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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 March 31, 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)
  
  
  þ o
 o þ o
 o þ
      1




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##### 



PageNo.Part I Financial InformationItem 1. Financial Statements (Unaudited)Condensed Balance Sheets as of March 31, 2006 and December 31, 2005
    
    3Condensed Statements of Operations for the three months ended March 31, 2006 and 2005
    
    4Condensed Statements of Cash Flows for the three months ended March 31, 2006 and 2005
    
    5Notes to Unaudited Condensed Financial Statements
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    19Item 4. Controls and Procedures
    
    19Part II Other InformationItem 1A. Risk Factors
    
    20Item 6. Exhibits
    
    21Exhibit 31.1Exhibit 31.2Exhibit 32
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##### Table of Contents



PART I
 Financial Information
 
 Item 1. Financial Statements
 
 
 (in thousands)
 March 31,
    
    December 31,2006
    
    2005ASSETSCurrent assetsCash and cash equivalents
    
    $
    41,429
    
    
    $
    35,111Short-term investments
    
    
    32,389
    
    
    
    46,437Prepaids and other current assets
    
    
    756
    
    
    
    857Total current assets
    
    
    74,574
    
    
    
    82,405Furniture and equipment, net
    
    
    593
    
    
    
    525Long-term investments
    
    
    6,974
    
    
    
    2,084Deferred income taxes
    
    
    1,106
    
    
    
    1,106Patents, net
    
    
    2,240
    
    
    
    2,223Total assets
    
    $
    85,487
    
    
    $
    88,343LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesAccounts payable
    
    $
    1,516
    
    
    $
    1,036Accrued compensation
    
    
    262
    
    
    
    711Accrued clinical
    
    
    737
    
    
    
    544Accrued severance and other restructuring costs
    
    
    410
    
    
    
    602Other accrued liabilities
    
    
    800
    
    
    
    1,089Total current liabilities
    
    
    3,725
    
    
    
    3,982Deferred rent and other non-current liabilities
    
    
    454
    
    
    
    183Total liabilities
    
    $
    4,179
    
    
    $
    4,165Stockholders EquityCommon Stock $.0005 par value;
    
    
    20
    
    
    
    19100,000,000 shares authorized;
40,573,489 and
38,124,742 shares issued and outstandingAdditional paid-in capital
    
    
    184,965
    
    
    
    171,355Accumulated deficit
    
    
    (103,677
    )
    
    
    (87,196
    )Total stockholders equity
    
    
    81,308
    
    
    
    84,178Total liabilities and stockholders equity
    
    $
    85,487
    
    
    $
    88,343
 See notes to unaudited condensed financial statements
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(in thousands, except per share data)


DevelopmentThree months ended
    
    Stage CompanyMarch 31,
    
    August 5, 2004 -2006
    
    2005
    
    March 31, 2006OPERATING EXPENSESGeneral and administrative
    
    $
    2,093
    
    
    $
    910
    
    
    $
    8,881Research and development
    
    
    6,716
    
    
    
    5,403
    
    
    
    40,240Other divestiture and related gains
    
    
    
    
    
    
    (250
    )
    
    
    (375
    )Purchased in-process research and development
    
    
    8,434
    
    
    
    
    
    
    
    34,274Total operating expenses
    
    
    17,243
    
    
    
    6,063
    
    
    
    83,020Interest income, net
    
    
    (762
    )
    
    
    (552
    )
    
    
    (4,153
    )Loss from continuing operations before taxes
    
    
    16,481
    
    
    
    5,511
    
    
    
    78,867Income tax benefit
    
    
    
    
    
    
    (12
    )
    
    
    (750
    )Loss from continuing operations
    
    
    16,481
    
    
    
    5,499
    
    
    
    78,117Discontinued operations  net gain on sale of the
bone device business, net of taxes ($267)
    
    
    
    
    
    
    
    
    
