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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549


FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2003

or

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[  ] |  | 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.  xYes  oNo

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 126-2 of the Exchange Act):  xYes  oNo

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.

33,306,293 shares of common stock outstanding as of October 31, 2003

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TABLE OF CONTENTS



|                               |                                                                                               |                                                                |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | -------------------------------------------------------------- |  |  |  |  |  | 
|PART I  Financial Information
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                         
|                               |                                                                                               | Condensed Consolidated Statement of Operations                
|                               |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW                
|                               |                                                                                               | NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|Part II  Other Information   
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 6. Exhibits and Reports                                                                 
|SIGNATURES                    
|Exhibit Index                 
|EX-3.1                        
|EX-3.2                        
|Ex-10.1                       
|Ex-10.2                       
|Ex-31.1                       
|Ex-31.2                       
|EX-32                         



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ORTHOLOGIC CORP.
INDEX

|        |  |                       |  |                                                                                                                        |  |          |    | 
|------- |  | --------------------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | -------- | -- | 
|        |  |                       |  |                                                                                                                        |  | Page No.
|Part I  |  | Financial Information |  |                                                                                                                        |  |         
|        |  |                       |  | Item 1. Financial Statements (Unaudited)                                                                               |  |          |    | 
|        |  |                       |  | Condensed Consolidated Balance Sheets as of
September 30, 2003 and December 31, 2002                                   |  |          | 3  | 
|        |  |                       |  | Condensed Consolidated Statements of Operations for
the Three months and Nine months ended September 30,
2003 and 2002 |  |          | 4  | 
|        |  |                       |  | Condensed Consolidated Statements of Cash Flows for
the Nine months ended September 30, 2003 and
2002                  |  |          | 5  | 
|        |  |                       |  | Notes to Unaudited Condensed Consolidated Financial
Statements                                                         |  |          | 6  | 
|        |  |                       |  | Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations                          |  |          | 16 | 
|        |  |                       |  | Item 3. Quantitative and Qualitative Disclosures
about Market Risk                                                     |  |          | 26 | 
|        |  |                       |  | Item 4. Controls and Procedures                                                                                        |  |          | 26 | 
|Part II |  | Other Information     |  |                                                                                                                        |  |         
|        |  |                       |  | Item 2. Changes in Securities and Use of Proceeds                                                                      |  |          | 35 | 
|        |  |                       |  | Item 6. Exhibits and Reports                                                                                           |  |          | 37 | 

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##### Table of Contents












PART I  Financial Information
Item 1. Financial Statements

ORTHOLOGIC CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share data)
(Unaudited)

|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                   |    |       |        | 
|-------------------------------------------- | ------------------------------------------ | ------------------------------------------------------------------------------------------------------------------- | ---------------------------- | ----------------------------------------------------------------------------- | -- | ------------------ | ------- | ----------------- | -- | ----- | ------ | 
|                                             |                                            |                                                                                                                     |                              |                                                                               |    | September 30, 2003 |         | December 31, 2002
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|ASSETS                                       |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|Current assets                               |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            |                                                                                                                     |                              | Cash and cash equivalents                                                     |    | $                  | 12,287  |                   |    | $     | 11,286 | 
|                                             |                                            |                                                                                                                     |                              | Short-term investments                                                        |    |                    | 22,174  |                   |    |       | 18,660 | 
|                                             |                                            |                                                                                                                     |                              | Accounts receivable less allowance for doubtful
accounts of $2,951 and $3,111 |    |                    | 9,479   |                   |    |       | 9,641  | 
|                                             |                                            |                                                                                                                     |                              | Inventory                                                                     |    |                    | 2,284   |                   |    |       | 2,568  | 
|                                             |                                            |                                                                                                                     |                              | Prepaids and other current assets                                             |    |                    | 595     |                   |    |       | 598    | 
|                                             |                                            |                                                                                                                     |                              | Deferred income taxes  current                                               |    |                    | 1,667   |                   |    |       | 1,667  | 
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            |                                                                                                                     |                              | Total current assets                                                          |    |                    | 48,486  |                   |    |       | 44,420 | 
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|Furniture and equipment                      |                                            |                                                                                                                     | 7,568                        |                                                                               |    |                    | 8,572   |                  
|Accumulated depreciation                     |                                            |                                                                                                                     | (6,323                       | )                                                                             |    |                    | (7,074  | )                
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            |                                                                                                                     | Furniture and equipment, net |                                                                               |    | 1,245              |         |                   |    | 1,498 |       
|Long-term investments                        |                                            |                                                                                                                     | 5,024                        |                                                                               |    |                    | 5,659   |                  
|Deferred income taxes  non-current          |                                            |                                                                                                                     | 964                          |                                                                               |    |                    | 964     |                  
|Investment in Chrysalis BioTechnology        |                                            |                                                                                                                     | 750                          |                                                                               |    |                    | 750     |                  
|Deposits and other assets                    |                                            |                                                                                                                     | 210                          |                                                                               |    |                    | 129     |                  
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             | TOTAL ASSETS                               |                                                                                                                     | $                            | 56,679                                                                        |    |                    | $       | 53,420            |   
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|LIABILITIES & STOCKHOLDERS EQUITY           |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|Current liabilities                          |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            |                                                                                                                     |                              | Accounts payable                                                              |    | $                  | 988     |                   |    | $     | 477    | 
|                                             |                                            |                                                                                                                     |                              | Accrued liabilities                                                           |    |                    | 5,277   |                   |    |       | 4,148  | 
|                                             |                                            |                                                                                                                     |                              | Accrued CPM divestiture costs                                                 |    |                    |        |                   |    |       | 210    | 
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            |                                                                                                                     |                              | Total current liabilities                                                     |    |                    | 6,265   |                   |    |       | 4,835  | 
|Deferred rent                                |                                            |                                                                                                                     | 298                          |                                                                               |    |                    | 352     |                  
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             | TOTAL LIABILITIES                          |                                                                                                                     |                              | 6,563                                                                         |    |                    |         | 5,187             |   
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|STOCKHOLDERS EQUITY                         |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|Common stock, $.0005 par value:              |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             |                                            | 50,000,000 shares authorized; 33,072,025
and 32,088,821 shares issued; 33,030,225 and
32,047,021 shares outstanding |                              |                                                                               | 16 |                    |         |                   | 16 |      
|Additional paid-in capital                   |                                            |                                                                                                                     | 139,700                      |                                                                               |    |                    | 136,945 |                  
|Common stock to be used for legal settlement |                                            |                                                                                                                     |                             |                                                                               |    |                    | 2,078   |                  
|Accumulated deficit                          |                                            |                                                                                                                     | (89,463                      | )                                                                             |    |                    | (90,669 | )                
|Treasury stock at cost, 41,800 shares        |                                            |                                                                                                                     | (137                         | )                                                                             |    |                    | (137    | )                
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             | TOTAL STOCKHOLDERS EQUITY                 |                                                                                                                     |                              | 50,116                                                                        |    |                    |         | 48,233            |   
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  
|                                             | TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |                                                                                                                     | $                            | 56,679                                                                        |    |                    | $       | 53,420            |   
|                                             |                                            |                                                                                                                     |                              |                                                                               |    |                    |         |                  

See Notes to Unaudited Condensed Consolidated Financial Statements.

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OrthoLogic Corp.
Condensed Consolidated Statement of Operations
(in thousands, except per share data)
(Unaudited)

|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |        |        |       |        | 
|---------------------------------------------------- | ----------------------------------- | ------------------------------------- | ---------------------- | ------------------------ | ------ | ------------------ | ------ | ----------------- | ------ | ----- | ------ | ------ | ------ | ----- | ------ | ------ | ------ | ----- | ------ | 
|                                                     |                                     |                                       |                        |                          |        | Three months ended |        | Nine months ended
|                                                     |                                     |                                       |                        |                          |        | September 30,      |        | September 30,    
|                                                     |                                     |                                       |                        |                          |        |                    |        |                  
|                                                     |                                     |                                       |                        |                          |        | 2003               |        | 2002              |        | 2003  |        | 2002  
|Revenues                                             |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|                                                     |                                     | Net sales                             |                        | $                        | 12,523 |                    |        | $                 | 10,279 |       |        | $      | 34,263 |       |        | $      | 28,221 |      
|                                                     |                                     | Royalties from co-promotion agreement |                        |                          |       |                    |        |                   | 501    |       |        |        |       |       |        |        | 1,872  |      
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|                                                     |                                     |                                       |                        | Total net revenues       |        |                    | 12,523 |                   |        |       | 10,780 |        |        |       | 34,263 |        |        |       | 30,093 | 
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Cost of Revenues                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|                                                     | Cost of goods sold                  |                                       |                        | 1,926                    |        |                    |        | 1,865             |        |       |        | 5,088  |        |       |        | 4,621  |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |        |        |      
|                                                     |                                     |                                       | Total cost of revenues |                          |        | 1,926              |        |                   |        | 1,865 |        |        |        | 5,088 |        |        |        | 4,621 |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |        |        |      
|Gross Profit                                         |                                     |                                       | 10,597                 |                          |        |                    | 8,915  |                   |        |       | 29,175 |        |        |       | 25,472 |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Operating expenses                                   |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|                                                     | Selling, general and administrative |                                       |                        | 7,821                    |        |                    |        | 7,179             |        |       |        | 22,503 |        |       |        | 20,534 |       
|                                                     | Research and development            |                                       |                        | 2,522                    |        |                    |        | 722               |        |       |        | 6,299  |        |       |        | 2,391  |       
|                                                     | CPM divestiture and related gains   |                                       |                        | (132                     | )      |                    |        | (221              | )      |       |        | (477   | )      |       |        | (1,047 | )     
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|                                                     |                                     |                                       |                        | Total operating expenses |        |                    | 10,211 |                   |        |       | 7,680  |        |        |       | 28,325 |        |        |       | 21,878 | 
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Operating income                                     |                                     |                                       | 386                    |                          |        |                    | 1,235  |                   |        |       | 850    |        |        |       | 3,594  |       
|Other income                                         |                                     |                                       | 125                    |                          |        |                    | 169    |                   |        |       | 387    |        |        |       | 537    |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Income before income taxes                           |                                     |                                       | 511                    |                          |        |                    | 1,404  |                   |        |       | 1,237  |        |        |       | 4,131  |       
|Provision for income taxes                           |                                     |                                       | 5                      |                          |        |                    | 12     |                   |        |       | 31     |        |        |       | 37     |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|NET INCOME                                           |                                     | $                                     | 506                    |                          |        | $                  | 1,392  |                   |        | $     | 1,206  |        |        | $     | 4,094  |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |        |        |      
|Net income per common share  basic                  |                                     | $                                     | 0.02                   |                          |        | $                  | 0.04   |                   |        | $     | 0.04   |        |        | $     | 0.13   |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Net income per common and equivalent share  diluted |                                     | $                                     | 0.02                   |                          |        | $                  | 0.04   |                   |        | $     | 0.04   |        |        | $     | 0.13   |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Basic shares outstanding                             |                                     |                                       | 32,975                 |                          |        |                    | 32,719 |                   |        |       | 32,892 |        |        |       | 32,615 |       
|Equivalent shares                                    |                                     |                                       | 684                    |                          |        |                    | 530    |                   |        |       | 385    |        |        |       | 96     |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       
|Diluted shares outstanding                           |                                     |                                       | 33,659                 |                          |        |                    | 33,249 |                   |        |       | 33,277 |        |        |       | 32,711 |       
|                                                     |                                     |                                       |                        |                          |        |                    |        |                   |        |       |        |        |        |       |        |       

