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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
 For the quarterly period ended June 30, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 0-21214
 ORTHOLOGIC CORP.
  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)
  (Registrants telephone number, including area code)
 (Former name, former address and former fiscal year, if changed since last report)
 þ o
  o þ o
 o þ




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##### 



PageNo.Part I Financial InformationItem 1. Financial Statements (Unaudited)Condensed Balance Sheets as of June 30, 2006 and December 31, 2005
    
    
    3Condensed Statements of Operations for the three and six months ended June 30, 2006 and 2005
    
    
    4Condensed Statements of Cash Flows for the six months ended June 30, 2006 and 2005
    
    
    5Notes to Unaudited Condensed Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    20Part II Other InformationItem 1A. Risk Factors
    
    
    21Item 4. Submission of Matters to a Vote of Security Holders
    
    
    23Item 6. Exhibits
    
    
    23Exhibit 10.1Exhibit 10.2Exhibit 10.3Exhibit 10.4Exhibit 10.7Exhibit 10.8Exhibit 31.1Exhibit 31.2Exhibit 32
  
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##### Table of Contents



PART I  Financial Information
 
 Item 1. Financial Statements
 
 
  (in thousands, except per share data)
  June 30,
    
    December 31,2006
    
    2005ASSETSCurrent assetsCash and cash equivalents
    
    $
    36,992
    
    
    $
    35,111Short-term investments
    
    
    28,425
    
    
    
    46,437Prepaids and other current assets
    
    
    546
    
    
    
    857Total current assets
    
    
    65,963
    
    
    
    82,405Furniture and equipment, net
    
    
    512
    
    
    
    525Long-term investments
    
    
    10,182
    
    
    
    2,084Deferred income taxes
    
    
    
    
    
    
    1,106Patents, net
    
    
    2,170
    
    
    
    2,223Total assets
    
    $
    78,827
    
    
    $
    88,343LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    785
    
    
    $
    1,036Accrued compensation
    
    
    448
    
    
    
    711Accrued clinical
    
    
    557
    
    
    
    544Accrued severance and restructuring costs
    
    
    349
    
    
    
    602Other accrued liabilities
    
    
    829
    
    
    
    1,089Total current liabilities
    
    
    2,968
    
    
    
    3,982Deferred rent and other non-current liabilities
    
    
    412
    
    
    
    183Total liabilities
    
    
    3,380
    
    
    
    4,165Stockholders EquityCommon Stock $.0005 par value;
100,000,000 shares authorized; 40,661,039 and
38,124,742 shares issued and outstanding at
2006 and 2005, respectively
    
    
    20
    
    
    
    19Additional paid-in capital
    
    
    185,646
    
    
    
    171,355Accumulated deficit
    
    
    (110,219
    )
    
    
    (87,196
    )Total stockholders equity
    
    
    75,447
    
    
    
    84,178Total liabilities and stockholders equity
    
    $
    78,827
    
    
    $
    88,343
 See notes to unaudited condensed financial statements
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(in thousands, except per share data)
  As a DevelopmentThree months ended June 30,
    
    Six months ended June 30,
    
    Stage Company2006
    
    2005
    
    2006
    
    2005
    
    8/5/2004 - 6/30/2006OPERATING EXPENSESGeneral and administrative
    
    $
    2,061
    
    
    $
    1,273
    
    
    $
    4,153
    
    
    $
    2,183
    
    
    $
    10,941Research and development
    
    
    4,208
    
    
    
    5,991
    
    
    
    10,924
    
    
    
    11,394
    
    
    
    44,448Other divestiture and related gains
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (250
    )
    
    
    (375
    )Purchased in-process research and development
    
    
    34
    
    
    
    
    
    
    
    8,469
    
    
    
    
    
    
    
    34,309Total operating expenses
    
    
    6,303
    
    
    
    7,264
    
    
    
    23,546
    
    
    
    13,327
    
    
    
    89,323Interest income, net
    
    
    (867
    )
    
    
    (654
    )
    
    
    (1,629
    )
    
    
    (1,206
    )
    
    
    (5,020
    )Loss from continuing operations before taxes
    
    
    5,436
    
    
    
    6,610
    
    
    
    21,917
    
    
    
    12,121
    
    
    
    84,303Income tax expense (benefit)
    
    
    1,106
    
    
    
    
    
    
    
    1,106
    
    
    
    (12
    )
    
    
    356Loss from continuing operations
    
    
    6,542
    
    
    
    6,610
    
    
    
    23,023
    
    
    
    12,109
    
    
    
    84,659Discontinued operations  net gain on the sale
of the bone device business, net of taxes ($267)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,202
    )NET LOSS
    
