, 2006, the Company reported results of an analysis of topline data from its Phase 3 clinical trial of the novel synthetic peptide Chrysalin ^{^®} (TP508) in unstable, displaced distal radius (wrist) fractures. Treatment with 10 µg Chrysalin did not demonstrate a statistically significant benefit compared to placebo in the primary efficacy endpoint of time to removal of immobilization. Within the secondary endpoints, radiographic evidence of time to radial cortical bridging, showed a statistically significant benefit for Chrysalin–treated subjects (p = 0.046). This benefit mirrored findings from the Phase 1/2 clinical trial that provided part of the foundation for the Phase 3 study. A statistically significant difference between Chrysalin treatment and placebo in the functional secondary endpoints was not observed. From a safety perspective, there were no adverse events related to Chrysalin reported in this Phase 3 trial, nor were there any differences in adverse event rates observed between the Chrysalin and placebo treated subject.

The Company is currently assessing Chrysalin in a Phase 2b human clinical trial in distal radius fractures, which is a double-blind, randomized placebo controlled trial that explores a wider dose range of Chrysalin, including 1 µg, 3 µg, 10 µg, or 30 µg doses. Our enrollment goal was 590 subjects in approximately 60 sites. On March 15, 2006, the Company temporarily interrupted enrollment in its Phase 2b fracture repair dosing human clinical trial to perform an interim analysis of the subjects enrolled up to that date. The Company plans to announce the results of the interim analysis of the Phase 2b fracture repair human clinical trial in the 3 ^rd Quarter of 2006.

Dermal Wound Healing

Our dermal wound healing studies are focused on healing diabetic foot ulcers, a common problem for diabetic patients. Diabetic patients suffer from open wound foot ulcers because diabetes related nerve damage causes the patient to lose sensation. Patients thus may not notice an injury to the foot and neglect the injury. This fact and the diminished blood flow to extremities caused by diabetes cause a diabetic patient’s wounds to heal more slowly or not at all.

Current standard treatment for diabetic foot ulcer wounds focuses on sanitation of the wound and non-use of the foot (off loading) to allow for the body’s natural healing processes to occur. These treatments require high patient compliance and effectively heal only approximately 33% of these ulcers. Wounds that do not respond to treatment can sometimes result in amputation of the affected limb.

We believe topical treatment of the wound with Chrysalin will promote new tissue growth necessary for healing of a diabetic foot ulcer. CBI conducted a multicenter Phase 1/2 double blind human trial with 60 subjects, the results of which were presented at the Wound Healing Society in May of 2002. We found no drug related adverse events due to Chrysalin in this trial and complete wound closure occurred in 70% of Chrysalin-treated ulcers relative to 33% in placebo controls, a statistically significant difference.

AZX100 — ICARMs™

AZX100, a 24-amino acid synthetic peptide, is one of a new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™.

AZX100 relaxes smooth muscle, which modulates the function of blood vessels, sphincters, the gastrointestinal tract, the genitourinary tract, and the airways. Sustained abnormal contraction of any of these muscles is called spasm. Any disorders known to be associated with excessive constriction or inadequate dilation of smooth muscle represent potential applications for AZX100, including:

	•		Subarachnoid hemorrhage (SAH) induced spasm of the intracranial blood vessels

	•		Spasm of vein grafts after harvest

	•		Spasm of the portal vein (PHT)

	•		Spasm of airway smooth muscle (asthma)

	•		Spasm of lung vessels, which causes pulmonary (lung) hypertension

	•		Male and female sexual dysfunction

	•		Toxemia of pregnancy (pre-eclampsia/eclampsia)

	•		Pre-term labor

	•		Reynaud’s disease or phenomenon

	•		Achalasia (spasm of the lower esophageal sphincter)

	•		Non-occlusive mesenteric ischemia

	•		Hemolytic-uremia

	•		Prinzmetal’s angina (a form of coronary spasm that causes angina), and

	•		Anal fissure.

AZX100 may also reverse the fibrotic phenotype of fibroblasts and smooth muscle cells in a mechanism similar to that which causes vasorelaxation. Through phenotypic modulation of fibroblasts and smooth muscle cells, AZX100 may inhibit the scarring that results from wound healing and disease states in the dermis, blood vessels, lungs, liver and other organs.

AZX100 is currently being evaluated by the Company for applications such as the treatment of vasospasm associated with subarachnoid hemorrhage, prevention of keloid scarring, pulmonary fibrosis and the treatment of asthma. Preclinical and human in vitro studies have shown that this novel compound has the ability to relax smooth muscle in multiple tissue types. The Company will continue pre-clinical activities on AZX100 in 2006.

Results of Operations Comparing Three-Month Period Ended June 30, 2006 to the Corresponding Period in 2005.

General and Administrative (“G&A”) Expenses: G&A expenses related to our ongoing development operations increased by $788,000 from $1,273,000 in the second quarter of 2005 to $2,061,000 in the second quarter of 2006. Our administrative expenses during the second quarter of 2006 were higher than the same period of 2005 primarily as a result of non-cash stock compensation as described in Note A, increased compensation costs associated with our previously disclosed management changes and a reduction in the allocation of general and administration expenses to research and development due to the decline in clinical activity.

Research and Development Expenses: Research and development expenses were $4,208,000 for the three months ended June 30, 2006 compared to $5,991,000 for the same period in 2005. Our research and development expenses decreased $1,783,000 in the second quarter of 2006 over the same period in 2005 primarily due to the substantial completion of our Phase 3 human clinical trial for fracture repair and the temporary interruption on March 15, 2006 of our Phase 2b dose-ranging human clinical trial for fracture repair. The primary focus of our research and development work was our Chrysalin-based fracture repair indication. In 2006, we expect to continue our efforts in fracture repair and diabetic foot ulcer healing and, as disclosed in Note B, the Company acquired and will also continue to develop AZX100 in 2006.

Interest Income, Net : Interest income, net, increased from $654,000 in the second quarter of 2005 to $867,000 in the second quarter of 2006 due to the increase in interest rates between the two periods.

Net Loss : We incurred a net loss in the three months ended June 30, 2006 of $6.5 million compared to a net loss of $6.6 million in the same period in 2005. The net loss in the three months ended June 30, 2006 includes the recognition of income tax expense related to the recording of a valuation allowance of $1,106,000 for a deferred tax asset related to a Alternative Minimum Tax credit

carryover and non-cash stock compensation expenses of $700,000. These items were offset by the decrease in fracture repair human clinical trial activity compared to the same period in 2005.