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ORTHOLOGIC CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(in thousands)
(Unaudited)

|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |         |     |         |       | 
|--------------------------------------------------------------------- | ------------------------------------------- | ------------------------------------------------------ | -------------------------------------------------------- | ----------------------------------------- | ----- | ------------------------------- | ------ | ------- | --- | ------- | ----- | 
|                                                                      |                                             |                                                        |                                                          |                                           |       | Nine months ended September 30,
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                
|                                                                      |                                             |                                                        |                                                          |                                           |       | 2003                            |        | 2002   
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|OPERATING ACTIVITIES                                                  |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|                                                                      | Net income                                  |                                                        | $                                                        | 1,206                                     |       |                                 | $      | 4,094   |    
|                                                                      | Non-cash items:                             |                                                        |                                                          |                                           |       |                                 |        |         |    
|                                                                      |                                             |                                                        | Depreciation                                             |                                           |       | 487                             |        |         |     | 526     |      
|                                                                      | Change in operating assets and liabilities: |                                                        |                                                          |                                           |       |                                 |        |         |    
|                                                                      |                                             |                                                        | Accounts receivable                                      |                                           |       | 162                             |        |         |     | 988     |      
|                                                                      |                                             |                                                        | Inventories                                              |                                           |       | 284                             |        |         |     | (1,334  | )    
|                                                                      |                                             |                                                        | Prepaids and other current assets                        |                                           |       | 3                               |        |         |     | (138    | )    
|                                                                      |                                             |                                                        | Deposits and other assets                                |                                           |       | (81                             | )      |         |     | (19     | )    
|                                                                      |                                             |                                                        | Accounts payable                                         |                                           |       | 511                             |        |         |     | 516     |      
|                                                                      |                                             |                                                        | Accrued liabilities and deferred rent                    |                                           |       | 1,075                           |        |         |     | (453    | )    
|                                                                      |                                             |                                                        | Accrued liabilities on CPM divestiture and related gains |                                           |       | (210                            | )      |         |     | (754    | )    
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |         |    
|                                                                      |                                             |                                                        |                                                          | Net cash provided by operating activities |       |                                 | 3,437  |         |     |         | 3,426 | 
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|INVESTING ACTIVITIES                                                  |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|                                                                      | Expenditures for equipment and furniture    |                                                        |                                                          | (234                                      | )     |                                 |        | (239    | )  
|                                                                      | Purchases of investments                    |                                                        |                                                          | (19,945                                   | )     |                                 |        | (27,860 | )  
|                                                                      | Maturities of investments                   |                                                        |                                                          | 17,066                                    |       |                                 |        | 15,250  |    
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |         |    
|                                                                      |                                             |                                                        | Net cash used in investing activities                    |                                           |       | (3,113                          | )      |         |     | (12,849 | )    
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|FINANCING ACTIVITIES                                                  |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|                                                                      | Net proceeds from stock option exercises    |                                                        |                                                          | 677                                       |       |                                 |        | 54      |    
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                  |                                             |                                                        | 1,001                                                    |                                           |       |                                 | (9,369 | )      
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                        |                                             |                                                        | 11,286                                                   |                                           |       |                                 | 19,503 |        
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|CASH AND CASH EQUIVALENTS, END OF PERIOD                              |                                             | $                                                      | 12,287                                                   |                                           |       | $                               | 10,134 |        
|                                                                      |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES: |                                             |                                                        |                                                          |                                           |       |                                 |        |        
|                                                                      |                                             | Cash paid during the period for interest               |                                                          | $                                         | 9     |                                 |        | $       | 8   |        
|                                                                      |                                             | Cash paid during the period for income taxes           |                                                          | $                                         | 21    |                                 |        | $       | 42  |        
|                                                                      |                                             | Common stock issued for legal settlement               |                                                          | $                                         | 2,078 |                                 |        |         |     |        
|                                                                      |                                             | Conversion of Series B preferred stock to common stock |                                                          |                                           |       |                                 |        | $       | 600 |        

See Notes to Unaudited Condensed Consolidated Financial Statements.

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ORTHOLOGIC CORP.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of the Business. OrthoLogic Corp. (OrthoLogic or the
Company) develops, manufactures and markets proprietary, technologically
advanced orthopedic products designed to promote the healing of musculoskeletal
tissue, with particular emphasis on fracture healing and spinal repair.
OrthoLogics products are designed to enhance the healing of diseased, damaged,
degenerated or recently repaired musculoskeletal tissue. The Companys
products focus on improving the clinical outcomes and cost-effectiveness of
orthopedic procedures that are characterized by compromised healing, high-cost,
potential for complication and long recuperation time.

On October 9, 2003, the Company announced that it had entered into an
Asset Purchase Agreement to sell our bone growth stimulation device business
(the Bone Device Business) assets (including the rights to produce and market
the OL1000, OL1000 SC, SpinaLogic and OrthoFrame/Mayo) to dj Orthopedics.

Pursuant to the Asset Purchase Agreement, OrthoLogic will sell
substantially all of the assets of our Bone Device Business, including
substantially all of the related machinery, equipment, inventory, work in
process, licenses, customer lists, intellectual property, certain agreements
and contracts to dj Orthopedics. dj Orthopedics will assume substantially all
of the Bone Device Business trade payables and other current liabilities less
payables in an amount approximately equal to the amount of retained Medicare
receivables (Note 2).

In 1999, we exercised our option to license the United States development,
marketing, and distribution rights for the fracture indications for Chrysalin,
a new tissue repair synthetic peptide. In 2000, we exercised our option to
license Chrysalin for all orthopedic applications worldwide. Since that time,
our research and development efforts have focused primarily on our Chrysalin
product development program. We currently have three potential Chrysalin
products either in human clinical trials or in late-stage pre-clinical
development.

Financial Statement Presentation

In the opinion of management, the unaudited interim financial statements
include all adjustments necessary for the fair presentation of the Companys
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. The balance sheet as of
December 31, 2002 is derived from the Companys audited financial statements
included in the 2002 Annual Report on Form 10-K. These financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Companys 2002 Annual Report on Form 10-K.

Use of estimates.The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the

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reported amounts of revenue and expenses during the reporting period.
Actual results could differ from these estimates. Significant estimates
include the allowance for doubtful accounts (approximately $3.0 million at
September 30, 2003 and $3.1 million at December 31, 2002), which is based
primarily on trends in historical collection rates, consideration of current
events, payor mix and other considerations. The Company derives a significant
amount of its revenues in the United States from third-party payors, including
Medicare and certain commercial insurance carriers, health maintenance
organizations, and preferred provider organizations. Amounts paid under these
plans are generally based on fixed or allowable reimbursement rates. Revenues
are recorded at the expected or pre-authorized reimbursement rates when earned
and include unbilled receivables of $611,000 and $860,000 on September 30, 2003
and December 31, 2002, respectively. The decrease in the unbilled receivables
from December 31, 2002 to September 30, 2003 was primarily the result of
changes to the Companys product placement procedures made in late 2002,
resulting in improved billing processes. Billings are subject to review by
third party payors and may be subject to adjustments. Any differences between
estimated reimbursement and final determinations are reflected in the period
finalized. The Company maintained a reserve for inventory shrinkage and
obsolescence of $814,000 and $687,000 on September 30, 2003 and December 31,
2002, respectively. In the opinion of management, adequate allowances have
been provided for doubtful accounts, contractual adjustments and inventory
reserves.

Principles of consolidation.The consolidated financial statements
include the accounts of OrthoLogic and its subsidiaries. All inter-company
accounts and transactions have been eliminated. The Company prepares its
consolidated financial statements in accordance with accounting principles
generally accepted in the United States of America. The following briefly
describes the significant accounting policies used in the preparation of the
financial statements of the Company:

A.     Cash and cash equivalents.Cash and cash equivalents consist of cash
on hand and cash deposited with financial institutions, including money market
accounts, and commercial paper purchased with an original maturity of three
months or less.

B.     Inventories.Business inventories are stated at the lower of cost
(first in, first out method) or market. The Company writes down its inventory
for inventory shrinkage and obsolescence. Inventory is written down to
estimated market value based on a number of assumptions, including future
demand and market conditions.

C.     Furniture and equipment.Furniture and equipment are stated at cost
or, in the case of leased assets under capital leases, at the present value of
future lease payments at inception of the lease. Depreciation is calculated on
a straight-line basis over the estimated useful lives of the various assets,
which range from three to seven years. Leasehold improvements and leased assets
under capital leases are amortized over the life of the asset or the period of
the respective lease using the straight-line method, whichever is the shortest.

The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
effective January 1, 2002. SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets, and supersedes
Statement of Financial Accounting Standards No. 121, Accounting of the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.
SFAS No. 144 requires that the Company evaluate long-lived assets based on the
net future

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cash flow expected to be generated from the asset on an undiscounted basis
whenever significant events or changes in circumstances occur that indicate
that the carrying amount of an asset may not be recoverable. The adoption of
SFAS No. 144 did not have a significant impact on the Companys operating
results or financial position.

D.     Investment in Chrysalis.The Company owns a minority ownership
interest in Chrysalis BioTechnology, Inc., which is recorded at cost (see Note
5).

E.     Income taxes.Under Financial Accounting Standards Board (FASB)
SFAS No. 109, Accounting for Income Taxes, income taxes are recorded based on
current year amounts payable or refundable, as well as the consequences of
events that give rise to deferred tax assets and liabilities. The Company
bases its estimate of current and deferred taxes on the tax laws and rates that
are currently in effect in the appropriate jurisdiction. Pursuant to SFAS No.
109, the Company has determined that the majority of the deferred tax asset at
September 30, 2003 requires a valuation allowance.

F.     Restructuring and other related charges.The Company recorded
restructuring charges during the second quarter of 2001 using the authoritative
guidance in Emerging Issues Task Force Issue No. 94-3 (EITF No. 94-3),
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). In
June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities(SFAS No. 146). The provisions of SFAS No. 146
are effective for exit or disposal activities that are initiated after December
31, 2002, with earlier adoption encouraged. The Company adopted SFAS No. 146
effective January 1, 2003. SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
EITF No. 94-3. Under SFAS No. 146, the liability for costs associated with
exit or disposal activities is recognized and measured initially at fair value
only when the liability is incurred, rather than at the date the Company
committed to the exit plan. The adoption of SFAS No. 146 did not have a
significant impact on the Companys operating results or financial position.

G.     Revenue.Revenue is recognized for sales of the OL1000 and SpinaLogic
products at the time the product is delivered to and accepted by the patient,
as verified by the patient signing a Patient Agreement Form accepting
financial responsibility. If the sale of either product is to a commercial
buyer, a purchase order is required, and the revenue is recognized at the time
of shipment to the commercial buyer. The Companys shipping terms are FOB
shipping point.

The amount of revenue recorded at the time of sale is based on contractual
terms, or if the Company does not have a contract with the third-party payor,
then the amount of revenue recorded is the pricing expected to be approved by
the third-party payor, based on historical experience with that payor. The
Company records differences, if any, between the net revenue amount recognized
at the time of the sale and the ultimate pricing by the primary third-party
payor as an adjustment to sales in the period the Company receives payments
from the third-party payor or earlier if the Company becomes aware of
circumstances that warrant a change in estimate.

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The Hyalgan royalties were recorded in accordance with a Co-Promotion
Agreement and a Termination Agreement the Company had with Hyalgans
distributor. The agreements with Hyalgans distributor concluded in December
2002. The Company will receive no subsequent Hyalgan related revenues (see
Note 4).

H.     Warranties.The Company maintains a warranty reserve for the expected
cost to replace or repair products and the Technology You Can Trust program
for the OL1000 device beginning March 1, 2003. Warranty costs are recorded in
cost of goods sold. The business does not offer price protection or rebates to
any of its customers. Warranty reserves totaled approximately $30,000 and
$97,000 at December 31, 2002 and September 30, 2003, respectively.

|             |         |                |  |                |  |                |   |             |  |               |   |         |   |         |   |        | 
|------------ | ------- | -------------- |  | -------------- |  | -------------- | - | ----------- |  | ------------- | - | ------- | - | ------- | - | ------ | 
|Reserve      |         |                |  |                |  |                |   |             |  |               |   |         |   | Reserve
|December 31, |         |                |  |                |  | Increase       |   | Adjustments |  | September 30,
|2002         |         | Use of reserve |  | to the reserve |  | to the reserve |   | 2003       
|             |         |                |  |                |  |                |   |            
|             | $30,000 |                |  |               |  |                | $ | 99,400      |  |               | $ | (32,100 | ) |         | $ | 97,300 | 
|             |         |                |  |                |  |                |   |             |  |               |   |         |   |         |   |       

I.     Research and development.Research and development represents both
costs incurred internally for research and development activities, as well as
costs incurred by the Company to fund the research activities with which the
Company has contracted and certain milestone payments regarding the continued
clinical testing of Chrysalin. All research and development costs are
expensed when incurred.

