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, 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. (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.   xYesoNo

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

41,564,291 shares of common stock outstanding as of October 31, 2006

1

ORTHOLOGIC CORP.

(A Development Stage Company)

INDEX

		Page No.
Part I	Financial Information
	Item 1. Financial Statements (Unaudited)
	Condensed Balance Sheets as of September 30, 2006 and December 31, 2005	3
	Condensed Statements of Operations for the three and nine months ended September 30, 2006 and 2005	4
	Condensed Statements of Cash Flows for the nine months ended September 30, 2006 and 2005	5
	Notes to Unaudited Condensed Financial Statements	6
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3. Quantitative and Qualitative Disclosures about Market Risk	21
	Item 4. Controls and Procedures	21
Part II	Other Information
	Item 1A. Risk Factors	21
	Item 6. Exhibits	24

EXHIBIT 31.1

EXHIBIT 31.2

EXHIBIT 32

2

PART I - Financial Information

Item 1. Financial Statements

ORTHOLOGIC CORP.

(A Development Stage Company)

CONDENSED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

	September 30, 2006			December 31, 2005
ASSETS
Current assets
Cash and cash equivalents	$	36,890		$	35,111
Short-term investments		27,318			46,437
Prepaids and other current assets		480			857
Total current assets		64,688			82,405
Furniture and equipment, net		403			525
Long-term investments		9,930			2,084
Deferred income taxes		-			1,106
Patents, net		-			2,223
Total assets	$	75,021		$	88,343
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable	$	852		$	1,036
Accrued compensation		642			711
Accrued clinical		472			544
Accrued severance and restructuring costs		178			602
Other accrued liabilities		813			1,089
Total current liabilities		2,957			3,982
Deferred rent and other non-current liabilities		372			183
Total liabilities		3,329			4,165
Stockholders' Equity
Common Stock $.0005 par value; 100,000,000 shares authorized; 41,564,291 and 38,124,742 shares issued and outstanding at 2006 and 2005, respectively		21			19
Additional paid-in capital		187,708			171,355
Accumulated deficit		(116,037	)		(87,196	)
Total stockholders' equity		71,692			84,178
Total liabilities and stockholders' equity	$	75,021		$	88,343

See notes to unaudited condensed financial statements

3

ORTHOLOGIC CORP.

(A Development Stage Company)

CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three months endedSeptember 30,						Nine months endedSeptember 30.						As a Development Stage Company
	2006			2005			2006			2005			8/5/2004 - 9/30/2006
OPERATING EXPENSES
General and administrative	$	1,414		$	1,027		$	5,567		$	3,210		$	12,355
Research and development		5,651			7,266			16,575			18,660			50,099
Other divestiture and related gains		-			-			-			(250	)		(375	)
Purchased in-process research and development		2			-			8,471			-			34,311
Total operating expenses		7,067			8,293			30,613			21,620			96,390
Interest and other income, net		(1,250	)		(700	)		(2.879	)		(1,906	)		(6,270	)
Loss from continuing operations before taxes		5,817			7,593			27,734			19,714			90,120
Income tax expense (benefit)		-			-			1,106			(12	)		356
Loss from continuing operations		5,817			7,593			28,840			19,702			90,476
Discontinued operations - net gain on the saleof the bone device business, net of taxes ($267)		-			-			-			-			(2,202	)
NET LOSS	$	5,817		$	7,593		$	28,840		$	19.702		$	88,274
Per Share Information:
Net loss, basic and diluted	$	0.14		$	0.20		$	0.71		$	0.52
Basic and diluted shares outstanding		41,545			38,025			40,496			38,019

See notes to unaudited condensed financial statements

4

ORTHOLOGIC CORP.