Results of Operations Comparing Six-Month Period Ended June 30, 2006 to the Corresponding Period in 2005.

General and Administrative (“G&A”) Expenses: G&A expenses related to our ongoing development operations increased by $1,970,000 from $2,183,000 in the first half of 2005 to $4,153,000 in the second half of 2006. Our administrative expenses during the first half of 2006 were higher than the same period of 2005 primarily as a result of non-cash stock compensation expense of $1,310,000, as described in Note A, increased compensation expense associated with our previously disclosed management changes, and a reduction in the allocation of general and administrative expenses to research and development due to the decline in clinical activity.

Research and Development Expenses: Research and development expenses were $10,924,000 for the first six months in 2006 and are comparable to the $11,394,000 of expenses incurred in the first six months in 2005. The primary focus of our research and development work in 2005 and 2006 was our Chrysalin-based fracture repair indication.

Interest Income, Net : Interest income, net increased from $1,206,000 in the first half of 2005 to $1,629,000 in the first half of 2006 due to the increase in interest rates between the two periods.

Net Loss : We incurred a net loss in the first six months of 2006 of $23.0 million compared to a net loss of $12.1 million in the first six months of 2005. The $10.9 million increase in the net loss in the six months ended June 30, 2006 compared to the same period in 2005, results primarily from $8.4 million in-process research and development costs related to AzERx (Note B), $1.7 million of non-cash stock compensation expense, and recognition of income tax expense related to the recording of a valuation allowance of $1.1 million for a deferred tax asset related to a Alternative Minimum Tax credit carryover.

With the adoption of FAS 123 (R), as discussed in Note A, we recorded a non-cash compensation expense, related to restricted stock and stock options granted to our employees and members of our Board of Directors, of $1.7 million for the six months ended June 30, 2006 and currently estimate the expense for the year ended December 31, 2006, will be approximately $2.8 million.

Liquidity and Capital Resources

We have historically financed our operations through operating cash flows and the public and private sales of equity securities. However, with the sale of our Bone Device Business in November 2003, we sold all of our revenue producing operations. Since that time, we have relied on our cash and investments to finance all our operations, the focus of which was research and development of our Chrysalin Product Platform. We received approximately $93.0 million in cash from the sale of our Bone Device Business. On December 1, 2005, we received the additional $7.2 million, including interest, from the escrow balance related to the sale of the Bone Device Business. On February 27, 2006, the Company entered into an agreement with Quintiles, (see Note C), which provides an investment by Quintiles, in the Company’s common stock of up to $5,000,000, of which $2,000,000 was received on February 27, 2006 and $1,500,000 was received on July 3, 2006. The Company also

received net proceeds of $2,962,000 from the exercise of stock options during the six months ended June 30, 2006. At June 30, 2006, we had cash and cash equivalents of $37.0 million, short-term investments of $28.4 million and long-term investments of $10.1 million.

We do not expect to make significant capital investments in 2006 but anticipate continuing research and development expenditures related to clinical trials for Chrysalin in fracture repair and diabetic foot ulcers, and further pre-clinical studies for AZX100.

Our future research and development expenses may vary significantly from prior periods depending on the Company’s decisions on its future Chrysalin and AZX100 development plans.

We anticipate that our cash and short-term investments will be sufficient to meet our presently projected cash and working capital requirements for the next two years. Within two years, we may need to identify other sources of capital to continue our research programs. However, the timing and amounts of cash used will depend on many factors, including our ability to continue to control our expenditures related to our current research and development programs. If we decide to expand our clinical trials or if we consider other opportunities in the market, our expense levels may change, which could require us to seek other sources of capital. If additional funding is required, we would be required to seek new sources of funds, including raising capital through the sales of securities or licensing agreements. These sources of funds may not be available or could only be available at terms that would have a material adverse impact on our existing stockholders’ interests.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We had no debt outstanding and no derivative instruments at June 30, 2006.

Our investment portfolio is used to preserve our capital until it is required to fund our operations. All of these investment instruments are classified as held-to-maturity. We do not own derivative financial instruments in our investment portfolio. Our investment portfolio contains instruments that are subject to the risk of a decline in interest rates. We maintain a non-trading investment portfolio of investment grade, liquid debt securities that limits the amount of credit exposure of any one issue, issuer or type of instrument. Due to the short duration and conservative nature of these instruments, we do not believe that we have a material exposure to interest rate risk.

We have deposited our cash with national banking institutions, which we believe are stable. Even though our accounts in each of these banks have balances in excess of the $100,000 limit that is insured by the Federal Deposit Insurance Corporation, we believe these accounts are not subject to significant market risk due to bank failure.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our principal executive officer and chief financial officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based on their evaluation, the principal executive officer and chief financial officer have each concluded that, as of the end of such period, our disclosure controls and procedures are effective and provide reasonable assurance that we record, process, summarize, and report information required

to be disclosed in the reports we file under the Securities Exchange Act of 1934 within the time periods specified by the Securities and Exchange Commission’s rules and forms.

Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II – Other Information

Item 1A. Risk Factors

Forward looking statements

OrthoLogic may from time to time make written or oral forward-looking statements, including statements contained in our filings with the Securities and Exchange Commission and our reports to stockholders. The safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 protects companies from liability for their forward looking statements if they comply with the requirements of that Act. This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, and contains forward-looking statements made pursuant to that safe harbor. These forward-looking statements relate to future events or to our future financial performance, and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by the use of words such as “may,” “could,” “expect,” “intend,” “plan,” “seek,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or the negative of these terms or other comparable terminology. You should not place undue reliance on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond our control and which could materially affect actual results, levels of activity, performance or achievements. Factors that may cause actual results to differ materially from current expectations include, but are not limited to:

	•		unfavorable results of our product candidate development efforts;

	•		unfavorable results of our pre-clinical or clinical testing;

	•		delays in obtaining, or failure to obtain FDA approvals;

	•		increased regulation by the FDA and other agencies;

	•		the introduction of competitive products;

	•		impairment of license, patent or other proprietary rights;

	•		failure to achieve market acceptance of our products;

	•		the impact of present and future collaborative agreements; and

	•		failure to successfully implement our drug development strategy.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in this Quarterly Report on Form 10-Q reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions

relating to our operations, results of operations, business strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Except as set forth below, there were no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005.

The results of our late stage clinical trials may be insufficient to obtain FDA approval, which could result in a substantial delay in our ability to generate revenue.