J.     Stock-based compensation.In December 2002, the FASB issued SFAS No.
148, Accounting for Stock-Based Compensation - Transition and Disclosure(SFAS
No. 148) which is effective for fiscal years ended after December 15, 2002.
SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition
to SFAS No. 123s fair value method of accounting for stock-based employee
compensation if a company elects to account for its equity awards under this
method. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and
APB Opinion No. 28, Interim Financial Reporting, to require disclosure of the
effects of an entitys accounting policy with respect to stock-based employee
compensation on reported net income and earnings per share in both annual and
interim financial statements. The Company is currently evaluating the impact
if it were to adopt the fair value method of accounting for stock-based
employee compensation under all three methods.

The Company has two stock-based employee compensation plans. The Company
accounts for those plans under the recognition and measurement principles of
APB Opinion No. 25, Accounting for Stock Issued to Employees,and related
Interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table (in thousands) presents pro forma disclosures required by SFAS No. 148 of net
income and basic and diluted earnings per share as if stock-based employee
compensation had been recognized during the three and nine months ended
September 30, 2003 and 2002, as determined under the fair value method using
the Black-Scholes pricing model.

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|                                                                            |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |       |   | 
|--------------------------------------------------------------------------- | -------------------------------- | ---- | --------- | ------------------ | --------- | ----------------- | --------- | ----- | --------- | ---- | ---- | ----- | - |  | - | ----- | - | 
|                                                                            |                                  |      |           | Three months ended |           | Nine months ended
|                                                                            |                                  |      |           | September 30,      |           | September 30,    
|                                                                            |                                  |      |           |                    |           |                  
|                                                                            |                                  |      |           | 2003               |           | 2002              |           | 2003  |           | 2002
|Estimated weighted-average fair value
of options granted during the period: |                                  | None |           | None               |           | $                 | 1.74      |       |           | $    | 2.58 |      
|Net income attributable to common stockholders:                             |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |      
|                                                                            | As reported                      |      | $         | 506                |           |                   | $         | 1,392 |           |      | $    | 1,206 |   |  | $ | 4,094 |  
|                                                                            | Stock based compensation expense |      | $         | (115               | )         |                   | $         | (171  | )         |      | $    | (355  | ) |  | $ | (526  | )
|                                                                            |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |      
|                                                                            | Pro forma                        |      | $         | 391                |           |                   | $         | 1,221 |           |      | $    | 851   |   |  | $ | 3,568 |  
|Basic net income per share:                                                 |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |      
|                                                                            | As reported                      |      | $         | 0.02               |           |                   | $         | 0.04  |           |      | $    | 0.04  |   |  | $ | 0.13  |  
|                                                                            | Pro forma                        |      | $         | 0.01               |           |                   | $         | 0.04  |           |      | $    | 0.03  |   |  | $ | 0.11  |  
|Diluted net income per share:                                               |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |      
|                                                                            | As reported                      |      | $         | 0.02               |           |                   | $         | 0.04  |           |      | $    | 0.04  |   |  | $ | 0.13  |  
|                                                                            | Pro forma                        |      | $         | 0.01               |           |                   | $         | 0.04  |           |      | $    | 0.03  |   |  | $ | 0.11  |  
|Black Scholes model assumptions:                                            |                                  |      |           |                    |           |                   |           |       |           |      |      |       |   |  |   |      
|                                                                            | Risk free interest rate          |      |           | 1.6                | %         |                   |           | 1.8   | %         |      |      | 1.6   | % |  |   | 1.8   | %
|                                                                            | Expected volatility              |      |           | 44                 | %         |                   |           | 38    | %         |      |      | 41    | % |  |   | 53    | %
|                                                                            | Expected term                    |      | 2.7 Years |                    | 2.7 Years |                   | 2.7 Years |       | 2.7 Years
|                                                                            | Dividend yield                   |      |           | 0                  | %         |                   |           | 0     | %         |      |      | 0     | % |  |   | 0     | %

The proposed sale qualifies as an accelerating event for the Companys two
stock-based compensation plans. See Note 2 for further discussion.

J.     Income per common share.Income per common share is computed on the
weighted average number of common or common and equivalent shares outstanding
during each year. Basic earnings per share is computed as net income divided
by the weighted average number of common shares outstanding during the period.
Diluted earnings per share reflects the potential dilution that could occur
from common shares issuable through stock options, warrants, and other
convertible securities when the effect would be dilutive.

K.     New Accounting Pronouncements.In November 2002, the FASB issued
Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of the Indebtedness
of Others,which clarifies the requirements of SFAS No. 5, Accounting for
Contingencies,relating to a guarantors accounting for and disclosures of
certain guarantees issued. FIN 45 requires enhanced disclosures for certain
guarantees. FIN 45 also requires certain guarantees that are issued or
modified after December 31, 2002, to be initially recorded on the balance sheet
at fair value. The application of FIN 45 did not have a material effect on the
Companys financial statements.

In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the application of
Accounting Research Bulletin No. 51, Consolidated Financial
Statements,
relating to consolidation of certain entities. First, FIN 46 will require
identification of the Companys participation in variable interest entities
(VIEs), which are defined as entities with a level of invested equity that is
not sufficient to fund future activities to permit it to operate on a stand
alone basis. For entities identified as a VIE, FIN 46

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sets forth a model to evaluate potential consolidation based on an
assessment of which party to the VIE (if any) bears a majority of the exposure
to its expected losses, or stands to gain from a majority of its expected
returns. Interpretation No. 46 applies to VIEs created or acquired after
January 31, 2003. For VIEs existing at January 31, 2003, FIN 46, as amended by
financial Statement Position No. 46-6, is effective for public companies for
annual or interim periods beginning after December 15, 2003. The application
of FIN 46 did not have a material effect on the Companys financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No.
133 on Derivative Instruments and Hedging Activities(SFAS No. 149). SFAS
No. 149 amended and refined certain characteristics of derivative instruments
and hedges. The application of SFAS No. 149 did not have a material effect on
the Companys financial statements.

In May 2003, the FASB issued a SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity
(SFAS No. 150). SFAS No. 150 requires the classification of certain
financial instruments, previously classified within the equity section of the
balance sheet, to be included in liabilities. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003 and June 15,
2003 for all other instruments. The application of SFAS No. 150 did not have a
material effect on the Companys financial statements.

2. ASSET SALE TO dj ORTHOPEDICS

On October 9, 2003, the Company announced that it had entered into an
Asset Purchase Agreement to sell the Bone Device Business assets (including the
rights to produce and market the OL1000, OL1000 SC, SpinaLogic and
OrthoFrame/Mayo) to dj Orthopedics. Pursuant to the Asset Purchase Agreement,
OrthoLogic will sell substantially all of the assets of the Bone Device
Business, including substantially all of the related machinery, equipment,
inventory, work in process, licenses, customer lists, intellectual property,
certain agreements and contracts to dj Orthopedics. dj Orthopedics will pay
the Company $93.0 million in cash at closing and assume substantially all of
the Bone Device Business trade payables and other current liabilities less
payables in an amount approximately equal to the amount of retained Medicare
receivables.
Upon the closing of the asset sale the Company will assign and dj Orthopedics
will assume and agree to perform those obligations outstanding on or arising
after the closing date relating to the operation of the Bone Device Business
(including various liabilities related to the Companys employees).

The $93.0 million purchase price is subject to certain adjustments. In
particular, the purchase price may be adjusted downward on a dollar-for dollar
basis if the closing date net working capital (as defined in the Asset Purchase
Agreement) is less than $8.0 million. As of September 30, 2003, the net
working capital, as so defined, was approximately $8.7 million. In addition,
the purchase price may be adjusted downward by the amount by which Medicare
accounts receivable excluded from the purchased assets exceeds the amount of
trade payables retained. The net amount of the Medicare receivables was $1.1
million at September 30, 2003.

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Of the $93.0 million the Company will receive in the sale, $7.5 million
will be placed in an escrow account. The funds will be divided into two
accounts: $7.0 million from which dj Orthopedics eligible indemnity and breach
of contract claims, if any, may be paid and $0.5 million from which a portion
of the agreed upon incentive stay bonuses will be paid by dj Orthopedics to
former OrthoLogic executives on the first anniversary of the closing. The
remaining funds in the $7.0 million escrow account, in excess of the amount of
any pending claims, will be released to the Company on the second anniversary
of the closing.

The proposed transaction is considered an accelerating event for the
Companys stock-based compensation plans. Terminated employees unvested
options will vest immediately upon the sale. The Companys directors and
employees who are retained will have 75% of their unvested options vest upon
the sale, with the remainder vesting over a 12 month period or on their regular
vesting period, whichever is earlier.

The proposed sale did not meet the requirements of SFAS No. 144 at
September 30, 2003 since shareholder approval is required. The shareholder
vote on the sale is expected to be finalized on or about November 26, 2003. If
finalized, the sale of the Bone Device Business will be accounted for as
discontinued operations.

If the sale of the Bone Device Business had occurred on September 30,
2003, net assets of approximately $9.4 million would be transferred to dj
Orthopedics and a gain of approximately $71.1 million would have been recorded.

3. CPM DIVESTITURE AND RELATED GAINS

CPM Divestiture and Change in Estimated Collectability of CPM receivables.
In July 2001, the Company announced the sale of its CPM business to
OrthoRehab, Inc. The Company received $12.0 million in cash, with the
purchaser assuming approximately $2.0 million in liabilities in connection with
the sale of certain CPM related assets that had been recorded in the Companys
financial statements at a carrying value of approximately $20.7 million. The
Company recorded a $6.9 million charge to write down the CPM assets to their
fair value less direct costs of selling the assets. Under the CPM Asset
Purchase Agreement, the Company was eligible to receive up to an additional
$2.5 million of cash if certain objectives were achieved by the purchaser of
the CPM business.

The parties settled litigation over the $2.5 million payment and other
matters in April 2003. OrthoRehab, Inc. agreed to pay $1.2 million to settle
the contingent payment due to OrthoLogic, and all outstanding claims between
the two companies. Total cash payments of $477,000 were received during the
second and third quarter of 2003, and are included in the CPM divestiture and
related charges line item on the Consolidated Statement of Operations for the
three and nine month periods ended September 30, 2003. The remaining $723,000
balance plus interest is scheduled to be paid over the next 30 months.
Management has determined that it is appropriate to reflect income on the
settlement as cash is received. The litigation is described in greater detail
in Note 6.

At December 31, 2001, the Company had collected $10.2 million of the
remaining $10.8 million of the retained CPM receivables. During 2002,
collection of these receivables was better than anticipated. Based on the
improved collection trends, the Company revised its estimates

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and increased the estimated total collection of the retained CPM accounts
receivable by $600,000 in the quarter ended March 31, 2002, which is included
in the CPM Divestiture and Related Charges line item in the consolidated
statement of operations.

In connection with the sale of the CPM business, the Company notified
approximately 331 of the Companys 505 employees that their positions were
being eliminated. The consolidated statement of operations for the year ended
December 31, 2001 included a charge of approximately $3.3 million in the CPM
Divestiture and Related Charges total for severance and related benefits. The
Company also recorded additional exit charges of approximately $1.4 million for
CPM commissions, write offs of prepaid rents, space build out costs relating to
the purchasers sublease with the Company and other similar charges, and other
CPM related prepaid expenses for which no future benefits were expected to be
received by the Company. These additional exit costs were also included in the
CPM Divestiture and Related Charges total in the 2001 statement of
operations.