    
    (2,202
    )NET LOSS
    
    $
    16,481
    
    
    $
    5,499
    
    
    $
    75,915Per Share Information:Net loss, basic and diluted
    
    $
    (0.42
    )
    
    $
    (0.14
    )Basic and diluted shares outstanding
    
    
    39,250,851
    
    
    
    38,047,198


See notes to unaudited condensed financial statements


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(in thousands)
 As a DevelopmentThree months ended
    
    Stage CompanyMarch 31,
    
    August 5th 2004 -2006
    
    2005
    
    March 31, 2006OPERATING ACTIVITIESNet loss
    
    $
    (16,481
    )
    
    $
    (5,499
    )
    
    $
    (75,708
    )Non Cash items:Deferred tax asset
    
    
    
    
    
    
    
    
    
    
    (336
    )Depreciation and amortization
    
    
    357
    
    
    
    30
    
    
    
    582Non-cash stock compensation
    
    
    952
    
    
    
    
    
    
    
    1,114Gain on sale of bone growth stimulation business
    
    
    
    
    
    
    
    
    
    
    (2,298
    )In-process research and development
    
    
    8,434
    
    
    
    
    
    
    
    34,274Change in other operating items:Accounts receivable
    
    
    
    
    
    
    
    
    
    
    227Prepaids and other current assets
    
    
    100
    
    
    
    (80
    )
    
    
    726Accounts payable
    
    
    264
    
    
    
    (332
    )
    
    
    580Accrued liabilities
    
    
    (788
    )
    
    
    (523
    )
    
    
    (299
    )Cash flows used in operating activities
    
    
    (7,162
    )
    
    
    (6,404
    )
    
    
    (41,138
    )INVESTING
ACTIVITIESExpenditures for furniture and equipment, net
    
    
    (83
    )
    
    
    (5
    )
    
    
    (402
    )Proceeds from sale of assets
    
    
    
    
    
    
    
    
    
    
    7,000Cash paid for assets of AzERx/CBI
    
    
    (390
    )
    
    
    
    
    
    
    (4,058
    )Cash paid for patent assignment rights
    
    
    (100
    )
    
    
    
    
    
    
    (500
    )Purchases of investments
    
    
    (10,068
    )
    
    
    (15,135
    )
    
    
    (99,453
    )Maturities of investments
    
    
    19,226
    
    
    
    13,160
    
    
    
    118,028Cash flows provided by (used in) investing activities
    
    
    8,585
    
    
    
    (1,980
    )
    
    
    20,615FINANCING
ACTIVITIESNet proceeds from stock option exercises
    
    
    2,962
    
    
    
    
    
    
    
    4,612Net proceeds from sale of stock
    
    
    1,933
    
    
    
    
    
    
    
    1,933Cash flows provided by financing activities
    
    
    4,895
    
    
    
    
    
    
    
    6,545NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    6,318
    
    
    
    (8,384
    )
    
    
    (13,978
    )CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    35,111
    
    
    
    38,377
    
    
    
    55,407CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    41,429
    
    
    $
    29,993
    
    
    $
    41,429Supplemental Disclosure of Non-Cash Investing Activities
    
    AzERx
    
    
    
    
    
    AzERx and CBIAzERx/CBI AcquisitionCurrent assets acquired
    
    
    
    
    
    
    
    
    
    $
    29Patents acquired
    
    
    
    
    
    
    
    
    
    
    2,142Liabilities acquired, and accrued acquisition costs
    
    
    (280
    )
    
    
    
    
    
    
    (420
    )Original investment reversal
    
    
    
    
    
    
    
    
    
    
    (750
    )In-process research and development acquired
    
    
    8,434
    
    
    
    
    
    
    
    34,274Common 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
 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
  8




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Three months endedMarch 31, 2005Estimated weighted-average fair value
of options granted during the period
    