Positive results from pre-clinical studies and early clinical trials do not ensure positive results in more advanced clinical trials. If we are unable to demonstrate that a product candidate will be safe and effective in advanced clinical trials involving larger numbers of patients, we will be unable to submit the NDA necessary to receive approval from the FDA to commercialize that product.

We are currently conducting a Phase 2b and Phase 3 human clinical trial on Chrysalin for fracture repair indications. On March 15, 2006, the Company reported results of its Phase 3 Fracture Repair human clinical trial. For the primary endpoint, immobilization removal, no statistically significant difference between placebo and a single injection of Chrysalin were achieved. Consistent with the Phase 1/2 human clinical trial results, a statistically significant difference for a secondary endpoint, radiographic evidence of radial cortical bridging, was achieved. A statistically significant difference between Chrysalin treatment and placebo in the other secondary endpoints was not observed. On March 15, 2006, the Company temporarily interrupted enrollment in the Phase 2b fracture repair dosing clinical trial to perform an interim analysis of the subjects enrolled up to that date. The Company plans to announce the results of the interim analysis of the Phase 2b fracture repair human clinical trial in the 3 ^rd Quarter of 2006.

Upon a receipt of the interim analysis of the results of our Phase 2b fracture repair dosing clinical trial we will have to determine whether to redesign our Chrysalin fracture repair product candidate and our protocols and continue with additional testing, evaluate the interest of other companies in partnering for this indication, or cease activities in this area. Redesigning the product candidate could be extremely costly and time-consuming. A substantial delay in obtaining FDA approval or termination of the Chrysalin fracture repair product candidate could result in a delay in our ability to generate revenue, or affect our ability to obtain future funding.

Our stock price is volatile and fluctuates due to a variety of factors.

Our stock price has varied significantly in the past (from a high of $8.96 to a low of $1.54 from January 1, 2003 to June 30, 2006) and may vary in the future due to a number of factors, including:

	•		announcement of the results of, or delays in, preclinical or studies of clinical trials;

	•		fluctuations in our operating results;

	•		developments in litigation to which we or a competitor is subject;

	•		announcements and timing of potential acquisitions, divestitures or issuance of preferred stock;

	•		announcements of technological innovations or new products by us or our competitors;

	•		FDA and other regulatory actions;

	•		developments with respect to our or our competitors’ patents or proprietary rights;

	•		public concern as to the safety of products developed by us or others; and

	•		changes in stock market analyst recommendations regarding us, other drug development companies or the pharmaceutical industry generally.

In addition, the stock market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our stock.

Item 4. Submission of Matters to a Vote of Security Holders

On May 12, 2006, the Company held its Annual Shareholder Meeting at which the shareholders voted to elect two Class III Directors, whose terms will expire at the annual meeting to be held in the year of 2009, and approve the 2005 Equity Incentive Plan.

Elwood D. Howse, Jr., was elected as a Class III director with 34,194,606 votes for and 1,372,800 votes withheld and William M. Wardell, MD, Ph.D., was elected as a Class III director with 34,622,210 votes for and 945,196 votes withheld. The 2005 Equity Incentive Plan was approved with 14,853,293 votes for, 1,899,046 votes against, 407,517 votes abstained and 18,407,550 broker non-votes.

Michael D. Casey, Fredric J. Feldman, Ph.D., John M. Holliman, III, and Augustus A. White, III, MD, Ph.D., are directors whose terms continued after the meeting.

Item 6. Exhibits

See Exhibit List following this report

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

ORTHOLOGIC CORP.
(Registrant)


Signature	Title	Date
/s/ John M. Holliman, III John M. Holliman, III	Executive Chairman (Principal Executive Officer)	August 8, 2006

/s/ Les M. Taeger	Senior Vice President and Chief	August 8, 2006
Les M. Taeger	Financial Officer
	(Principal Financial and Accounting Officer)

OrthoLogic Corp.
(the “Company”)
Exhibit Index to Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 30, 2006


Exhibit
No.	Description	Incorporated by Reference To:	Filed Herewith
10.1	Form of Incentive Stock Option grant letter for use in connection with the Company’s 2005 Equity Incentive Plan. **		X

10.2	Form of Non-Qualified Stock Option grant letter for use in connection with the Company’s 2005 Equity Incentive Plan. **		X

10.3	Amendment to Employment Agreement dated January 10, 2006 between Les Taeger and the Company. (1)		X

10.4	Amendment to Employment Agreement dated January 1, 2001 between James T. Ryaby, Ph.D. and the Company. (1)		X

10.5	Form of Indemnification Agreement *	Exhibit 10.16 to Amendment No. 2 to the Company’s Registration Statement on Form S-1 (No. 033-47569) filed with the SEC on January 25, 1993

10.6	2005 Equity Incentive Plan. (1)	Exhibit 10.1 to the Company’s current Report on Form 8-K filed with the SEC on May 18, 2006.

10.7	Employment Agreement between Randolph C. Steer, MD, Ph.D., President, and the Company, effective May 12, 2006. (1)		X

10.8	Management Services Agreement between VV III Management, LLC, John M. Holliman, III, Executive Chairman, and the Company, effective May 12, 2006. (1)		X

10.9	Separation Agreement dated April 5, 2006 by and between the Company and James M. Pusey. (1)	Exhibit 10.1 to the Company’s current Report on Form 8-K filed with the SEC on April 11, 2006.

31.1	Certification of Principal Executive Officer Pursuant to Securities Exchange Act Rule 13a-14		X

31.2	Certification of Chief Financial Officer Pursuant to Securities Exchange Act Rule 13a-14		X

32	Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350*		X


(1)		Management contract or compensatory plan or arrangement.

**		OrthoLogic from time to time issues stock options to its employees , officers and directors pursuant to its 2005 Equity Incentive Plan. The incentive stock option grant letters and non-qualified stock option grant letters that evidence these issuances differ only such terms as the identity of the recipient, the grant date, the number of securities covered by the award, the price(s) at which the recipient may acquire the securities and the vesting schedule. Pursuant to the instructions accompanying Item 601 of Regulation S-K, OrthoLogic has filed the form of such incentive stock option grant letter and non-qualified stock option grant.


*	OrthoLogic has entered into separate indemnification agreements with each of its current directors and executive officers that differ only in party names and dates. During the quarter ended June 30, 2006 OrthoLogic entered into such indemnification agreement with Randolph C. Steer, MD, Ph.D. Pursuant to the instructions accompanying Item 601 of Regulation S-K, OrthoLogic has filed the form of such indemnification agreement.