A summary of the severance and other reserve balances at September 30,
2003 and December 31, 2002 are as follows (in thousands):

|                            |  |                   |     |      |  |                    |      |   |  |   |   | 
|--------------------------- |  | ----------------- | --- | ---- |  | ------------------ | ---- | - |  | - | - | 
|                            |  | Reserves          |     | Cash |  | Reserves          
|                            |  | December 31, 2002 |     | Paid |  | September 30, 2003
|                            |  |                   |     |      |  |                   
|Severance                   |  | $                 | 161 |      |  | $                  | (161 | ) |  | $ |  | 
|Other exit costs            |  |                   | 49  |      |  |                    | (49  | ) |  |   |  | 
|                            |  |                   |     |      |  |                    |      |   |  |   |   | 
|Total non-recurring charges |  | $                 | 210 |      |  | $                  | (210 | ) |  | $ |  | 

|                            |  |                   |       |      |  |                   |      |   |  |   |     | 
|--------------------------- |  | ----------------- | ----- | ---- |  | ----------------- | ---- | - |  | - | --- | 
|                            |  | Reserves          |       | Cash |  | Reserves         
|                            |  | December 31, 2001 |       | Paid |  | December 31, 2002
|                            |  |                   |       |      |  |                  
|Severance                   |  | $                 | 946   |      |  | $                 | (785 | ) |  | $ | 161 | 
|Other exit costs            |  |                   | 76    |      |  |                   | (27  | ) |  |   | 49  | 
|                            |  |                   |       |      |  |                   |      |   |  |   |     | 
|Total non-recurring charges |  | $                 | 1,022 |      |  | $                 | (812 | ) |  | $ | 210 | 

Cash requirements for the severance and exit costs were funded from the
Companys current cash balances. Subsequent to the sale, the Company is no
longer in the CPM business. Substantially all costs, expenses and impairment
charges related to CPM exit activities were recorded prior to the end of the
second quarter of 2001.

4. CO-PROMOTION AGREEMENT FOR HYALGAN

In June 1997, the Company signed an exclusive Co-Promotion Agreement with
Sanofi Synthelabo, Inc. (Sanofi) at a cost of $4.0 million, which provided
the Company with the right to market the Hyalgan product to orthopedic surgeons
in the United States. The Company capitalized the $4.0 million investment in
the agreement.

In the fourth quarter of 2000, the Company and Sanofi mutually agreed to
terminate this Co-Promotion Agreement. The Termination Agreement stipulated
that the Company would receive royalties of $5 for each unit of the Hyalgan
product distributed by Sanofi during the two-year period from January 1, 2001
through December 31, 2002. During the nine month period

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ended September 30, 2002, the Company received $1.9 million in royalty
payments. The royalty payments ended December 2002. All of the royalties and
co-promotion fees received from Sanofi are included in the line item entitled
Royalties from co-promotion agreement in the statement of operations.

5. LICENSING AGREEMENT FOR CHRYSALIN

In January 1998, the Company acquired a minority equity investment (less
than 10%) in a biotech firm, Chrysalis BioTechnology, Inc. (Chrysalis), for
$750,000. As part of the transaction, the Company was awarded a worldwide
exclusive option to license the orthopedic applications of Chrysalin, a
patented 23-amino acid synthetic peptide that had shown promise in accelerating
the healing process. The Companys agreement with Chrysalis contains
provisions for the Company to continue and expand its option to license
Chrysalin contingent upon regulatory approvals, successful pre-clinical trials,
and certain trials and milestone payments to Chrysalis by the Company.

In January 1999, the Company exercised its option to license the United
States development, marketing and distribution rights for Chrysalin for
fracture indications. As part of the license agreement, and in conjunction
with the Food and Drug Administration (FDA) authorization of an
Investigational New Drug (IND) application to begin human clinical trials for
fracture repair, OrthoLogic made a $500,000 milestone payment to Chrysalis in
the fourth quarter of 1999. In January 2000, the Company began enrolling
patients in the combined Phase 1/2 clinical trial for Chrysalin. In July 2000,
the Company made a $2.0 million payment to Chrysalis and announced it was
expanding its license agreement to include all Chrysalin orthopedic indications
worldwide.

In July 2001, the Company paid $1.0 million to Chrysalis to extend its
worldwide license for Chrysalin to include the rights for orthopedic soft
tissue indications including cartilage, tendon and ligament repair. The
license agreement calls for the Company to pay certain additional milestone
payments and royalty fees, based upon products developed and achievement of
commercial services.

In March 2002, the Company received authorization from the FDA to commence
a Phase 1/2 clinical trial under an IND application for a spinal fusion
indication and made a $500,000 milestone payment to Chrysalis for receiving
this FDA authorization to begin the trial. The Company began enrolling
patients during the fourth quarter of 2002. The clinical trial will include
approximately 330 patients and will be performed at 15 to 20 centers in the
United States. The purpose of the study is to evaluate the safety and
preliminary efficacy of Chrysalin in combination with allograft. The patient
enrollment process is expected to take approximately 18 to 24 months with a
nine-month follow-up period.

The Company completed a Phase 1/2 clinical trial utilizing Chrysalin for
fresh fracture repair, and in July of 2002, announced that the FDA had
authorized a Phase 3 trial for that indication. The trial will be performed at
25 to 30 clinical sites with approximately 500 patients. In addition, the
Company is currently moving forward towards a potential IND application for a
human clinical trial for Chrysalin for articular cartilage defect repair.
There can be no assurance

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that any of these clinical trials will result in favorable data or that
New Drug Application (NDA) approvals by the FDA, if sought, will be obtained.

A payment of $250,000 was expensed in the quarter ended March 31, 2003 and
is included in research and development and reflects a payment made to
Chrysalis in anticipation of a potential IND filing with the FDA for a human
clinical trial for a cartilage indication.

At this stage of research, the Company is not yet able to apply for FDA
approval to market Chrysalin. The process of obtaining necessary government
approvals is time consuming and expensive. There can be no assurance that the
necessary approvals for new products or applications will be obtained by the
Company or, if they are obtained, that they will be obtained on a timely basis.
Significant additional costs for the Company will be necessary to complete
development of these products.

OrthoLogic does not own the patents to Chrysalin. Chrysalin was developed
by and patented by Chrysalis. Except for the $750,000 minority equity
investment in Chrysalis, all payments made to Chrysalis have been expensed as
research and development. The license agreement with Chrysalis calls for the
Company to pay certain other additional milestone payments and royalty fees,
based upon the products development and achievement of commercial
introduction.

6. LITIGATION

United States of America ex rel. David Barmak v. Sutter Corp., United
States Orthopedic Corp., OrthoLogic Corp., et al., United States District
Court, Southern District of New York, Civ Action No 95 Civ 7637. The complaint
in this matter was filed in September 1997 under the Qui Tam provisions of the
Federal False Claims Act and primarily relate to events occurring prior to the
Companys acquisition of Sutter Corporation. The allegations relate to the
submission of claims for reimbursement for continuous passive motion exercisers
to various federal health care programs. In June 2001, the U.S. Department of
Justice and the Company entered into a settlement agreement and the
governments amended complaint was dismissed with prejudice. In October 2001,
Plaintiff Barmak filed a second amended complaint, pursuing the claim
independent of the U.S. Department of Justice, which was dismissed by the court
in March 2002. In June 2002, Plaintiff Barmak filed his third amended
complaint, which was dismissed with prejudice by the court on June 19, 2003.

OrthoRehab, Inc. and OrthoMotion, Inc. v. OrthoLogic Corporation and
OrthoLogic Canada, Ltd., Superior Court of the State of Delaware, County of New
Castle, Case No. C.A. No. 01C-11-224 WCC. In November 2001, OrthoRehab, Inc.,
filed a complaint in connection with its acquisition of certain assets used in
the Companys CPM business in July 2001 alleging, among other things, that some
of the assets purchased were overvalued and that the Company had breached its
contract. The Company settled the dispute in April 2003. Under the terms of
the settlement agreement, OrthoRehab, Inc. agreed to pay $1.2 million to settle
all outstanding claims between the two companies. Cash payments totaling
$477,000 were received during the second and third quarter and are included in
the CPM divestiture and related gains line item on the Consolidated Statement
of Operations in the period ended September 30, 2003. The remaining $723,000
balance plus interest is scheduled to be paid over the next 30 months.

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Management has determined that it is appropriate to reflect income on the
settlement as cash is received.

In addition to the matters disclosed above, the Company is involved in
various other legal proceedings that arise in the ordinary course of business.
In managements opinion, the ultimate resolution of these other legal
proceedings are not likely to have a material adverse effect on the financial
position, results of operations or cash flows of the Company.

The health care industry is subject to numerous laws and regulations of
federal, state, and local governments. Compliance with these laws and
regulations, specifically those relating to the Medicare and Medicaid programs,
can be subject to government review and interpretations, as well as regulatory
actions unknown and unasserted at this time. Recently, federal government
activity has increased with respect to investigations and allegations
concerning possible violations by health care providers of regulations, which
could result in the imposition of significant fines and penalties, as well as
significant repayments of previously billed and collected revenues from patient
services. Management believes that the Company is in substantial compliance
with current laws and regulations.

7. LINE OF CREDIT

The Company has a $4.0 million accounts receivable revolving line of
credit with a lending institution. The Company may borrow up to 75% of the
eligible accounts receivable, as defined in the agreement. The interest rate
is at the prime rate. Interest accruing on the outstanding balance and a
monthly administration fee is due in arrears on the first day of each month.
The line of credit was extended in 2002 and expires February 28, 2005. There
are certain financial covenants and reporting requirements associated with the
line of credit. Included in the financial covenants are (1) tangible net worth
of not less than $30.0 million, (2) a quick ratio of not less than 2.0 to 1.0,
(3) a debt to tangible net worth ratio of not less than 0.50 to 1.0, and (4)
capital expenditures will not exceed more than $7.0 million dollars during any
fiscal year. The Company has not utilized this line of credit. As of
September 30, 2003, the Company was in compliance with all the financial
covenants. The Proposed Sale of the Bone Device Business assets would require
a change in the basis for the current line of credit agreement.

8. SEGMENT INFORMATION

The Company operates as one segment. The various types of revenues and
cost of goods sold are separately identified by product line in the Statement
of Operations. Operating expenses were not directly allocated between the
Companys various lines of business.




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

When used in this report, the terms OrthoLogic, we, our, or us
refer to OrthoLogic Corp. or OrthoLogic Corp. and its subsidiaries, as
appropriate in the context.

The following is managements discussion of significant factors that
affected OrthoLogics interim financial condition and results of operations.
This should be read in

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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 ending December 31, 2002 and the Special Note Regarding Forward
Looking Statements below following Item 4.

On October 9, 2003, we announced that we had signed a definitive agreement
to sell substantially all the assets of our Bone Device Business to dj
Orthopedics, LLC for $93.0 million and the assumption of some liabilities.
Completion of the transaction is subject to a number of conditions, including
approval by our stockholders, normal governmental approvals, and customary
closing conditions. We have scheduled a stockholders meeting on November 26,
2003 to approve the sale. If the sale is consummated, our balance sheet will
reflect the sale of the Bone Device Business assets and associated liabilities.
In addition, our liquidity will increase with the infusion of the cash
purchase price in the short term, but will decrease in the long run because we
will be selling our revenue generating operations. Our October 27, 2003 proxy
statement describes in greater detail the terms of the sale and the effect the
sale will have on our financial statements and condition on a pro forma basis.
Copies of the proxy statement we delivered to shareholders can be viewed on the
Securities and Exchange Commission website via EDGAR at www.sec.gov.

Overview of Our Products and Other Product Development

OrthoLogic develops, manufactures and markets proprietary, technologically
advanced orthopedic products designed to promote the healing of musculoskeletal
bone and tissue, with particular emphasis on fracture healing and spinal
repair. Our products are designed to enhance the healing of diseased, damaged,
degenerated or recently repaired musculoskeletal tissue. Our products focus
on improving the clinical outcomes and cost-effectiveness of orthopedic
procedures that are characterized by compromised healing, high-cost, potential
for complication and long recuperation time.

In 1999, we exercised our option to license the United States development,
marketing, and distribution rights for the fracture indications for Chrysalin,
a new tissue repair synthetic peptide. In 2000, we exercised our option to
license Chrysalin for all orthopedic applications worldwide. Since that time,
our research and development efforts have focused primarily on our Chrysalin
product development program. We currently have three potential Chrysalin
products either in human clinical trials or in late-stage pre-clinical
development.

Products

Our Bone Device Business product line, which comprises all of our current
products, includes bone growth stimulation and fracture fixation devices.

Bone Growth Stimulation Products. The OL1000 is a U.S. Food and Drug
Administration (FDA) approved portable, noninvasive, physician-prescribed,
electromagnetic bone growth stimulator designed for patients with nonunion
fractures. The OL1000 comprises two magnetic field treatment transducers
(coils) and a microprocessor-controlled signal generator that delivers a highly
specific, low energy signal to the injured area. The device is attached to the
patients arm, leg or other area where there is a nonunion fracture. The
OL1000 then evenly distributes a magnetic field over the patients injured
area.