    $
    2.66Net loss attributable to common stockholders:As reported
    
    $
    (5,499
    )Stock based compensation expense
(included in net loss)
    
    
    Stock based compensation expense,
net of tax
    
    
    (172
    )Pro forma
    
    $
    (5,671
    )Basic and diluted net loss per share:As reported
    
    $
    (0.14
    )Pro forma
    
    $
    (0.15
    )Black-Scholes model assumptions:Risk free interest rate
    
    
    3.9
    %Expected volatility
    
    
    44
    %Expected term
    
    2.7 YearsDividend yield
    
    
    0
    %
    9




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Weighted
    
    
    Weightedaverage exercise
    
    
    average remainingNumber of
    
    
    price
    
    
    contractual termOptions
    
    
    $
    
    
    (years)Options outstanding at December 31, 2005
    
    
    3,040,285
    
    
    
    5.17Plus: Options granted
    
    
    644,000
    
    
    
    5.21Less:Options exercised
    
    
    (670,400
    )
    
    
    4.42Options expired/forfeited
    
    
    (52,612
    )
    
    
    4.38Options outstanding at March 31, 2006
    
    
    2,961,773
    
    
    
    5.36
    
    
    
    6.81Options exercisable at March 31, 2006
    
    
    1,914,313
    
    
    
    5.44
    
    
    
    5.36
  WeightedaverageGrant dateNumber of
    
    
    Fair ValueUnvested Shares
    
    Options
    
    
    $Unvested shares at December 31, 2005
    
    
    200,000
    
    
    
    5.88GrantedVested
    
    
    100,000
    
    
    
    5.88Canceled/forfeitedUnvested shares at March 31, 2006
    
    
    100,000
    
    
    
    5.88
  10




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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
    
    
    207,000Liabilities assumed
    
    
    73,000In-process Research and Development costs
    
    $
    8,434,000
 
 (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.  C. Sale of Shares of Company Stock, Issuance of Warrants and Entry into Master Services Agreement
  11




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Capital Stock and Additional paid-in Capital
    
    $
    1,933,000Accrued transaction costs
    
    
    67,000Cash proceeds
    
    $
    2,000,000
    
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
  12




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Overview of the Business
  CHRYSALIN®
  ®
  rd
 AZX100   ICARMs
 in vitro
 13




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Chrysalin Product Platform
     Acceleration of Fracture Repair
  14




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®
 rd
 Dermal Wound Healing
  15




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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)
    
    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.
  16




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in vitro
 Results of Operations Comparing Three-Month Period Ended March 31, 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
 st
 17




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®
 rd
   18




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Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
 Item 4. Controls and Procedures
 Disclosure Controls and Procedures
  Internal Control Over Financial Reporting
  19




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Part
II  Other Information
 
 Item 1A. Risks 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.
   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.
 20




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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, and
conversions of preferred stock,
    
    announcements of technological innovations or new products by us or our competitors;
    
    FDA and other regulatory actions;
    
    developments with respect to our or our competitors patents or proprietary rights;
    
    public concern as to the safety of products developed by us or others; and
    
    changes in stock market analyst recommendations regarding us, other drug
development companies or the pharmaceutical industry generally.
  
 Item 6.
  21




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SIGNATURES
  ORTHOLOGIC CORP.
  Signature
    
    Title
    
    Date/s/ John M. Holliman, III
    
    Executive Chairman
    
    May 8, 2006John M. Holliman, III
    
    (Principal Executive Officer)/s/ Les M. Taeger
    
    Senior Vice-President and ChiefLes M. Taeger
    
    Financial Officer
    
    May 8, 2006(Principal Financial and Accounting Officer)
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OrthoLogic Corp.
(the Company)
Exhibit Index to Quarterly Report on Form 10-Q
For the Quarterly Period Ended March 31, 2006
 Exhibit
    
    
    
    
    
    FiledNo.
    