EXHIBIT 10.1

LETTER OF INCENTIVE OPTION GRANT
ORTHOLOGIC CORP. 2005 EQUITY INCENTIVE PLAN

Date

Name & address

RE: OrthoLogic Corp. 2005 Equity Incentive Plan

Dear ,

In order to provide additional incentive to certain employees and directors, OrthoLogic Corp. (the “Company”) adopted the OrthoLogic Corp. 2005 Equity Incentive Plan (the “2005 Plan”). By means of this letter (the “Letter of Grant”), the Company is offering you an incentive stock option pursuant to the 2005 Plan. The Company’s sale of its common shares underlying the option granted to you hereby has been or will be registered with the U.S. Securities and Exchange Commission. A copy of the prospectus, including a copy of the 2005 Plan relating to that registration, can be obtained from the Company by request.

The option granted to you hereunder shall be subject to all of the terms and conditions of the 2005 Plan, which you should carefully review. In addition, such option is subject to the following terms and conditions:

1. Grant of Option . The Company hereby grants to you, pursuant to the 2005 Plan, the option to purchase from the Company upon the terms and conditions and at the times hereinafter set forth, an aggregate of shares of the Company’s $0.0005 par value common stock (the “Shares”) at a purchase price of $ per Share. The date of grant of this option is (hereinafter referred to as the “Option Date”).

This option is an incentive stock option within the meaning of the Internal Revenue Code of 1986, as amended (the “Code”), except if required by applicable tax rules, to the extent that the aggregate fair market value (determined as of the date these options are granted) of Shares exercisable for the first time by you during any calendar year (when aggregated, if appropriate, with shares subject to other incentive stock option grants made under the 2005 Plan and any other plan maintained by the Company or any ISO Group member as defined in the 2005 Plan) exceeds $100,000 (or such other limit as is prescribed by the Internal Revenue Code, as amended), the option granted hereby as to such excess Shares shall be treated as a nonqualified stock option (NQO pursuant to Code Section 422(d).

2. Exercise Term of Option . Unless earlier terminated as described in Section 7, the option will vest and may be exercised for the purchase of Shares as described in the following schedule:

[Optionee]
[Date]
Page 2


Number of Shares		Vesting Schedule

3. Nontransferability. This option shall not be transferable otherwise than by will or by the laws of descent and distribution, and the option shall be exercisable only by you during your lifetime.

4. Other Conditions and Limitations.

	(a)		Any Shares issued upon exercise of this option shall not be issued unless the issuance and delivery of Shares pursuant thereto shall comply with all relevant provisions of law including, without limitation, the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, any applicable state securities or “Blue Sky” law or laws (or an exemption from such provision is available), and the requirements of any stock exchange or national market system of a national securities association upon which the Shares may then be listed and shall be further subject to the approval of counsel for the Company with respect to such compliance.

	(b)		No transfer of any Shares issued upon the exercise of the option will be permitted by the Company, unless any request for transfer is accompanied by evidence satisfactory to the Company that the proposed transfer will not result in a violation of any applicable law, rule or regulation, whether federal or state, including in the discretion of the Company an opinion of counsel reasonably acceptable to the Company.

	(c)		Inability of the Company to obtain approval from any regulatory body having jurisdictional authority deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder shall relieve the Company of any liability in respect to the nonissuance or sale of such Shares as to which such requisite authority shall not have been obtained.

	(d)		Unless the Shares are subject to a then effective registration statement under the Securities Act of 1933, upon exercise of this option (in whole or in part) and the issuance of the Shares, the Company shall instruct its transfer agent to enter stop transfer orders with respect to Shares, and all certificates representing the Shares shall bear on the face thereof substantially the following legend:

“The shares of common stock represented by this certificate have not been registered

[Optionee]
[Date]
Page 3

under the Securities Act of 1933, as amended, and may not be sold, offered for sale, assigned, transferred or otherwise disposed of unless registered pursuant to the provisions of that Act or an opinion of counsel to the Company is obtained stating that such disposition is in compliance with an available exemption from such registration.”

5. Exercise of Option . You may exercise the option only by giving the Executive Chairman of the Company written notice (including the number of Shares that you are intending to acquire, accompanied by the full exercise price), by personal hand delivery, by professional overnight delivery service, or by registered or certified mail, postage prepaid with return receipt requested, at the following address:

Executive Chairman
OrthoLogic Corp.
1275 West Washington
Phoenix, Arizona 85281

Payment of the option price shall be made either in (i) cash or by check, or (ii) at your request and with the written approval of the Company, (a) by delivering shares of the Company’s common stock which have been beneficially owned by you for a period of at least six months prior to the time of exercise (“Delivered Stock”), or (b) a combination of cash and Delivered Stock. The Company may arrange for or cooperate in permitting broker-assisted cashless exercise procedures. Payment in the form of Delivered Stock shall be in the amount of the fair market value of the stock at the date of exercise, determined pursuant to the 2005 Plan.

6. Valuation and Withholding . If required by applicable regulations, the Company shall, at the time of issuance of any Shares purchased pursuant to the 2005 Plan, provide you with a statement of valuation of the Shares issued. The Company shall be entitled to withhold amounts from your compensation or otherwise to receive an amount adequate to provide for any applicable federal, state and local income taxes (or require you to remit such amount as a condition of issuance). The Company may, in its discretion, satisfy any such withholding requirement, in whole or in part, by withholding from the shares to be issued the number of shares that would satisfy the withholding amount due.

7. Termination of Incentive Stock Option . Notwithstanding anything to the contrary, this option can become exercisable only while you are an employee of the Company, and shall not be exercisable after the earliest of (i) the tenth anniversary of the Option Date; (ii) three months after the date your employment with the Company terminates, if such termination is for any reason other than permanent disability, death, or cause; (iii) the date your employment terminates, if such termination is for cause, as determined by the Company in its sole discretion; or (iv) one year after the date your employment with the Company terminates, if such termination is the result of death or permanent disability.

[Optionee]
[Date]
Page 4

8. Notice of Disposition of Shares. If you dispose of any Shares acquired on the exercise of this option within either (a) two years after the Option Date or (b) one year after the date of exercise of this option, you must notify the Company within seven days of such disposition.