    $
    6,542
    
    
    $
    6,610
    
    
    $
    23,023
    
    
    $
    12,109
    
    
    $
    82,457Per Share Information:Net loss, basic and diluted
    
    $
    0.16
    
    
    $
    0.17
    
    
    $
    0.58
    
    
    $
    0.32Basic and diluted shares outstanding
    
    
    40,622
    
    
    
    38,220
    
    
    
    39,962
    
    
    
    38,134
 See notes to unaudited condensed financial statements
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(in thousands)
  As a DevelopmentFor six months ended June 30,
    
    Stage Company2006
    
    2005
    
    8/5/2004  6/30/2006OPERATING ACTIVITIESNet loss
    
    $
    (23,023
    )
    
    $
    (12,109
    )
    
    $
    (82,457
    )Non-cash items:Depreciation and amortization
    
    
    507
    
    
    
    231
    
    
    
    939Deferred tax expense
    
    
    1,106
    
    
    
    
    
    
    
    770Non-cash stock compensation
    
    
    1,652
    
    
    
    
    
    
    
    1,814Gain on sale of bone device business
    
    
    
    
    
    
    
    
    
    
    (2,298
    )In-process research and development
    
    
    8,469
    
    
    
    
    
    
    
    34,309Change in other operating items:Prepaids and other current assets
    
    
    310
    
    
    
    (425
    )
    
    
    1,163Accounts payable
    
    
    (251
    )
    
    
    410
    
    
    
    65Accrued liabilities
    
    
    (1,105
    )
    
    
    (161
    )
    
    
    (616
    )Cash flows used in operating activities
    
    
    (12,335
    )
    
    
    (12,054
    )
    
    
    (46,311
    )INVESTING ACTIVITIESExpenditures for equipment and furniture
    
    
    (83
    )
    
    
    (87
    )
    
    
    (402
    )Proceeds from sale of assets
    
    
    
    
    
    
    
    
    
    
    7,000Cash paid for assets of AzERx/CBI
    
    
    (390
    )
    
    
    
    
    
    
    (4,058
    )Cash paid for patent assignment rights
    
    
    (100
    )
    
    
    (400
    )
    
    
    (500
    )Purchases of investments
    
    
    (24,463
    )
    
    
    (29,891
    )
    
    
    (113,848
    )Maturities of investments
    
    
    34,377
    
    
    
    38,744
    
    
    
    133,179Cash flows provided by investing activities
    
    
    9,341
    
    
    
    8,366
    
    
    
    21,371FINANCING ACTIVITIESNet proceeds from stock option exercises
    
    
    2,962
    
    
    
    44
    
    
    
    4,612Net proceeds from sale of stock
    
    
    1,913
    
    
    
    
    
    
    
    1,913Cash flows provided by financing activities
    
    
    4,875
    
    
    
    44
    
    
    
    6,525NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    1,881
    
    
    
    (3,644
    )
    
    
    (18,415
    )CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    35,111
    
    
    
    38,377
    
    
    
    55,407CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    36,992
    
    
    $
    34,733
    
    
    $
    36,992Supplemental Disclosure of Non-Cash Investing Activities
    
    AzERx
    
    
    
    
    
    AzERx and CBIAzERx/CBI AcquisitionsCurrent assets acquired
    
    $
    
    
    
    
    
    
    
    $
    29Patents acquired
    
    
    
    
    
    
    
    
    
    
    2,142Liabilities acquired, and accrued acquisition costs
    
    
    (315
    )
    
    
    
    
    
    
    (455
    )Original investment reversal
    
    
    
    
    
    
    
    
    
    
    (750
    )In-process research and development acquired
    
    
    8,469
    
    
    
    
    
    
    
    34,309Common stock issued for acquisition
    
    
    (7,764
    )
    
    
    
    
    
    
    (31,217
    )Cash paid for acquisition
    
    $
    390
    
    
    
    
    
    
    $
    4,058
 See notes to unaudited condensed financial statements
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ORTHOLOGIC CORP.
(A Development Stage Company)
 
 NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
 JUNE 30, 2006
 OVERVIEW OF BUSINESS
 Description of the business
     Company History
    6




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in vitro
       7




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A. STOCK BASED COMPENSATION
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Three months ended
    
    Six months endedJune 30, 2005
    
    June 30, 2005Estimated weighted-average fair value
of options granted during the period
    
    $
    2.66
    
    
    $
    3.78Net loss attributable to common stockholders:As reported
    
    $
    (6,610
    )
    
    $
    (12,109
    )Stock based compensation expense
(included in net loss)
    
    
    
    
    
    
    Stock based compensation expense,
net of tax
    
    
    (315
    )
    
    
    (580
    )Pro forma
    
    $
    (6,925
    )
    
    $
    (12,689
    )Basic and diluted net loss per share:As reported
    
    $
    (0.17
    )
    
    $
    (0.32
    )Pro forma
    
    $
    (0.18
    )
    