    Description
    
    Incorporated by Reference To:
    
    HerewithExhibit
    
    Description
    
    Incorporated Herein By Reference To4.1
    
    Class A Warrant Agreement dated
February 24, 2006, between
OrthoLogic Corp. and PharmaBio
Development Inc.
    
    Exhibit 4.1 to the Companys
Current Report on Form 8-K, filed
with the SEC on March 3, 2006 (the
March 3rd 8-K)4.2
    
    Class B Warrant Agreement dated
February 24, 2006, between
OrthoLogic Corp. and PharmaBio
Development Inc. (asterisks
located within exhibit denote
information that has been deleted
pursuant to a request for
confidential treatment filed with
the Securities and Exchange
Commission)
    
    Exhibit 4.2 to the March 3rd 8-K4.3
    
    Class C Warrant Agreement dated
February 24, 2006, between
OrthoLogic Corp. and PharmaBio
Development Inc. (asterisks
located within exhibit denote
information that has been deleted
pursuant to a request for
confidential treatment filed with
the Securities and Exchange
Commission)
    
    Exhibit 4.3 to the March 3rd 8-K4.4
    
    Class D Warrant Agreement dated
February 24, 2006, between
OrthoLogic Corp. and PharmaBio
Development Inc. (asterisks
located within exhibit denote
information that has been deleted
pursuant to a request for
confidential treatment filed with
the Securities and Exchange
Commission)
    
    Exhibit 4.4 to the March 3rd 8-K4.5
    
    Form of Class A Warrant Agreement
for Additional Class A Warrants
    
    Exhibit 4.8 to the Companys
Registration Statement on Form S-3
filed with the SEC on April 13,
2006 (the April 13th S-3)10.1
    
    Employment Agreement dated
January 10, 2006 between the
Company and Les M. Taeger
    
    Exhibit 10.1 to the Companys
Current Report on Form 8-K filed
with the SEC on January 11, 2006
(the January 11th 8-K)10.2
    
    Intellectual Property,
Confidentiality and
Non-Competition Agreement dated
as of January 10, 2006 between
the Company and Les M. Taeger
    
    Exhibit 10.2 to the January 11th 8-K10.3
    
    Asset Purchase Agreement and Plan
of Reorganization dated February
23, 2006, by and between the
Company and AzERx, Inc.
    
    Exhibit 10.1 to the Companys
Registration Statement on Form S-3
filed with the SEC on April 25,
2006 (the April 25th S-3)10.4
    
    Amended and Restated License
Agreement dated February 23, 2006
between the Company and Arizona
Science & Technology Enterprises,
LLC
    
    Exhibit 10.5 to the April 25th S-3
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Exhibit
    
    
    
    
    
    FiledNo.
    
    Description
    
    Incorporated by Reference To:
    
    HerewithExhibit
    
    Description
    
    Incorporated Herein By Reference To10.5
    
    Common Stock and Warrant Purchase
Agreement dated February 24,
2006, by and between the Company
and PharmaBio Development Inc.
    
    Exhibit 10.1 to the April 13th S-310.6
    
    Common Stock and Warrant Purchase
Agreement dated February 24,
2006, by and between the Company
and PharmaBio Development Inc.
    
    Exhibit 10.1 to the April 13th S-310.7
    
    Registration Rights Agreement
dated February 24, 2006, between
PharmaBio Development Inc. and
the Company,
    
    Exhibit 10.2 to the April 13th S-310.8
    
    Registration Rights Agreement
dated February 27, 2006, by and
among the Company, AzERx, Inc.
and the other shareholders listed
thereon
    
    Exhibit 10.3 to the April 13th S-310.9
    
    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, 199331.1
    
    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
 
 *
    
    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 March
31, 2006, OrthoLogic entered into such indemnification agreements with Dana Shinbaum and William
Wardell. Pursuant to the instructions accompanying Item 601 of Regulation S-K, OrthoLogic has
filed the form of such indemnification agreement. 24