9. Miscellaneous. You will have no rights as a stockholder with respect to the Shares until the exercise of the option and payment of the full purchase price therefor in accordance with the terms of the 2005 Plan and this Letter of Grant. Nothing herein contained shall impose any obligation on the Company or any parent or subsidiary of the Company or on you with respect to your continued employment by the Company or any parent or subsidiary of the Company. Nothing herein contained shall impose any obligation upon you to exercise this option. While the option granted hereunder is intended to qualify as an incentive stock option under Section 422 of the Code, the Company cannot assure you that such option will, in fact, qualify as an incentive stock option, and makes no representation as to the tax treatment to you upon receipt or exercise of the option or sale or other disposition of the Shares covered by the option.

10. Governing Law. This Letter of Grant shall be subject to and construed in accordance with the law of the State of Arizona, except as may be required by the Delaware General Corporation Law or the federal securities laws. Venue for any action arising from or relating to this Agreement shall lie exclusively in Superior Court, Maricopa County, Arizona or the United States District Court for the District of Arizona, Phoenix Division.

11. Relationship to the 2005 Plan . The option contained in this Letter of Grant is subject to the terms, conditions and definitions of the 2005 Plan. To the extent that the terms, conditions and definitions of this Letter of Grant are inconsistent with the terms, conditions and definitions of the 2005 Plan, the terms, conditions and definitions of the 2005 Plan shall govern. You hereby accept this option subject to all terms and provisions of the 2005 Plan. You agree to accept as binding, conclusive and final all decisions or interpretations of the Board or any committee appointed by the Board upon any questions arising under the 2005 Plan. You agree to consult your independent tax advisors with respect to the income tax consequences to you, if any, of participating in the 2005 Plan and authorize the Company to withhold in accordance with applicable law from any compensation otherwise payable to you any taxes required to be withheld by federal, state or local law as a result of your participation in the 2005 Plan.

12. Communication . No notice or other communication under this Letter of Grant shall be effective unless the same is in writing and is personally hand-delivered, or is sent by professional overnight delivery service or mailed by registered or certified mail, postage prepaid and with return receipt requested, addressed to the Company at the address set forth in Section 5 above, or such other address as the Company has designated in writing to you, in accordance with the provisions hereof, or you at the address set forth at the beginning of this letter, or such other address as you have designated in writing to the Company, in accordance with the provisions hereof.

[Optionee]
[Date]
Page 5

You should execute the enclosed copy of this Letter of Grant and return it to the Company as soon as possible. The additional copy is for your records.


Very truly yours,

OrthoLogic Corp.



By:	John M. Holliman, III
	Executive Chairman

		ACCEPTED AND AGREED TO:


		Name:

		Date:

EXHIBIT 10.2

LETTER OF NON-QUALIFIED OPTION GRANT
ORTHOLOGIC CORP. 2005 EQUITY INCENTIVE PLAN

Date

Name & address

RE: OrthoLogic Corp. 2005 Equity Incentive Plan

Dear ,

In order to provide additional incentive to certain employees, directors and appropriate third parties, OrthoLogic Corp. (the “Company”) adopted the OrthoLogic Corp. 2005 Equity Incentive Plan (the “2005 Plan”). By means of this letter (the “Letter of Grant”), the Company is offering you a non-qualified stock option pursuant to the 2005 Plan. The Company’s sale of its common shares underlying the option granted to you hereby has been or will be registered with the U.S. Securities and Exchange Commission. A copy of the prospectus, including a copy of the 2005 Plan relating to that registration, can be obtained from the Company by request.

2. Exercise Term of Option . Unless earlier terminated as described in Section 7, the option will vest and may be exercised for the purchase of Shares as described in the following schedule:


Number of Shares		Vesting Schedule

3. Nontransferability. This option shall not be transferable otherwise than by will or by the laws of descent and distribution, and the options shall be exercisable only by you during your lifetime. Notwithstanding the foregoing, the Board of Directors or a committee appointed by the Board of Directors may permit you to transfer a non-qualified stock option to a family member or a trust or partnership for the benefit of a family member, in accordance with rules established by the Board or a committee appointed thereby.

[Optionee]
[Date]
Page 2

4. Other Conditions and Limitations.

	(a)		Any Shares issued upon exercise of this option shall not be issued unless the issuance and delivery of Shares pursuant thereto shall comply with all relevant provisions of law including, without limitation, the Securities Act of 1933, as amended, the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, any applicable state securities or “Blue Sky” law or laws (or an exemption from such provision is available), and the requirements of any stock exchange or national market system of a national securities association upon which the Shares may then be listed and shall be further subject to the approval of counsel for the Company with respect to such compliance.

	(b)		No transfer of any Shares issued upon the exercise of the option will be permitted by the Company, unless any request for transfer is accompanied by evidence satisfactory to the Company that the proposed transfer will not result in a violation of any applicable law, rule or regulation, whether federal or state, including in the discretion of the Company an opinion of counsel reasonably acceptable to the Company.

	(c)		Inability of the Company to obtain approval from any regulatory body having jurisdictional authority deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder shall relieve the Company of any liability in respect to the nonissuance or sale of such Shares as to which such requisite authority shall not have been obtained.

	(d)		Unless the Shares are subject to a then effective registration statement under the Securities Act of 1933, upon exercise of this option (in whole or in part) and the issuance of the Shares, the Company shall instruct its transfer agent to enter stop transfer orders with respect to Shares, and all certificates representing the Shares shall bear on the face thereof substantially the following legend:

“The shares of common stock represented by this certificate have not been registered under the Securities Act of 1933, as amended, and may not be sold, offered for sale, assigned, transferred or otherwise disposed of unless registered pursuant to the provisions of that Act or an opinion of counsel to the Company is obtained stating that such disposition is in compliance with an available exemption from such registration.”

[Optionee]
[Date]
Page 3

Executive Chairman
OrthoLogic Corp.
1275 West Washington
Phoenix, Arizona 85281

7. Termination of Non-Qualified Stock Options . Notwithstanding anything to the contrary, this option can become exercisable, and shall not be exercisable after the earliest of (i) the tenth anniversary of the Option Date; (ii) two years after the date you cease to perform services for the Company, if such termination of services is for any reason other than death, permanent disability, retirement or cause, (iii) three years after the date you cease to perform services for the Company, if such termination of services is by reason of death, permanent disability or retirement, or (iv) the date you cease to perform services for the Company, if such termination is for cause, as determined by the Board of Directors in its sole discretion. Notwithstanding anything to the contrary in this Section 7, if you are a non-employee director of the Company and you have served as a director of the Company for at least five years at the time you cease to serve in such capacity, your options will be fully exercisable until the expiration of such options.