(A Development Stage Company)

CONDENSED STATEMENTS OF CASH FLOW

(in thousands)

(Unaudited)

	For nine months ended September 30,						As a Development Stage Company
	2006			2005			8/5/2004 - 9/30/2006
OPERATING ACTIVITIES
Net loss	$	(28,840	)	$	(19,702	)	$	(88,274	)
Non-cash items:
Deprecation and amortization		2,790			296			3,222
Deferred tax expense		1,106			-			770
Non-cash stock compensation		2,252			-			2,414
Gain on sale of bone device business		-			-			(2,298	)
In-process research and development		8,471			-			34,311
Change in other operating items:
Prepaids and other current assets		374			(15	)		1,227
Accounts payable		(184	)		482			132
Accrued liabilities		(1,225	)		(512	)		(736	)
Cash flows used in operating activities		(15,256	)		(19,451	)		(49,232	)
INVESTING ACTIVITIES
Expenditures for equipment and furniture		(86	)		(229	)		(405	)
Proceeds from sale of assets		-			-			7,000
Cash Paid for assets of AzERx/CBI		(390	)		-			(4,058	)
Cash paid for patent assignment rights		(100	)		(400	)		(500	)
Purchases of investments		(34,432	)		(35,514	)		(123,817	)
Maturities of investments		45,705			46,917			144,507
Cash flows provided by investing activities		10,697			10,774			22,727
FINANCING ACTIVITIES
Net proceeds from stock option exercises		2,962			44			4,612
Net proceeds from sale of stock		3,376			-			3,376
Cash flows provided by financing activities		6,338			44			7,988
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		1,779			(8,633	)		(18,517	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		35,111			38,377			55,407
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	36,890		$	29,744		$	36,890
	AzERx						AzERx and CBI
Supplement Disclosure of Non-Cash Investing Activities
AzERx/CBI Acquisitions
Current assets acquired	$	-					$	29
Patents acquired		-						2,142
Liabilities acquired, and accrued acquisition costs		(317	)					(457	)
Original investment reversal		-						(750	)
In-process research and development accquired		8,471						34,311
Common Stock issued for acquisition		(7,764	)					(31,217	)
Cash paid for accuistion	$	390					$	4,058

See notes to unaudited condensed financial statements

5

ORTHOLOGIC CORP.

(A Development Stage Company)

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

OVERVIEW OF BUSINESS

Description of the business

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

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

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

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

Company History

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

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

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

6

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

Our development activities for the Chrysalin Product Platform and AZX100 represent a single operating segment as they share the same product development path and utilize the same Company resources. As a result, we have determined that it is appropriate to reflect our operations as one reportable segment. Through September 30, 2006, we have incurred $88 million in net losses as a development stage company.

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

Financial Statement Presentation

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

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

As discussed in the following section of this report, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the results of the Company’s Phase 3 Chrysalin fracture repair human clinical trial resulted in a change in our planned clinical pathway and timeline for our Chrysalin fracture repair indication. This potential change, when factored with our current significant net operating loss carryovers and current period net loss, resulted in a revision of our estimate of the need for a valuation allowance for the previously recorded deferred tax asset related to a Alternative Minimum Tax credit carryover. Due to the uncertainty that the deferred tax asset will be realized, we recorded a valuation allowance for the full amount of the deferred tax asset ($1,106,000) in the nine month period ended September 30, 2006.

7

The interim analysis of data from the Company’s Phase 2b fracture repair dose ranging clinical trial, as discussed in the following section of this report, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, confirmed the above discussed potential changed timeline to market for Chrysalin-based products. On November 2, 2006, the Company announced that it has no immediate plans to re-enter clinical trials for Chrysalin-based product candidates and a strategic shift in its development approach to its Chrysalin product platform. The Company currently intends to pursue development partnering or licensing opportunities for its Chrysalin-based product candidates, a change from its previous development history of independently conducting human clinical trials necessary to advance its Chrysalin-based product candidates to market. SFAS No. 142 requires an impairment loss be recognized for an amortizable intangible asset whenever the net cash in-flow to be generated from an asset is less that its carrying cost. Currently, the Company is unable to determine the timing or amount of net cash in-flow to be generated from Chrysalin-based product candidates. Accordingly, due to this uncertainty, the Company has elected to recognize an impairment loss for the amount of unamortized Chrysalin product platform patent costs of $2,100,000 at September 30, 2006. The impairment loss is included in research and development expenses in the Condensed Statements of Operations at September 30, 2006.