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The patient wears the device for 30 minutes each day. We believe the
reduced treatment time leads to increased patient compliance with treatment
protocol. In addition, the micro-controller tracks the patients daily
treatment compliance.

The OL1000 is used for the noninvasive treatment of an established
nonunion fracture acquired secondary to trauma, excluding vertebrae and all
flat bones. A nonunion fracture is considered to be established when the
fracture site shows no visibly progressive signs of healing.

The OL1000 SC is an FDA approved single coil device for the same
indication, which utilizes the same combined magnetic field as the OL1000, is
available in three sizes and is designed to be more comfortable for patients
with certain types of fractures.

SpinaLogic® is a portable, noninvasive, electromagnetic bone growth
stimulator, which enhances the healing process as an adjunct to spinal fusion
surgery. SpinaLogic offers benefits similar to those of the OL1000 in that it
is relatively easy to use, requires a small power supply and requires only 30
minutes of treatment per day. The patient attaches the device to the lumbar
injury location where it provides localized magnetic field treatment to the
fusion site. Like the OL1000, the SpinaLogic device contains a
micro-controller that tracks the patients daily treatment compliance and can
easily be checked by the surgeon upon follow-up visits. SpinaLogic is approved
by the FDA as an adjunct treatment for primary lumbar spinal fusions for one or
two levels. It is designed for single patient use and is programmed for 270
consecutive, 30-minute daily treatments.

Our OL1000 product line is sold primarily through our direct sales force
supplemented by regional distributors. Our SpinaLogic product line is sold
exclusively through a worldwide spine product distributor.

Fracture Fixation Devices.We began to manufacture and distribute the
OrthoFrame®/Mayo® line of external fixation products in 1993. The
OrthoFrame/Mayo product is an external fixation device used in conjunction with
surgical procedures. It is low profile, lightweight, and primarily sold to
hospitals. We temporarily ceased manufacturing this product in 2000 to improve
the product packaging, and began its relaunch in the fourth quarter of 2002.

Products In Research

In addition to our Bone Device Business products, we are developing a
Chrysalin-based product platform. In January 1998, we made a minority equity
investment (less than 10%) in a biotech firm, Chrysalis BioTechnology, Inc.
(Chrysalis), and acquired, as part of that investment, an option to license a
unique synthetic peptide called TP508, or Chrysalin. Chrysalin is a 23-amino
acid synthetic peptide representing a fragment of the human thrombin molecule.
Thrombin has been shown to be involved in the healing process for both soft
tissue and bone. By mimicking specific attributes of the thrombin molecule,
Chrysalin stimulates the bodys natural healing processes, resulting in
accelerated tissue repair.

During 2001 we completed a Phase 1/2 human clinical trial utilizing
Chrysalin for fracture repair to test the safety and preliminary efficacy of
Chrysalin. In July 2002, we received authorization to begin a Phase 3 human
clinical trial under an Investigational New Drug

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application from the U.S. Food and Drug Administration (FDA). The trial
will be performed at 25 to 30 clinical sites and will include approximately 500
patients.

In March 2002, we received authorization from the FDA to commence a Phase
1/2 clinical trial for a spinal fusion indication for Chrysalin. We began
enrolling patients during the fourth quarter of 2002. The clinical trial will
include approximately 330 patients and will be performed at 15 to 20 centers in
the United States. The purpose of the study is to evaluate the safety and
preliminary efficacy of Chrysalin in combination with allograft bone (donor
bone graft). The patient enrollment process is expected to take approximately
18 to 24 months with a nine-month follow-up period. We also hope to begin a
human clinical trial for Chrysalin for articular cartilage defect repair in
2004.

We have not yet applied for FDA approval to market Chrysalin and there is
no assurance that we will do so or that we would receive such approval if
sought.

OrthoLogic does not own the patents to Chrysalin. Chrysalin was developed
by and patented by Chrysalis BioTechnology, Inc., a company in which we hold a
minority equity interest. We obtained the worldwide rights to use Chrysalin
for all orthopedic indications through a series of licensing agreements with
Chrysalis BioTechnology, Inc.

Discontinued or divested products

In July 2001, we sold our continuous passive motion (CPM) business. CPM
devices provide controlled, continuous movement to joints and limbs and are
designed to reduce swelling, increase joint range of motion, reduce the length
of hospital stay and reduce the incidence of post-trauma and post-surgical
complications.

In October 2000, we discontinued distributing Hyalgan® (sodium
hyaluronate), a therapeutic injectable for relief of pain from osteoarthritis
of the knee. We received royalties from Hyalgans distributor through December
2002. Hyalgan revenues were 6.2% of the Companys total revenues in the nine
months ended September 30, 2002. There will be no subsequent royalties.

Critical Accounting Policies and Estimates

Use of estimates.The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from these estimates. Significant estimates include the allowance
for doubtful accounts (approximately $3.0 million at September 30, 2003 and
$3.1 million at December 31, 2002), which is based primarily on trends in
historical collection rates, consideration of current events, payor mix and
other considerations. We derive a significant amount of our revenues in the
United States from third-party payors, including Medicare and certain
commercial insurance carriers, health maintenance organizations, and preferred
provider organizations. Amounts paid under these plans are generally based on
fixed or allowable reimbursement rates. Revenues are recorded at the expected
or pre-authorized reimbursement rates when earned and include unbilled
receivables of $611,000 and $860,000 on September 30, 2003 and December 31,
2002,

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respectively. The decrease in the unbilled receivables from December 31,
2002 to September 30, 2003 was primarily the result of changes to our billing
processes made in 2002. Billings are subject to review by third party payors
and may be subject to adjustments. Any differences between estimated
reimbursement and final determinations are reflected in the period finalized.
In the opinion of management, adequate allowances have been provided for
doubtful accounts and contractual adjustments.

Allowance for Doubtful Accounts.The allowance for doubtful accounts
(approximately $3.0 million at September 30, 2003 and $3.1 million at December
31, 2002) is based primarily on trends in historical collection rates,
consideration of current events, payor mix and other considerations. On a
quarterly basis, we evaluate historical collection trends and tracks the
percent of billings that are typically received by the first month after
billing, the second month, etc. This quarterly analysis of collections allows
us to develop trends and expectations for collection rates based on product,
payor category and date of billing. If we identify any change in the
collection rate or anticipate that future trends will not correspond to
previous collection experience, the reserve is adjusted to correspond with the
expected change. We derive a significant amount of our revenues in the United
States from third-party payors, including Medicare and certain commercial
insurance carriers, health maintenance organizations, and preferred provider
organizations. Amounts paid under these plans are generally based on fixed or
allowable reimbursement rates. Accounts receivable are recorded at the
expected or pre-authorized reimbursement rates. Billings are subject to review
by third-party payors and may be subject to adjustments. Any differences
between estimated reimbursement and final determinations are reflected in the
period finalized. In the opinion of management, adequate allowances have been
provided for doubtful accounts, contractual adjustments and inventory reserves.
If the financial condition of the third-party payors were to deteriorate,
resulting in an inability to make payments, or the other considerations
underlying the estimates were to change, additional allowances might be
necessary.

Revenue recognition.Revenue is recognized for sales of the OL1000 and
SpinaLogic products at the time the product is delivered to and accepted by the
patient, as verified by the patient signing a Patient Agreement Form
accepting financial responsibility. If the sale of either product is to a
commercial buyer, a purchase order is required, and the revenue is recognized
at the time of shipment to the commercial buyer. Our shipping terms are FOB
shipping point. The amount of revenue recorded at the time of sale, net of
sales discounts and contractual adjustments, is based on contractual terms. If
we do not have a contract with the third-party payor then the amount of revenue
recorded is the pricing expected to be approved by the third-party payor based
on historical experience with that payor. We record differences, if any,
between the net revenue amount recognized at the time of the sale and the
ultimate pricing by the primary third-party payor as an adjustment to sales in
the period we receive payments from the third-party payor or earlier if we
become aware of circumstances that warrant a change in estimate. In the
opinion of management, adequate allowances have been provided for sales
discounts and contractual adjustments.

We recognized royalties from the Co-Promotion Agreement of Hyalgan, based
on a flat royalty fee of $5 for each unit distributed by Hyalgans distributor
between January 1, 2001 and December 31, 2002, in accordance with the
termination agreement with Hyalgans distributor.

Inventory Valuation.We write down our inventory for inventory shrinkage
and obsolescence. Inventory is written down to estimated market value based on
a number of

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assumptions, including future demand and market conditions. We maintain a
reserve for inventory shrinkage and obsolescence of $814,000 and $687,000 on
September 30, 2003 and December 31, 2002, respectively. If actual conditions
used in determining these valuations change, future additional inventory
write-downs would be necessary.

Income Taxes.Under Financial Accounting Standards Board (FASB)
Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for
Income Taxes, income taxes are recorded based on current year amounts payable
or refundable, as well as the consequences of events that give rise to deferred
tax assets and liabilities. We base our estimate of current and deferred taxes
on the tax laws and rates that are currently in effect in the appropriate
jurisdiction. Changes in tax laws or rates may affect the current amounts
payable or refundable as well as the amount of deferred tax assets or
liabilities.

SFAS No. 109 requires that a valuation allowance be established when it is
more likely than not that all or a portion of a deferred tax asset will not be
realized. Changes in valuation allowances from period to period are included
in our tax provision in the period of change. In determining whether a
valuation allowance is required, we take into account all evidence with regard
to the utilization of a deferred tax asset including our past earnings history,
expected future earnings, the character and jurisdiction of such earnings,
unsettled circumstances that, if unfavorably resolved, would adversely affect
utilization of a deferred tax asset, carry-back and carry-forward periods, and
tax strategies that could potentially enhance the likelihood of realization of
a deferred tax asset.

We have
accumulated approximately $65.7 million in federal and state net
operating loss carryforwards (NOLs) and approximately $800,000 of general
business and alternative minimum tax credit carryforwards. Our management has
evaluated the available evidence about future taxable income and other possible
sources of realization of deferred tax assets and has established a valuation
allowance of approximately $32.0 million at September 30, 2003. The valuation
allowance reduces deferred tax assets to an amount that management believes
will more likely than not be realized. We believe that the net deferred tax
asset of $2.6 million at September 30, 2003, will be realized based primarily
on our historical and projected future earnings. However the amount of the
deferred tax assets actually realized could differ if we have little or no
future earnings. In the event we determine we are unable to realize deferred
tax assets in the future, an adjustment to the deferred tax asset and charge to
income would be necessary in the period such a determination is made.
Conversely, in the event we determine we are able to realize deferred tax
assets in the future, an adjustment to the valuation allowance and an income
tax benefit would be necessary in the period such as determination is made. If
the sale of the Bone Device Business assets to dj Orthopedics, LLC is
consummated on its current terms, our management believes we will be able to
apply our approximately $65.7 million tax loss carry-forward to offset the
majority of the taxable gain from the sale.

Investment in Chrysalis.We own a minority ownership interest in
Chrysalis BioTechnology, Inc., which is recorded at cost. Chrysalis is not
publicly traded so it is difficult to determine the value of the investment.
However, we do not believe the value of our investment has been impaired.
Should sometime in the future the investment be determined to be permanently
impaired, a charge to income would be recorded in the period such a
determination is made.

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Lease Cost.We lease our headquarters facility in Tempe, Arizona under an
operating lease arrangement. This lease has an expiration date of November
2007. As a result of the sale of our CPM business during 2001, we occupy
approximately 50% of all the available lease space. We subleased the unused
space to the purchaser of the CPM business. The sublease expired in 2002. We
subsequently entered into a sublease agreement for approximately 17% of the
building with a different subtenant through June 2005. While we believe the
facility is well maintained and adequate for use in the foreseeable future,
there can be no guarantee that a different lessee will assume the remaining
lease obligation. We recorded a charge of $400,000 in the quarter ended
September 30, 2002 and a charge of $362,000 in the quarter ended September 30,
2003, to establish a reserve for the period the available sublease space was
anticipated to be vacant. In addition, the terms of the proposed sale of the
Bone Device Business assets provides for dj Orthopedics, LLC to lease office
space for one year. In the opinion of management, the reserve balance of
$418,000 at September 30, 2003 is adequate to allow for time necessary to
acquire an additional tenant for the building.