    $
    (0.33
    )Black-Scholes model assumptions:Risk free interest rate
    
    
    3.7
    %
    
    
    3.7
    %Expected volatility
    
    
    79
    %
    
    
    63
    %Expected term
    
    2.6 Years
    
    2.6 YearsDividend yield
    
    
    0
    %
    
    
    0
    %
 2006 Stock Options
  9




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Three months ended
    
    Three months endedMarch 31, 2006
    
    June 30, 2006Risk free interest rate
    
    
    4.8
    %
    
    
    5.2
    %Volatility
    
    
    73
    %
    
    
    70
    %Expected term from vesting
    
    2.9 years
    
    2.9 yearsDividend yield
    
    
    0
    %
    
    
    0
    %
  2006 Restricted Stock
   10




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WeightedWeighted
    
    average remainingNumber of
    
    average exercise
    
    contractual termoptions
    
    price
    
    (years)Options outstanding at December 31, 2005
    
    
    3,135,575
    
    
    $
    5.28Plus: Options granted
    
    
    1,994,000
    
    
    $
    2.85Less:Options exercised
    
    
    (670,400
    )
    
    $
    4.42Options expired/forfeited
    
    
    (855,662
    )
    
    $
    6.92Options outstanding at June 30, 2006
    
    
    3,603,513
    
    
    $
    3.70
    
    
    
    7.87Options exercisable at June 30, 2006
    
    
    1,822,839
    
    
    $
    4.62
    
    
    
    6.02Options vested and expected to vest at June 30, 2006
    
    
    3,499,226
    
    
    $
    3.72
  WeightedaverageNumber of
    
    Grant dateUnvested Shares
    
    Options
    
    Fair ValueUnvested shares at December 31, 2005
    
    
    200,000
    
    
    $
    5.88Granted
    
    
    117,750
    
    
    $
    1.75Vested
    
    
    (187,550
    )
    
    $
    3.95Canceled/forfeited
    
    
    (100,000
    )
    
    $
    5.88Unvested shares at June 30, 2006
    
    
    30,200
    
    
    $
    1.75
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B. Acquisition of New Class of Molecules, ICARMs
     Cash
    
    $
    390,000Fair Market Value of the Companys common stock issued (1)
    
    
    7,764,000Transaction costs
    
    
    240,000Liabilities assumed
    
    
    75,000In-process research and development costs
    
    $
    8,469,000
 
 (1)
    
    The fair market value of the Companys common stock ($5.73) was determined by reference
to the closing market price of the Companys common stock for a reasonable period before and
after February 24, 2006.  12




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C. Sale of Shares of Company Stock, Issuance of Warrants and Entry into Master Services Agreement
   Capital stock and additional paid-in capital
    
    $
    1,913,000Accrued transaction costs
    
    
    87,000Cash proceeds
    
    $
    2,000,000
     13




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  Overview of the Business
 ®
 CHRYSALIN
    rd
 14




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AZX100   ICARMs
 in vitro
  Chrysalin Product Platform
    15




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Acceleration of Fracture Repair
    ®
 16




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rd
 Dermal Wound Healing
    AZX100  ICARMs
   
    
    Subarachnoid hemorrhage (SAH) induced spasm of the intracranial blood vessels
    
    Spasm of vein grafts after harvest
    
    Spasm of the portal vein (PHT)
    
    Spasm of airway smooth muscle (asthma)
    
    Spasm of lung vessels, which causes pulmonary (lung) hypertension
    
    Male and female sexual dysfunction
    
    Toxemia of pregnancy (pre-eclampsia/eclampsia)
 17




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
    
    Pre-term labor
    
    Reynauds disease or phenomenon
    
    Achalasia (spasm of the lower esophageal sphincter)
    
    Non-occlusive mesenteric ischemia
    
    Hemolytic-uremia
    
    Prinzmetals angina (a form of coronary spasm that causes angina), and
    
    Anal fissure.
  in vitro
 Results of Operations Comparing Three-Month Period Ended June 30, 2006 to the Corresponding
Period in 2005.
 General and Administrative (G&A) Expenses:
 Research and Development Expenses:
 Interest Income, Net
 Net Loss
 18




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Results of Operations Comparing Six-Month Period Ended June 30, 2006 to the Corresponding
Period in 2005.
 General and Administrative (G&A) Expenses:
 Research and Development Expenses:
 Interest Income, Net
 Net Loss
  Liquidity and Capital Resources
  19




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Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
 Item 4. Controls and Procedures
 Disclosure Controls and Procedures
  20




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Internal Control Over Financial Reporting
  