8. Miscellaneous. You will have no rights as a stockholder with respect to the Shares until the exercise of the option and payment of the full purchase price therefor in accordance with the terms of the 2005 Plan and this Letter of Grant. Nothing herein contained shall impose any obligation on the Company or any parent or subsidiary of the Company or on you with respect to your continued employment by the Company or any parent or subsidiary of the Company. Nothing herein contained shall impose any obligation upon you to exercise this option.

9. Governing Law. This Letter of Grant shall be subject to and construed in accordance with the law of the State of Arizona, except as may be required by the Delaware General Corporation Law or the federal securities laws. Venue for any action arising from or relating to this

[Optionee]
[Date]
Page 4

Agreement shall lie exclusively in Superior Court, Maricopa County, Arizona or the United States District Court for the District of Arizona, Phoenix Division.

10. Relationship to the 2005 Plan . The option contained in this Letter of Grant is subject to the terms, conditions and definitions of the 2005 Plan. To the extent that the terms, conditions and definitions of this Letter of Grant are inconsistent with the terms, conditions and definitions of the 2005 Plan, the terms, conditions and definitions of the 2005 Plan shall govern. You hereby accept this option subject to all terms and provisions of the 2005 Plan. You agree to accept as binding, conclusive and final all decisions or interpretations of the Board or any committee appointed by the Board upon any questions arising under the 2005 Plan. You agree to consult your independent tax advisors with respect to the income tax consequences to you, if any, of participating in the 2005 Plan and authorize the Company to withhold in accordance with applicable law from any compensation otherwise payable to you any taxes required to be withheld by federal, state or local law as a result of your participation in the 2005 Plan.

11. Communication . No notice or other communication under this Letter of Grant shall be effective unless the same is in writing and is personally hand-delivered, or is sent by professional overnight delivery service or mailed by registered or certified mail, postage prepaid and with return receipt requested, addressed to the Company at the address set forth in Section 5 above, or such other address as the Company has designated in writing to you, in accordance with the provisions hereof, or you at the address set forth at the beginning of this letter, or such other address as you have designated in writing to the Company, in accordance with the provisions hereof.

You should execute the enclosed copy of this Letter of Grant and return it to the Company as soon as possible. The additional copy is for your records.


Very truly yours,

OrthoLogic Corp.



By:	John M. Holliman, III
	Executive Chairman

		ACCEPTED AND AGREED TO:


		Name:

		Date:

EXHIBIT 10.3

ORTHOLOGIC CORP.

Amendment No. 1 to Les M. Taeger’s Employment Agreement
dated January 16, 2006

Effective June 5, 2006, Mr. Les M. Taeger’s base salary is increased to $227,000 per year.

Additionally, OrthoLogic may terminate Mr. Taeger’s employment at any time, immediately and without cause, by giving written notice to Mr. Taeger. If OrthoLogic terminates Mr. Taeger without cause, provided Mr. Taeger first executes a Severance Agreement in the form then used by OrthoLogic, OrthoLogic shall continue to pay to Mr. Taeger his minimum base salary in effect at the time of termination for a period of one year following the date of termination, at the time and in the manner dictated by OrthoLogic’s standard payroll policies. Should such termination occur as a result of a change in control, OrthoLogic shall also pay Mr. Taeger a pro-rata share of his bonus at the time of termination.


By:		/s/ John M. Holliman, III

		John M. Holliman, III
		Executive Chairman

Date: June 5, 2006

EXHIBIT 10.4

June 5, 2006

AMENDMENT
Employment Agreement of James T. Ryaby

This Amendment is to the Employment Agreement between James T. Ryaby, Ph.D. and OrthoLogic Corp., dated June 1, 2001. Effective June 5, 2006 the base salary of James T. Ryaby, Ph.D. is increased to $270,000 per year.


/s/ John M. Holliman, III

John M. Holliman, III
Executive Chairman

/s/ James T. Ryaby, Ph.D.

James T. Ryaby, Ph.D.
Sr. VP, Chief Scientific Officer

EXHIBIT 10.7

AGREEMENT
(President and Chief Operating Officer)

THIS AGREEMENT (the “Agreement”) is entered into this 12th day of May, 2006, by and between Randolph C. Steer (“Executive”) and OrthoLogic Corp., a Delaware corporation (the “Company”).

1. Services . Pursuant to the terms of this Agreement, Executive shall serve as the Company’s President and Chief Operating Officer with responsibility for all clinical and regulatory strategy and operations. Executive shall devote the time, attention, skill and efforts to the performance of such duties as are normal and customary to the positions of President and Chief Operating Officer as required by or reasonably requested by the Company’s Board of Directors (the “Board”). Executive agrees to use his best efforts to comply with any and all rules of conduct established by the Company and to perform any and all assigned duties in a manner that is acceptable to the Company.

2. Compensation; Bonus; Reimbursement .

(a) Compensation . Company shall pay Executive annual base cash compensation of $300,000 payable in accordance with the Company’s standard payroll practices, retroactive to May 1, 2006. Executive shall not be entitled to any compensation under any consulting or similar arrangement with the Company during the term of this Agreement in respect of periods after May 1, 2006.

(b) Bonuses . Executive shall be entitled to participate in a discretionary bonus plan established for Executive from time to time by the Compensation Committee of the Board (the “Compensation Committee”) with reasonable consultation with Executive. Executive’s target bonus will be 40% of his annual base cash compensation upon the achievement of individual and corporate performance objectives established jointly from time to time by the Compensation Committee and Executive. Such cash bonus, if earned, will be payable to Executive annually on or before the first day of April immediately following the end of the calendar year for which it is earned. Any bonus will be paid in such manner so that it is not subject to the provisions of Section 409A of the Internal Revenue Code of 1986, as amended, and shall be interpreted in a manner consistent with that intention.

(c) Equity and Equity-Based Compensation . Executive shall be entitled to participate in the Company’s equity compensation plans, including, but not limited to, the 1997 Stock Option Plan, as amended, and the 2005 Equity Incentive Plan, all subject to the terms and conditions provided therein.

(d) Reimbursement . In addition to the compensation provided above, the Company shall reimburse Executive, in accordance with the policies and practices of the Company in effect from time to time with respect to other members of senior management of the Company, for all reasonable and necessary traveling expenses and other disbursements incurred by him for or on behalf of the Company in connection with the performance of his duties

hereunder upon presentation by Executive to the Company of appropriate documentation therefor.