Results of Operations Comparing Three-Month Period Ended September 30, 2003 to
the Corresponding Period in 2002.

Revenues.Our total revenues increased 16.2% from $10.8 million in the
third quarter of 2002 to $12.5 million in the third quarter of 2003. Revenues
for the third quarter of 2002 included Hyalgan royalty payments from the
termination of the Co-Promotion Agreement of $501,000. The Hyalgan royalty
payments ended December 31, 2002. Sales recorded for the bone growth
stimulation products, the OL1000 and SpinaLogic, increased by 21.8% in the
third quarter of 2003 as compared to the same period in 2002. We believe the
significant increase in bone growth stimulation sales signifies an expansion in
the market and growth in market share for both the OL1000 and SpinaLogic
products.

Gross Profit.Gross profit for the three month period ended September 30,
increased from $8.9 million in 2002 to $10.6 million in 2003. Gross profit, as
a percent of revenue, was 84.6% for the quarter ended September 30, 2003.
Gross profit for the same period in 2002 was 82.7%. Gross profit as a percent
of the bone growth stimulation sales increased over the period due to improved
pricing on material costs.

Selling, General and Administrative (SG&A) Expenses.SG&A expenses
increased 9.0% from $7.2 million in the three month period ended September 30,
2002 to $7.8 million in the same period in 2003. SG&A expenses, as a
percentage of total revenues, were 62.5% in the three month period ended
September 30, 2003 and 66.6% in the same period in 2002. The decrease in SG&A
expenses as a percentage of total revenues was a result of the stabilization in
fixed administrative cost for the Bone Device Business. While revenues and
variable expenses are increasing, fixed costs such as salaries and
administrative expenses, have remained constant.

Research and Development Expenses.Research and development expenses were
$2.5 million in the three month period ended September 30, 2003, compared to
$722,000 for the same period in 2002. Research and development expenses in the
quarter ended September 30, 2003 are for the overall Chrysalin development
program, which include pre-clinical studies in cartilage and continuation of
the Phase 1/2 human clinical trial under an investigational new drug
application (IND) for spinal fusion and the Phase 3 human clinical trial
under an IND for

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fracture repair. The increase in research and development expenses is
directly related to the Chrysalin clinical trials. We anticipate the research
and development expenses to increase by $2 to $3 million per quarter as patient
enrollment continues for the clinical trials.

Other Income. Other income consisting primarily of interest income,
decreased from $169,000 in the three month period ended September 30, 2002 to
$125,000 for the same period in 2003. The decrease is the result of declining
interest rate returns on the investment portfolio.

Net Income.We had a net income in the three month period ended September
30, 2003 of $506,000 compared to a net income of $1.4 million in the same
period in 2002.

Results of Operations Comparing Nine-Month Period Ended September 30, 2003 to
the Corresponding Period in 2002.

Revenues.Our total revenues increased 13.9% from $30.1 million in the
first nine month period ended September 30, 2002 to $34.3 million in the first
nine month period ended September 30, 2003. Revenues for the first nine months
of 2002 included Hyalgan royalty payments from the termination of the
Co-Promotion Agreement of $1.9 million. The Hyalgan royalty payments ended
December 31, 2002. Sales recorded for the bone growth stimulation products,
the OL1000 and SpinaLogic, increased by 21.4% in the first nine months of 2003
as compared to the same period in 2002. We believe the significant increase in
bone growth stimulation sales signifies an expansion in the market and growth
in market share for both the OL1000 and SpinaLogic products.

Gross Profit.Gross profit for the nine months ended September 30,
increased from $25.5 million in 2002 to $29.2 million in 2003. Gross profit,
as a percent of revenue, was 85.2% for the nine months ending September 30,
2003. Gross profit for the same period in 2002 was 84.6%. Gross profit as a
percent of the bone growth stimulation sales increased over the period due to
improved pricing on material costs.

Selling, General and Administrative (SG&A) Expenses.SG&A expenses
increased 9.6% from $20.5 million in the nine month period ended September 30,
2002 to $22.5 million in the same period in 2003. SG&A expenses, as a
percentage of total revenues, were 65.7% in the nine month period ended
September 30, 2003 and 68.2% in the same period in 2002. The decrease in SG&A
expenses as a percentage of total revenues was a result of the stabilization in
fixed administrative costs for the Bone Device Business. While revenues and
variable expenses are increasing, fixed costs such as salaries and other
administrative expenses, have remained constant.

Research and Development Expenses.Research and development expenses were
$6.3 million in the nine month period ended September 30, 2003, compared to
$2.4 million for the same period in 2002. The research and development costs
for the nine month period ended September 30, 2003 included a $250,000
milestone payment made to Chrysalis BioTechnology, Inc. in anticipation of a
potential IND filing with the FDA for a human clinical trial for cartilage
defect repair. Research and development expenses in the nine month period
ended September 30, 2003 are for the overall Chrysalin development program,
which include pre-clinical studies in cartilage and continuation of the Phase
1/2 human clinical trial under an IND for spinal fusion and the Phase 3 human
clinical trial under an IND for fracture repair. The increase in research

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and development expenses is directly related to the Chrysalin clinical
trials. We anticipate the research and development expenses to increase over
the next several quarters as patient enrollment occurs for the clinical trials.

Other Income. Other income consisting primarily of interest income,
decreased from $537,000 in the nine month period ended September 30, 2002 to
$387,000 for the same period in 2003. The decrease is the result of declining
interest rate returns on the investment portfolio.

Net Income.We had a net income in the nine month period ended September
30, 2003 of $1.2 million compared to a net income of $4.1 million in the same
period in 2002.

Liquidity and Capital Resources

On September 30, 2003, we had cash and cash equivalents of $12.3 million
compared to $11.3 million as of December 31, 2002. We also had $22.2 million
of short-term investments as of September 30, 2003 compared to $18.7 million at
December 31, 2002. The total of both cash and cash equivalents and short-term
investments increased to $34.5 million at September 30, 2003 compared to $29.9
million as of December 31, 2002. We also had long-term investments of $5.0
million, as of September 30, 2003, mostly consisting of government-backed
securities with maturities of fewer than 18 months, compared to long-term
investments of $5.7 million as of December 31, 2002.

The total of cash and cash equivalents, short-term investments, and
long-term investments increased to $39.5 million at September 30, 2003 compared
to $35.6 million at December 31, 2002. The most important factors in the
increase in total cash and investments were a decrease in accounts receivable
($162,000), proceeds from stock options exercised ($677,000), an increase in
accrued liabilities ($865,000) and an increase in accounts payable ($511,000)
during the nine months ended September 30, 2003.

In addition, we have a $4.0 million accounts receivable revolving line of
credit with a bank. We may borrow up to 75% of the eligible accounts
receivable, as defined in the agreement. The interest rate is at the prime
rate. Interest accruing on the outstanding balance and a monthly administration
fee is due in arrears on the first day of each month. The line of credit
expires February 28, 2005. There are certain financial covenants and reporting
requirements associated with the line of credit. Included in the financial
covenants are (1) tangible net worth of not less than $30.0 million, (2) a
quick ratio of not less than 2.0 to 1.0, (3) a debt to tangible net worth ratio
of not less than 0.50 to 1.0, and (4) capital expenditures will not exceed more
than $7.0 million dollars during any fiscal year. We have not utilized this
line of credit. As of September 30, 2003, we were in compliance with all the
financial covenants. The proposed sale of the Bone Device Business assets
would require a change in the basis for the current line of credit agreement.

Net cash provided by operations during the nine month periods ended
September 30, 2003 and September 2002 was $3.4 million for both periods. The
primary reason why there was no change in net cash provided by operations was
because the decline in net income ($2.9 million) and a decline in cash
generated by a smaller decrease in accounts receivable ($826,000) was offset by
other factors. These other factors were (1) a decline in inventories in the
nine month period ended September 30, 2003 ($284,000) compared to an increase
in inventory in the

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period ended September 30, 2002 ($1.3 million) and (2) an increase in accrued
liabilities in the nine month period ended September 30, 2003 ($865,000)
compared to a decline in accrued liabilities for the same period in 2002 ($1.2
million). The change in inventories was primarily due to the increased
inventories in 2002 associated with the re-launch of the fracture fixation
device. The change in accrued liabilities was due primarily to the timing of
payments of standard expenses and non-recurring payments in 2002 for severance
and other residual exit costs related to the CPM divestiture.

We do not expect to make significant capital investments in 2003 and
anticipate that our cash and short term investments on hand, cash from
operations and the funds available from our $4.0 million line of credit will be
sufficient to meet our presently projected cash and working capital
requirements for the next 12 months. The amount of cash we use in the next 12
months will depend on a number of factors, including our ability to continue to
increase revenues while reducing or controlling our expenditures, continued
profitability, stable research and development funding needs for our bone
growth stimulation products, predictable research and development funding needs
for our Chrysalin product platform and stability in the collection amounts due
from third-party payors. Additional funds may be required if we are not
successful in any of these areas. Our ability to continue funding our planned
operations beyond the next 12 months is dependent on our ability to generate
sufficient cash flow to meet our obligations on a timely basis, or to obtain
additional funds through equity or debt financing, as may be required.

In addition, the amount of cash we use in the next 12 months may change
dramatically if the sale of the Bone Device Business assets is consummated. If
the sale is consummated, we will have increased our liquidity by an infusion of
approximately $80.5 million (reflecting the sale price of $93.0 million net of
the $7.5 million placed in escrow and the estimated direct cost of the
transaction of $5.0 million), which will allow us to pursue our plan to
significantly increase funding of our Chrysalin product platform research and
development efforts. If the sale is not consummated, we will proceed on our
current spending schedule while exploring other options.

In March 2003, we announced that our Board of Directors authorized a
repurchase of up to one million of our outstanding shares over the subsequent
12 months. The repurchased shares will be held as treasury shares to reduce
the dilution from our stock option plans. No shares were repurchased as of
September 30, 2003 under this plan. The repurchase period will end March 6,
2004. Previously, we had repurchased 41,800 shares at a cost, net of fees, of
$137,300 or an average price of $3.28 per share.

The following table sets forth all known commitments as of September 30,
2003 and the year in which these commitments become due, or are expected to be
settled (in thousands):

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|           |  |                  |       |                         |  |                  |       |  |  |   |        | 
|---------- |  | ---------------- | ----- | ----------------------- |  | ---------------- | ----- |  |  | - | ------ | 
|           |  |                  |       |                         |  | Accounts Payable |       |  |  |  
|Year       |  | Operating Leases |       | and Accrued Liabilities |  | Total           
|           |  |                  |       |                         |  |                 
|2003       |  | $                | 270   |                         |  | $                | 6,265 |  |  | $ | 6,535  | 
|2004       |  | $                | 1,078 |                         |  |                  |      |  |  | $ | 1,078  | 
|2005       |  | $                | 1,078 |                         |  |                  |      |  |  | $ | 1,078  | 
|2006       |  | $                | 1,078 |                         |  |                  |      |  |  | $ | 1,078  | 
|Thereafter |  | $                | 989   |                         |  |                  |      |  |  | $ | 989    | 
|           |  |                  |       |                         |  |                  |       |  |  |   |        | 
|Total      |  | $                | 4,493 |                         |  | $                | 6,265 |  |  | $ | 10,758 | 




Item 3. Quantitative and Qualitative Disclosures about Market Risk

We have no debt outstanding and no derivative instruments at September 30,
2003.

Our Canadian operations were sold as part of the CPM asset sale, and
consequently we have no exposure to foreign currency exchange rate risks at
September 30, 2003.




Item 4. Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that the
information we must disclose in our filings with the Securities and Exchange
Commission is recorded, processed, summarized and reported on a timely basis.
Our Chief Executive Officer and Chief Financial Officer have reviewed and
evaluated our disclosure controls and procedures as defined in Rules 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
Exchange Act) as of the end of the period covered by this report (the
Evaluation Date). Based on such evaluation, such officers have concluded
that, as of the Evaluation date, our disclosure controls and procedures are
effective in bringing to their attention on a timely basis material information
relating to us required to be included in our periodic filings under the
Exchange Act.