 Part II  Other Information
 
 Item 1A. Risk Factors
   
    
    unfavorable results of our product candidate development efforts;
    
    unfavorable results of our pre-clinical or clinical testing;
    
    delays in obtaining, or failure to obtain FDA approvals;
    
    increased regulation by the FDA and other agencies;
    
    the introduction of competitive products;
    
    impairment of license, patent or other proprietary rights;
    
    failure to achieve market acceptance of our products;
    
    the impact of present and future collaborative agreements; and
    
    failure to successfully implement our drug development strategy.
  21




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The results of our late stage clinical trials may be insufficient to obtain FDA approval, which
could result in a substantial delay in our ability to generate revenue.
  rd
  Our stock price is volatile and fluctuates due to a variety of factors.
  
    
    announcement of the results of, or delays in, preclinical or studies of clinical trials;
    
    fluctuations in our operating results;
    
    developments in litigation to which we or a competitor is subject;
    
    announcements and timing of potential acquisitions, divestitures or issuance
of preferred stock;
    
    announcements of technological innovations or new products by us or our competitors;
    
    FDA and other regulatory actions;
 22




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
    
    developments with respect to our or our competitors patents or proprietary rights;
    
    public concern as to the safety of products developed by us or others; and
    
    changes in stock market analyst recommendations regarding us, other drug
development companies or the pharmaceutical industry generally.
  
 Item 4.
    
 Item 6.
  23




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SIGNATURES
  ORTHOLOGIC CORP.
 Signature
    
    
    
    Title
    
    Date/s/ John M. Holliman, III

John M. Holliman, III
    
    
    
    Executive Chairman
(Principal Executive Officer)
    
    August 8, 2006/s/ Les M. Taeger
    
    
    
    Senior Vice President and Chief
    
    August 8, 2006Les M. Taeger
    
    
    
    Financial Officer(Principal Financial and Accounting Officer)
 24




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OrthoLogic Corp.
(the Company)
Exhibit Index to Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 30, 2006
 ExhibitNo.
    
    Description
    
    Incorporated by Reference To:
    
    Filed Herewith10.1
    
    Form of Incentive Stock Option
grant letter for use in connection
with the Companys 2005 Equity
Incentive Plan. **
    
    
    
    X10.2
    
    Form of Non-Qualified Stock Option
grant letter for use in connection
with the Companys 2005 Equity
Incentive Plan. **
    
    
    
    X10.3
    
    Amendment to Employment Agreement
dated January 10, 2006 between Les
Taeger and the Company. (1)
    
    
    
    X10.4
    
    Amendment to Employment Agreement
dated January 1, 2001 between
James T. Ryaby, Ph.D. and the
Company. (1)
    
    
    
    X10.5
    
    Form of Indemnification Agreement *
    
    Exhibit 10.16 to Amendment
No. 2 to the Companys
Registration Statement on
Form S-1 (No. 033-47569)
filed with the SEC on
January 25, 199310.6
    
    2005 Equity Incentive Plan. (1)
    
    Exhibit 10.1 to the
Companys
current Report on Form 8-K
filed with the SEC on May
18, 2006.10.7
    
    Employment Agreement between
Randolph C. Steer, MD, Ph.D.,
President, and the Company,
effective May 12, 2006. (1)
    
    
    
    X10.8
    
    Management Services Agreement
between VV III Management, LLC,
John M. Holliman, III, Executive
Chairman, and the Company,
effective May 12, 2006. (1)
    
    
    
    X10.9
    
    Separation Agreement dated April
5, 2006 by and between the Company
and James M. Pusey. (1)
    
    Exhibit 10.1 to the
Companys current Report on
Form 8-K filed with the SEC
on April 11, 2006.31.1
    
    Certification of Principal
Executive Officer Pursuant to
Securities Exchange Act Rule
13a-14
    
    
    
    X31.2
    
    Certification of Chief Financial
Officer Pursuant to Securities
Exchange Act Rule 13a-14
    
    
    
    X32
    
    Certification of Principal
Executive Officer and Chief
Financial Officer Pursuant to 18
U.S.C. Section 1350*
    
    
    
    X
 
 (1)
    
    Management contract or compensatory plan or arrangement.**
    
    OrthoLogic from time to time issues stock options to its employees , officers and directors
pursuant to its 2005 Equity Incentive Plan. The incentive stock option grant letters and
non-qualified stock option grant letters that evidence these issuances differ only such terms as
the identity of the recipient, the grant date, the number of securities covered by the award, the
price(s) at which the recipient may acquire the securities and the vesting schedule. Pursuant to
the instructions accompanying Item 601 of Regulation S-K, OrthoLogic has filed the form of such
incentive stock option grant letter and non-qualified stock option grant. 25




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*

    OrthoLogic has entered into separate indemnification agreements with each of its current directors
and executive officers that differ only in party names and dates. During the quarter ended June
30, 2006 OrthoLogic entered into such indemnification agreement with Randolph C. Steer, MD, Ph.D.
Pursuant to the instructions accompanying Item 601 of Regulation S-K, OrthoLogic has filed the form
of such indemnification agreement. 26