(e) Fringe Benefits . Except as otherwise provided in this Section 2, Executive will not be entitled to participate in health, welfare, retirement or other similar benefit programs made available from time to time to other executives and employees of the Company.

3. Termination .

(a) Executive understands and acknowledges that the services to be provided by Executive to the Company hereunder constitute an “at-will” relationship between the parties. Either the Company or Executive may terminate Executive’s services to the Company hereunder, with or without cause, notice or procedural formality, for no reason or for any reason not prohibited by law, at any time. No individual or individuals associated with the Company, other than the Compensation Committee acting pursuant to the powers granted to it by the Company, has authority to make any agreement to the contrary, or any agreement for any specified period of time. Any such agreement must be in writing and approved by the Compensation Committee to be effective.

(b) Upon the termination of this Agreement, neither Executive nor Executive’s beneficiaries or estate shall have any further rights under this Agreement or any claims against the Company arising out of this Agreement, except that Executive shall be entitled to receive accrued and unpaid compensation and benefits which are then due and owing as of the date of termination, and, in the event of a termination by the Company without cause, Executive shall be entitled to a continuation of his base cash compensation, less applicable withholdings, at the rate in effect at the time of the termination of this Agreement, payable in accordance with the Company’s standard payroll practices as if Executive were continuing his services to the Company, for a period of (i) if such termination occurs before a Change of Control, as defined below, three months from the date of termination or (ii) if such termination follows or is in connection with a Change of Control, six months from the date of termination. For purposes of this Agreement, “cause” shall include neglect of duties, willful failure to abide by instructions or policies from or set by the Board, commission of a felony or serious misdemeanor offense or pleading guilty or nolo contendere to same, Executive’s breach of this Agreement or Executive’s breach of any other material obligation to the Company.

(c) Upon the termination of this Agreement, Executive shall promptly deliver to the Company all equipment, documents and other company property in his possession, custody or control.

(d) As used herein, the term “Change of Control” shall be defined as a change in ownership or control of the Company effected through any of the following transactions:

immediately thereafter beneficially owned, directly or indirectly, by the persons who beneficially owned the Company’s outstanding voting securities immediately prior to such transaction;

(ii) any stockholder approved transfer or other disposition of all or substantially all of the Company’s assets (whether held directly or indirectly through one or more controlled subsidiaries) except to or with a wholly-owned subsidiary of the Company); or

(iii) the acquisition, directly or indirectly by any person or related group of persons of beneficial ownership (within the meaning of Rule 13d-3 of the Securities Exchange Act of 1934, as amended), of securities possessing more than 50% of the total combined voting power of the Company’s outstanding securities pursuant to transactions with the Company’s stockholders and not solely by direct purchase from the Company.

4. Governing Law; Mediation . This Agreement is entered into in Arizona and shall in all respects be interpreted, construed and governed by and in accordance with the laws of the State of Arizona. The parties agree that any dispute between the parties relating to this Agreement shall be subject to mediation according to the mediation rules of the American Arbitration Association (the “AAA”) applicable to commercial disputes, such to be held at a mutually agreeable office of the AAA in Phoenix, Arizona. Mediation shall be a condition precedent to litigation and mediation shall in no way preclude either party from seeking and obtaining any prejudgment remedy against the other party. By signing this Agreement, the parties submit themselves to the jurisdiction of the courts of the State of Arizona, located in Maricopa County, for the purpose of resolving any and all disputes arising out of Executive’s services to the Company as provided herein, subject to the mediation procedures set forth in this Section.

5. Whole Agreement . This Agreement and the Indemnification Agreement and Intellectual Property, Confidentiality and Non-Competition Agreement entered into between the Company and Executive embody all of the representations, warranties, covenants and agreements between the parties and no other representations, warranties, covenants, understandings or agreements exist.

6. Benefits of Agreement; Assignment . The terms and provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors, assigns, representatives, heirs and estate, as applicable. Anything contained herein to the contrary notwithstanding, this Agreement shall not be assignable by any party hereto without the consent of the other party hereto; provided, however, that the Company may assign this Agreement in connection with a sale of all or substantially all of its assets or a merger.

7. Amendment . This Agreement may not be amended orally but only by an instrument in writing executed by the Company and Executive.

SIGNATURE PAGE FOLLOWS


Company:		Executive:

By:	/s/ John M. Holliman, III	Signature:	/s/ Randolph C. Steer, MD, Ph.D.


Title:	Executive Chairman	Print Name:	Randolph C. Steer, MD, Ph.D.

Date:	May 12, 2006	Date: May 12, 2006

EXHIBIT 10.8

MANAGEMENT SERVICES AGREEMENT

THIS MANAGEMENT SERVICES AGREEMENT (the “Agreement”) is entered into this 12th day of May, 2006, by and between VV III Management, LLC, a Delaware limited liability company (“Contractor”) and OrthoLogic Corp., a Delaware corporation (the “Company”).

RECITALS

WHEREAS, the Company wishes to engage Contractor to make available the services of John M. Holliman, III (“Executive”) to serve as the Company’s Executive Chairman and principal executive officer; and

WHEREAS, Contractor wishes to make available the services of Executive to the Company on the terms and conditions set forth in this Agreement.

NOW, THEREFORE, the parties agree as follows:

AGREEMENT

1. Services . Pursuant to the terms of this Agreement, Contractor shall cause Executive to serve, and Executive shall serve as the Company’s Executive Chairman and principal executive officer with responsibility for corporate strategy, executive management, investor relations, financial reporting and compliance. Contractor shall cause Executive to (i) devote the time, attention, skill and efforts to the performance of such duties as are normal and customary to the position of principal executive officer and as reasonably requested by the Company’s Board of Directors (the “Board”); and (ii) comply with any and all rules of conduct established by the Company and to perform any and all assigned duties in a manner that is acceptable to the Company.

2. Management Fee; Bonus; Reimbursement .

(a) Compensation . Company shall pay Contractor a management fee at the rate of $200,000 per year (the “Management Fee”) payable on the first and fifteenth day of each calendar month, retroactive to April 5, 2006.

(b) Bonuses . Executive shall be entitled to participate in a discretionary bonus plan established for Executive from time to time by the Compensation Committee of the Board (the “Compensation Committee”). The target bonus will be 40% of the annual Management Fee upon the achievement by Executive of individual and corporate performance objectives established from time to time by the Compensation Committee. Such cash bonus, if earned, will be payable to Contractor annually on or before the first day of April immediately following the end of the calendar year for which it is earned. Any bonus will be paid in such manner so that it is not subject to the provisions of Section 409A of the Internal Revenue Code of 1986, as amended, and shall be interpreted in a manner consistent with that intention.