There have not been any changes in our internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We 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 its reports to stockholders. This report contains
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. In connection with these
safe harbor provisions, we identify important factors that could cause actual
results to differ materially from those contained in any forward-looking
statements made by or on our behalf. Any such forward-looking statement is
qualified by reference to the following cautionary statements.

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Risks if Asset Sale is Not Approved

If the asset sale is not approved, OrthoLogic will continue to operate the
bone growth stimulation device business unless and until it is able to
negotiate another transaction that the Board of Directors believes is
acceptable to the stockholders and to OrthoLogic. As discussed in our proxy
statement, the Board of Directors believes that we will need additional funding
to properly continue the development of our Chrysalin product platform while
still making the necessary investments in the bone growth stimulation device
business to maintain our historical growth rates and profitability. To the
extent that we do not obtain needed capital through the proposed sale, we will
have to obtain it through the issuance of additional debt or equity, by
entering into a joint venture pursuant to which we share our rights to the
Chrysalin product platform, or through other means, any one of which may reduce
the value to us, perhaps substantially, of any commercialization of Chrysalin
products. There is no guarantee that we would be able to obtain such funding
on terms acceptable to us or at all.

Risks if the Asset Sale is Approved

The sale might not be consummated even though the stockholders approve the
sale.

Stockholder approval is only one of the closing conditions. If the
remaining closing conditions are not satisfied or waived, the sale might not be
consummated, even if the stockholders approve the sale.

By completing the asset sale, we will become less diversified.

By selling our bone growth stimulation device business assets, we will be
selling our only business that is generating revenue. We will become a pure
drug research and development company focused on the development of the
Chrysalin product platform. We may invest in other orthobiologic or
complementary technology in the future, but we have no current specific plans
to do so at this time. This would increase our business risk because we will
be less diversified than before the proposed sale and because our remaining
business is in the relatively high-risk, but potentially high reward, field of
orthobiologic pharmaceutical development.

After the sale, we will become a pure drug research and development company in
a highly regulated field with high investment costs and high risks.

After the sale, we will be a drug research and development company. We
currently have no pharmaceutical products being sold or ready for sale and do
not expect to be able to introduce any pharmaceutical products for at least
several years. Our Chrysalin product platform is still in the human testing
phase for two potential products. The U.S. Food and Drug Administration
(FDA) and comparable agencies in many foreign countries impose substantial
limitations on the introduction of new pharmaceuticals through costly and
time-consuming laboratory and clinical testing and other procedures. The
process of obtaining FDA and other required regulatory approvals is lengthy,
expensive and uncertain. Chrysalin, as a new drug, is subject to the most
stringent level of FDA review.

Even after we have invested substantial funds in the development of our
three Chrysalin products and even if the results of our current clinical trials
are favorable, there can be no

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guarantee that the FDA will grant approval of Chrysalin for the indicated
uses or that it will do so in a timely manner.

If we successfully bring one or more products to market, there is no
assurance that we will be able to successfully manufacture or market the
products or that potential customers will buy them if, for example, a
competitive product has greater efficacy or is deemed more cost effective. In
addition, the market in which we will sell any such products is dominated by a
number of large corporations that have vastly greater resources than we have,
which may impact our ability to successfully market our products or maintain
any technological advantage we might develop. We also would be subject to
changes in regulations governing the manufacture and marketing of our products,
which could increase our costs, reduce any competitive advantage we may have
and/or adversely affect our marketing effectiveness.

Risks Related to Our Industry

We are in a highly regulated field and we must obtain government approval
before selling any new products.

The Federal Drug Administration and comparable agencies in many foreign
countries and in state and local governments impose substantial limitations on
the introduction of medical devices through costly and time-consuming
laboratory and clinical testing and other procedures. The process of obtaining
FDA and other required regulatory approvals is lengthy, expensive and
uncertain. Moreover, regulatory approvals, if granted, typically include
significant limitations on the indicated uses for which a product may be
marketed. In addition, approved products may be subject to additional testing
and surveillance programs required by regulatory agencies, and product
approvals could be withdrawn and labeling restrictions may be imposed for
failure to comply with regulatory standards or upon the occurrence of
unforeseen problems following initial marketing.

Our current and future products and manufacturing activities are and will
be regulated under the Medical Devices Amendment Act of 1976 to the Federal
Food, Drug and Cosmetics Act, as amended, the Safe Medical Devices acts of 1990
and 1992, and the Food and Drug Administration Modernization Act of 1997, as
amended, (collectively the FDC Act). Our current BioLogic technology-based
products and fracture fixation devices are marketed for their current uses with
clearance from the FDA. Before we are able to market these products for any
other use, we would have to seek the approval of the FDA, which may require
lengthy and costly testing and review by the FDA. In addition, the FDA may, if
it believes our products have problems unforeseen at the time of the initial
approval, require additional testing to retain FDA approval.

Chrysalin, as a new drug, is subject to the most stringent level of FDA
review. We have received authorization to begin human clinical trials for
fracture repair and spinal fusion indications and are currently seeking
approval to conduct human testing for articular cartilage repair. Even if the
results of the current clinical trials are favorable, there can be no guarantee
that the FDA will grant approval of Chrysalin for the indicated uses or if it
will do so in a timely manner. In addition, changes in existing regulations or
interpretations of existing regulations or adoption of new or additional
restrictive regulations could prevent or delay obtaining regulatory approvals.

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We must adhere to current and evolving regulatory compliance standards in order
to maintain the approval to sell its products.

We are also required to adhere to applicable requirements for FDA Good
Manufacturing Practices/Quality System Regulation, to engage in extensive
record keeping and reporting and to make available our manufacturing facilities
for periodic inspections by governmental agencies, including the FDA and
comparable agencies in other countries. Failure to comply with these and other
applicable regulatory requirements could result in, among other things,
significant fines, suspension of approvals, seizures or recalls of products, or
operating restrictions and criminal prosecutions. From time to time, we may
receive letters from the FDA regarding regulatory compliance. We have
responded to all such letters and believe all issues raised in such letters
have been resolved.

If we experience a delay in receiving or fail to obtain any governmental
approval for any of our current or future products or fail to comply with any
regulatory requirements, our business, financial condition and results of
operations could be materially adversely affected.

Any limitations on third party payment reimbursement for our products and
related services would adversely affect the business and results of operations.

Our ability to sell products successfully in the United States and in
other countries will depend in part on the extent to which government health
administration authorities, private health insurers and other payors continue
to reimburse insureds for the cost of products and related treatment. Cost
control measures adopted by third party payors in recent years have had and may
continue to have a significant effect on the purchasing and practice patterns
of many health care providers, generally causing them to be more selective in
the purchase of medical products. In addition, payors are increasingly
challenging the prices and clinical efficacy of medical products and services.
Payors may deny reimbursement if they determine that the product used in a
procedure was experimental, was used for a non-approved indication or was
unnecessary, inappropriate, not cost-effective, unsafe, or ineffective.

Our products are reimbursed by most payors and recent governmental
regulations have favorably made our products available to patients earlier in
their medical treatment, however, there are generally specific product usage
requirements or documentation requirements in order for us to receive
reimbursement. In certain circumstances, we are successful in appealing
reimbursement coverage for those applications which do not comply with the
payor requirements. Significant uncertainty exists as to the reimbursement
status of newly approved health care products, and there can be no assurance
that adequate third party coverage will continue to be available to us at
current levels.

We operate in an intensely competitive field in which many of its competitors
are bigger or better known.

The orthopedic industry is characterized by intense competition.
Currently, we have three major competitors selling bone growth stimulation
products approved by the FDA for the treatment of nonunion fractures, which
include Electro-Biology (EBI), a subsidiary of Biomet, Inc., Orthofix
International N.V., and Exogen, Inc., a subsidiary of Smith & Nephew. There
are

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two competitors, EBI and Orthofix, selling bone growth stimulation
products for use with spinal fusion patients. We estimate that one of our
competitors has a dominant share of the market for bone growth stimulation
products for non-healing fractures in the United States, and another has a
dominant share of the market for use of their device as an adjunct to spinal
fusion surgery. In addition, several large, well-established companies sell
fracture fixation devices similar in function to those sold by us.

Many participants in the medical technology industry, including our
competitors, have substantially greater capital resources, research and
development staffs and facilities than us. Such participants have developed or
are developing products that may be competitive with the products that have
been or are being developed or researched by us. Other companies are
developing a variety of other products and technologies to be used in the
treatment of fractures and spinal fusions, including growth factors, bone graft
substitutes combined with growth factors, and non-thermal ultrasound.

Many of our competitors have substantially greater experience than us in
conducting research and development, obtaining regulatory approvals,
manufacturing, and marketing and selling medical devices. Any failure by us to
develop products that compete favorably in the marketplace would have a
material adverse effect on our business, financial condition and results of
operations.

Technology in the medical device industry changes rapidly. If we are not able
to keep up with technological advances by its competitors, the business will be
harmed.

The medical device industry is characterized by rapid and significant
technological change. There can be no assurance that our competitors will not
succeed in developing or marketing products or technologies that are more
effective or less costly, or both, and which render our products obsolete or
non-competitive. In addition, new technologies, procedures and medications
could be developed that replace or reduce the value of our products. Our
success will depend in part on its ability to respond quickly to medical and
technological changes through the development and introduction of new products.
Because of the lengthy testing period required to develop new products and the
costly FDA approval process, there can be no assurance that our new product
development efforts will result in any commercially successful products or will
do so in a timely manner. A failure to develop new products could have a
material adverse effect on our business, financial condition, and results of
operations.

The industry faces a high risk of product liability claims.

We face an inherent business risk of exposure to product liability claims
in the event that the use of its technology or products is alleged to have
resulted in adverse effects. To date, no product liability claims have been
asserted against us for our bone growth stimulation products. Over the years,
we have had limited product liability claims associated with CPM products, all
of which have been or are being managed by our insurance carrier. We sold the
CPM business in 2001.

We also face an inherent business risk of exposure to liability claims
with the current and potential Chrysalin clinical trials.

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We maintain a product liability and general liability insurance policy
with coverage of an annual aggregate maximum of $2.0 million per occurrence.
The product liability and general liability policy is provided on an occurrence
basis. The policy is subject to annual renewal. In addition, we maintain an
umbrella excess liability policy, which covers product and general liability
with coverage of an additional annual aggregate maximum of $25.0 million.

Based on the history of claims, we believe the levels of insurance
coverage are adequate, however, there can be no assurance that liability claims
will not exceed the coverage limits of such policies or that such insurance
will continue to be available on commercially reasonable terms or at all. If
we do not or cannot maintain sufficient liability insurance, our ability to
market our products may be significantly impaired. In addition, product
liability claims could have a material adverse effect on the business,
financial condition and results of operations.

There is an increase in the investigation of health care providers.

The health care industry is subject to numerous laws and regulations of
federal, state, and local governments. Compliance with these laws and
regulations, specifically those relating to the Medicare and Medicaid programs,
can be subject to government review and interpretations, as well as regulatory
actions unknown and unasserted at this time. Recently, federal government
activity has increased with respect to investigations and allegations
concerning possible violations by health care providers of regulations, which
could result in the imposition of significant fines and penalties, as well as
significant repayments of previously billed and collected revenues from patient
services. Our management believes that we are in substantial compliance with
current laws and regulations.

Legislative reform of the health care industry could have a negative effect on
our business.

In response to complaints from patients against insurance companies and
recent and continued expectations of rises in the cost of health care insurance
coverage, the health care industry is being reviewed and investigated by public
and private groups to (i) increase access to health care for the uninsured and
underinsured people, (ii) control the escalation of health care expenditures
within the economy and (iii) use health care reimbursement policies to help
control federal expenditures. Although this has been an ongoing public debate
for a number of years that has not resulted in substantial federal or state
legislation fundamentally changing the health care industry business model, we
expect public debate of these issues to continue. We cannot predict which, if
any, of the current reform proposals will be adopted and when they might be
adopted and what effect such reform would have on a patients ability to seek
reimbursement for use of our product and the costs associated with regulatory
and health care program compliance.

Significant changes in health care systems are likely to have a
substantial impact over time on the manner in which we conduct our business and
could have a material adverse effect on our business, financial condition and
results of operations and ability to market our products and future products as
currently contemplated.

Medicare pricing for the bone growth stimulation products has remained
constant, increasing slightly over the past several years. However, Congress
or other governmental agencies could enact legislation at any time that could
negatively impact revenues.

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Risks Related to Our Business

We are dependent on the sales of two primary products and have invested heavily
in a future product, which may not be available for sale for some time.

Our business is focused on the sales of two primary products, the OL1000
and SpinaLogic. We believe that, to sustain long-term growth, we must continue
to develop and introduce additional products and expand approved indications

for our remaining products. The development and commercialization of
additional products will require substantial product development, regulatory
review, and clinical testing, all of which may be expensive and lengthy. There
can be no assurance that we will develop new products or expand indications for
existing products in the future or that we will be able to manufacture or
market such products successfully. Any failure to develop new products or
expand indications could have a material adverse effect on our business,
financial condition and results of operations.

If the medical community does not accept our products as alternatives to
current products and procedures, sales will not grow and business will be
adversely affected.

The long-term commercial success of the OL1000 and SpinaLogic and our
other products will depend in significant part upon our widespread acceptance
by a significant portion of the medical community as a safe, efficacious and
cost-effective alternative to invasive procedures. We are unable to predict
how quickly, if at all, members of the orthopedic medical community may accept
our products. The widespread acceptance of our primary products represents a
significant change in practice patterns for the orthopedic medical community
and in reimbursement policy for third party payors. Historically, some
orthopedic medical professionals have indicated hesitancy in prescribing bone
growth stimulator products such as those we manufactured. Failure to create
widespread market acceptance by the orthopedic medical community and third
party payors of our products would have a material adverse effect on our
business, financial condition and results of operations.

Our ability to compete could be jeopardized we are unable to obtain and protect
our intellectual property or retain licenses for intellectual property.

In this industry, a companys success depends in part on its ability to
obtain and maintain patent protection for products and processes, to preserve
its trade secrets and proprietary know-how and to operate without infringing
the proprietary rights of third parties.

While we hold title to numerous United States and foreign patents and
licenses, and have filed a number of patent applications, no assurance can be
given that any additional patents will be issued or that the scope of any
patent protection will exclude competitors, or that any of the patents held by
or licensed to us will be held valid if subsequently challenged. The validity
and breadth of claims covered in medical technology patents involves complex
legal and factual questions and therefore may be highly uncertain. We license
the technologies in the BioLogic and OrthoFrame products for which we pay a
royalty.

There has been substantial litigation regarding patent and other
intellectual property rights in the orthopedic industry. Litigation, which
could result in substantial cost to and diversion of effort by us, may be
necessary to enforce patents issued or licensed to us, to protect

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trade secrets or know-how we own, or to defend against claimed infringement of
the rights of others and to determine the scope and validity of the proprietary
rights of others. There can be no assurance that the results of such
litigation would be favorable to us. In addition, competitors may employ
litigation to gain a competitive advantage. Adverse determinations in
litigation could subject us to significant liabilities, and could require us to
seek licenses from third parties or prevent us from manufacturing, selling or
using our products, any of which determinations could have a material adverse
effect on our business, financial condition and results of operations.

In addition the licenses for the technologies used by us in the BioLogic
and OrthoFrame products may be terminated by the licensor if we breach any
material provision of such license. The termination of any license would have
a material adverse effect on our business, financial condition and results of
operations.

We also rely on un-patented trade secrets and know-how. We generally
require our employees, consultants, advisors and investigators to enter into
confidentiality agreements which include, among other things, an agreement to
assign to us all inventions that were developed by the employee while employed
with us that are related to our business. There can be no assurance, however,
that these agreements will protect our proprietary information or that others
will not gain access to, or independently develop similar trade secrets or
know-how.

Sales for one of our primary products depends on the success of a distributor,
which has been given exclusive distribution rights.

To enhance the sales of our SpinaLogic product line, we entered into an
exclusive 10-year worldwide sales agreement in August 2000 with DePuy Spine
(DePuy Spine), a unit of Johnson and Johnson. The sales agreement provides
DePuy Spine with the right to terminate its sales activities on behalf of
SpinaLogic without cause, by giving OrthoLogic a minimum of 120 days written
notice. Any significant change in the business relationship or termination of
the sales agreement with DePuy Spine may have a material adverse effect on our
sales of SpinaLogic. We rely upon the distribution of the SpinaLogic product
for a large portion of our sales.

We rely on distributors and sales representatives to sell the OL1000.
There can be no guarantees that the terms of the distribution and sales
representative contracts will be renewed as they currently exist.

Our reliance on a primary supplier could result in disruption of operations.

We purchase some electronic components used in the OL1000 and SpinaLogic
devices from a single source supplier. In addition, there are single source
suppliers for other components used in devices. Establishment of additional or
replacement suppliers for these components cannot be accomplished quickly.
Therefore, we maintain sufficient inventories of such components in an attempt
to ensure availability of finished products in the event of supply shortage or
in the event that a redesign is required. We maintain a supply of certain
OL1000 and SpinaLogic components to meet sales forecasts for 3 to 12 months.

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We are dependent on outside vendors for key parts and processes in the
manufacture of the OrthoFrame/Mayo. Chrysalin, which is currently only in the
clinical trial phase, is produced by a third party sole supplier.

Any delay or interruption in the supply of components or products could
significantly impair our ability to deliver its products in sufficient
quantities, and therefore, could have a material adverse effect on our
business, financial condition and results of operations.

If we are not able to retain and compete for key management and technical
employees, our long-term business will be adversely affected.

Our success is dependent in large part on our ability to attract and
retain our key management, operating, technical, marketing and sales personnel
as well as clinical investigators who are not our employees. Such individuals
are in high demand, and the identification, attraction and retention of such
personnel could be lengthy, difficult and costly. We compete for our employees
and clinical investigators with other companies in the orthopedic industry and
research and academic institutions. There can be no assurance that we will be
able to attract and retain the qualified personnel necessary for the expansion
of our business. A loss of the services of one or more members of the senior
management group, or our inability to hire additional personnel as necessary,
could have an adverse effect on our business, financial condition and results
of operations.

The results of operations are affected by a number of conditions which are
outside our control.

We were founded in 1987 and only began generating revenues from the sale
of our primary product in 1994. We experienced significant operating losses
since our inception and had an accumulated deficit of approximately $89.5
million at September 30, 2003. We have only reported sustained profits since
the third quarter of 2001. There can be no assurance that we will maintain
sufficient revenues to retain net profitability on an on-going annual basis.
In addition, estimations of future profits based on our historical financial
reports may be speculative given our limited profitability history. We may
experience fluctuations in revenues and operating results based on such factors
as demand for our products; the timing, cost and acceptance of product
introductions and enhancements made by us or others; levels of third party
payment; alternative treatments that currently exist or may be introduced in
the future; completion of acquisitions and divestitures; changes in practice
patterns, competitive conditions, regulatory announcements and changes
affecting our products in the industry and general economic conditions. The
development and commercialization by us of additional products will require
substantial product development and regulatory, clinical and other
expenditures.

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

Our stock price has varied significantly in the past and may vary in the
future due to a number of factors including:



| |  |  | fluctuations in our operating results;                                                          
| | - |  | ------------------------------------------------------------------------------------------------
|
| |  |  | developments in litigation to which the we or a competitor is subject;                          
|
| |  |  | announcements and timing of potential acquisitions, divestitures,
conversion of preferred stock;
|
| |  |  | announcements of technological innovations or new products by us or
our competitors;            

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| |  |  | FDA and international regulatory actions;                                                                                                          
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | actions with respect to reimbursement matters;                                                                                                     
|
| |  |  | developments with respect to patents or proprietary rights of us or competitors;                                                                   
|
| |  |  | public concern as to the safety of products developed by us or others;                                                                             
|
| |  |  | changes in health care policy in the United States and internationally;                                                                            
|
| |  |  | changes in stock market analyst recommendations regarding our
company, other medical device companies or the medical device industry
generally; and
|
| |  |  | general market conditions.                                                                                                                         

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.

Developments in any of these areas could cause our results to differ
materially from results that have been or may be projected by or on our behalf.

We caution that the foregoing list of important factors is not exclusive.
We do not undertake to update any forward-looking statement that may be made
from time to time by or on our behalf.




Part II  Other Information




Item 2. Changes in Securities and Use of Proceeds

On October 8, 2003, OrthoLogic Corp. and Bank of New York entered into an
Amendment No. 2 amending the Rights Agreement dated March 4, 1997, as amended,
such that the proposed transactions described in or related to the Asset
Purchase Agreement dated October 8, 2003 by and between OrthoLogic Corp. and dj
Orthopedics, LLC, a Delaware limited liability company and wholly-owned
subsidiary of dj Orthopedics, Inc., will not constitute a Section 11(a)(ii)
Event or a Section 13(a) Event, and will not be subject to Section 13(a)(z)
under the Rights Agreement. Accordingly, common stockholders rights to
purchase shares of capital stock of dj Orthopedics would not be triggered by
the sale of the bone growth stimulation device business assets to dj
Orthopedics, LLC. The Amendment No. 2 was filed as an exhibit to a Form 8-K
filed October 20, 2003.




Item 6. Exhibits and Reports



| | (a) |  | Exhibit Index                         
| | --- |  | --------------------------------------
|
| |     |  | See Exhibit List following this report
|
| | (b) |  | Reports on Form 8-K                   

On July 24, 2003, we filed a press release, including financial
statements, announcing our earnings for the three and six month periods ended
June 30, 2003 on Form 8-K.

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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/ Thomas R. Trotter

Thomas R. Trotter |  | President and Chief Executive Officer
(Principal Executive Officer)                            |  | November 14, 2003
|                                         |  |                                                                                                |  |                  
|/s/ Sherry A. Sturman

Sherry A. Sturman |  | Senior Vice-President and Chief
Financial Officer
(Principal Financial and Accounting
Officer) |  | November 14, 2003

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OrthoLogic Corp.
Exhibit Index to Quarterly Report on Form 10-Q
For the Quarterly Period Ended September 30, 2003

|           |  |                                                                                                                                                           |  |                                                       |  |         
|---------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------- |  | --------
|           |  |                                                                                                                                                           |  | Incorporated by                                       |  | Filed   
|Exhibit No |  | Description                                                                                                                                               |  | Reference to:                                         |  | Herewith
|3.1        |  | Amended and Restated Certificate
of Incorporation                                                                                                         |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|3.2        |  | Certificate of Designation of Series A
Preferred Stock                                                                                                    |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|4.1        |  | Amendment No. 2 dated October 8,
2003, to the Rights Agreement
between OrthoLogic Corp. and
Bank of New York                                              |  | Exhibit 4.1 to
the Form 8-K
filed on October 20,
2003 |  |         
|           |  |                                                                                                                                                           |  |                                                       |  |         
|10.1       |  | Employment Agreement effective
July 15, 2002 between OrthoLogic
Corp. and Thomas R. Trotter (1)(2)                                                        |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|10.2       |  | August 30, 2003 Amendment to Employment Agreement between
OrthoLogic Corp. and
Thomas R. Trotter (1)(2)                                                   |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|31.1       |  | Certification of CEO pursuant to
Securities Exchange Act Rules 13a -
14 and 15D  14 as adopted pursuant
to Section 302 of the Sarbanes-Oxley
Act of 2002 |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|31.2       |  | Certification of CFO pursuant to
Securities Exchange Act Rules 13a -
14 and 15D  14 as adopted pursuant
to Section 302 of the Sarbanes-Oxley
Act of 2002 |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|32         |  | Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act
of 2002.                                   |  |                                                       |  | X       
|           |  |                                                                                                                                                           |  |                                                       |  |         
|           |  |  Thomas R. Trotter                                                                                                                                       |  |                                                       |  |         
|           |  |  Sherry A. Sturman                                                                                                                                       |  |                                                       |  |         
|           |  |                                                                                                                                                           |  |                                                       |  |         
|           |  |                                                                                                                                                           |  |                                                       |  |         
|(1)        |  | Management contract or compensatory plan or arrangement                                                                                                   |  |                                                       |  |         
|(2)        |  | Filed under confidential treatment request with the Securities and Exchange
Commission.                                                                   |  |                                                       |  |