(c) Reimbursement . In addition to the Management Fee provided above, the Company shall reimburse Executive, in accordance with the policies and practices of the Company in effect from time to time with respect to other members of senior management of the Company, for all reasonable and necessary traveling expenses and other disbursements incurred by him for or on behalf of the Company in connection with the performance of his duties to the Company upon presentation by Executive to the Company of appropriate documentation therefor.

(d) Fringe Benefits . Except as otherwise provided in this Section 2, Executive will not be entitled to participate in health, welfare, retirement or other similar benefit programs made available from time to time to other executives and employees of the Company.

3. Termination .

(a) This Agreement may be terminated at any time by Contractor or the Company with or without cause, notice or procedural formality. No individual or individuals associated with the Company, other than the Compensation Committee acting pursuant to the powers granted to it by the Company, has authority to make any agreement to the contrary, or any agreement for any specified period of time. Any such agreement must be in writing and approved by the Compensation Committee to be effective. The Company shall have no obligation to employ Executive after any such termination, and upon any termination hereof, Contractor shall cause Executive to tender his resignation to the Company.

(b) Upon the termination of this Agreement, neither Contractor, Executive nor Executive’s beneficiaries or estate shall have any further rights under this Agreement or any claims against the Company arising out of this Agreement, except that Contractor shall be entitled to receive accrued and unpaid Management Fees which are then due and owing as of the date of termination and, in the event of a termination by the Company without cause in connection with or following a Change of Control, as defined below, Contractor shall be entitled to a continuation of the semi-monthly payment of the Management Fee for a period of six months from the date of termination. For purposes of this Agreement, “cause” shall include Executive’s neglect of duties, willful failure to abide by instructions or policies from or set by the Board, commission of a felony or serious misdemeanor offense or pleading guilty or nolo contendere to same, Contractor’s breach of this Agreement or Contractor’s or Executive’s breach of any other material obligation to the Company.

(c) Upon the termination of this Agreement, Contractor shall, and shall cause Executive to promptly deliver to the Company all equipment, documents and other company property in their respective possession, custody or control.

(d) As used herein, the term “Change of Control” shall be defined as a change in ownership or control of the Company effected through any of the following transactions:

(i) a statutory share exchange, merger, consolidation or reorganization approved by the Company’s stockholders, unless securities representing more than 50% of the total combined voting power of the voting securities of the successor corporation are immediately thereafter beneficially owned, directly or indirectly, by the persons who beneficially owned the Company’s outstanding voting securities immediately prior to such transaction;

4. Governing Law; Mediation . This Agreement is entered into in Arizona and shall in all respects be interpreted, construed and governed by and in accordance with the laws of the State of Arizona. The parties agree that any dispute between the parties relating to this Agreement shall be subject to mediation according to the mediation rules of the American Arbitration Association (the “AAA”) applicable to commercial disputes, such to be held at a mutually agreeable office of the AAA in Phoenix, Arizona. Mediation shall be a condition precedent to litigation and mediation shall in no way preclude either party from seeking and obtaining any prejudgment remedy against the other party. By signing this Agreement, the parties submit themselves to the jurisdiction of the courts of the State of Arizona, located in Maricopa County, for the purpose of resolving any and all disputes arising out of this Agreement subject to the mediation procedures set forth in this Section.

5. Whole Agreement . This Agreement embodies all of the representations, warranties, covenants and agreements between the parties and no other representations, warranties, covenants, understandings or agreements exist, provided that it is understood that Executive shall enter into an Indemnification Agreement and Intellectual Property, Confidentiality and Non-Competition Agreement with the Company.

7. Amendment . This Agreement may not be amended orally but only by an instrument in writing executed by the Company and Contractor.

SIGNATURE PAGE FOLLOWS


COMPANY:		CONTRACTOR:


ORTHOLOGIC CORP.		VV III MANAGEMENT, LLC

By:	/s/ Fredric J. Feldman, Ph.D.	By:	/s/ John M. Holliman, III

Name:	Fredric J. Feldman, Ph.D.	Name:	John M. Holliman, III
Title:	Chair Compensation Committee	Title:	Executive Chairman
Date:	May 12, 2006	Date:	May 12, 2006

ACKNOWLEDGEMENT

Executive hereby acknowledges that he has read the foregoing Management Services Agreement and acknowledges and agrees that Executive shall have no rights to employment or other benefits in connection therewith, except as expressly provided therein. The Executive agrees that the termination by either party of the Management Services Agreement shall constitute the tender by Executive of his resignation from all positions held with the Company except, if applicable, as a Director of the Company. The Executive further agrees that so long as Executive is serving as an executive of the Company, Executive agrees that he shall: (i) devote the time, attention, skill and efforts to the performance of such duties as are normal and customary for such position and as reasonably requested by the Company’s Board of Directors; and (ii) use his best efforts to comply with any and all rules of conduct established by the Company and to perform any and all assigned duties in a manner that is acceptable to the Company.

EXECUTIVE :


Signature:		/s/ John M. Holliman, III

		John M. Holliman, III

Date: May 12, 2006

Exhibit 31.1

CERTIFICATION

I, John M. Holliman, III certify that:

	1.		I have reviewed this quarterly report on Form 10-Q of OrthoLogic Corp.;

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

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

	4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	a.		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b.		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c.		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d.		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

	a.		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: August 8, 2006

By:		/s/ John M. Holliman, III

John M. Holliman, III
Executive Chairman and principal executive officer

Exhibit 31.2

CERTIFICATION

I, Les Taeger, certify that:

	1.		I have reviewed this quarterly report on Form 10-Q of OrthoLogic Corp.;

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

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

	4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	a.		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b.		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c.		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d.		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	a.		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: August 8, 2006

By:		/s/ Les M. Taeger

Les M. Taeger
Chief Financial Officer

Exhibit 32

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of OrthoLogic Corp. (the “Company”) on Form 10-Q for the period ended June 30, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of John M. Holliman, III, Executive Chairman and principal executive officer of the Company, and Les M. Taeger, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of his knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


Date: August 8, 2006

/s/ John M. Holliman, III
John M. Holliman, III
Executive Chairman and principal executive officer

/s/ Les M. Taeger
Les M. Taeger
Chief Financial Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to OrthoLogic Corp. and will be retained by OrthoLogic Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

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