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

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

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

8

Unrecognized non-cash stock compensation expense related to unvested options outstanding as of December 31, 2005 was approximately $1 million (includes 328,124 shares valued at $500,000 unvested and cancelled on April 5, 2006 upon the resignation of James M. Pusey, MD). Because of the significant expected forfeiture rate caused by the options cancelled at the time of Dr. Pusey’s resignation, the expected compensation cost for unvested options at December 31, 2005, was approximately $250,000. Compensation cost recorded for the nine months ended September 30, 2006 for the options outstanding and unvested at December 31, 2005 was $154,000. At September 30, 2006 the remaining compensation cost related to unvested options outstanding at December 31, 2005, is approximately $100,000, which will be recognized over the remaining vesting period of approximately three years, with an estimated weighted average period of one year.

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

9

	Three months ended September 30, 2005			Nine months ended September 30, 2005
Estimated weighted-average fair value of options granted during the period	None			$	3.36
Net loss attributable to common stockholders:
As reported	$	7,593		$	19,702
Stock based compensation expense (included in net loss)		-			-
Stock based compensation expense, net of tax		392			1,044
Pro forma	$	7,985		$	20,746
Basic and diluted net loss per share:
As reported	$	0.20		$	0.52
Pro forma	$	0.21		$	0.55
Black-Scholes model assumptions:
Risk free interest rate		4.2	%		4.2	%
Expected volatility		30	%		55	%
Expected term		2.4 Years			2.4 Years
Dividend yield		0	%		0	%

2006 Stock Options

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

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

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

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

The Company used the Black-Scholes model with the following assumptions, to determine the total fair market value of $3,555,000 for options to purchase 1,994,000 shares of the Company’s common stock issued during the nine months ended September 30, 2006:

10

	Three months ended March 31, 2006	Three months ended June 30, 2006
Risk free interest rate	4.8%	5.2%
Volatility	73%	70%
Expected term from vesting	2.9 years	2.9 years
Dividend yield	0%	0%

Using an estimated forfeiture rate of 5%, compensation cost recorded for the nine months ended September 30, 2006, for options issued in that period, was $1,673,000. The options granted generally vest over a two to four-year period from the date of grant and, accordingly, the remaining unamortized cost at September 30, 2006 of approximately $1,622,000 will be amortized ratably over the period ending December 31, 2009, with an estimated weighted average period of 1.2 years.

2006 Restricted Stock

On May 12, 2006, the Shareholders of the Company approved the 2005 Equity Incentive Plan, which reserves an additional 2,000,000 shares of the Company’s common stock for equity incentive awards. In conjunction with the approval, on May 12, 2006, the Board of Directors of the Company awarded 117,750 shares of restricted stock, of which 87,550 shares were fully vested at September 30, 2006, and 30,200 shares will vest December 31, 2006. All of the restricted stock awards had been conditionally awarded in 2005, subject to shareholder approval of the 2005 Equity Incentive Plan. Of the restricted shares awarded, 62,750 shares related to annual awards to the Board of Directors, and 55,000 shares were performance based awards to officers of the Company. The total fair market value of the grants, determined using the closing price of the Company’s common stock on the date of grant, was $206,000, of which $181,000 has been recognized as compensation cost in the nine months ended September 30, 2006.

In connection with the employment of James M. Pusey, MD, President and CEO, in March 2005, the Company granted Dr. Pusey 200,000 shares of restricted stock, which vested if certain milestones were reached. In March 2006, 100,000 shares of restricted stock vested resulting in total compensation expense of $588,000, of which $426,000 was recorded in the quarter ended March 31, 2006 and $162,000 in fiscal year 2005, as general and administrative expenses. The compensation cost was determined using the closing price of the Company’s common stock on March 3, 2005, the date of grant. The remaining unvested 100,000 shares of restricted stock were cancelled upon Dr. Pusey’s resignation on April 5, 2006 of his employment with the Company.

Summary

Non-cash stock compensation cost for the nine months ended September 30, 2006 totaled $2,252,000 of which $607,000 related to restricted stock, as described above. In the condensed Statements of Operations for the nine months ended September 30, 2006, non-cash stock compensation expense of $1,649,000 was recorded as a general and administrative expense and $603,000 was recorded as a research and development expense.

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

11

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

	Number of options			Weighted average exercise price		Weighted average remaining contractual term (years)
Options outstanding at December 31, 2005		3,040,785		$	5.23
Plus: Options granted		1,994,000		$	2.85
Less:
Options exercised		(670,400	)	$	4.42
Options expired/forfeited		(794,666	)	$	7.22
Options outstanding at September 30, 2006		3,569,719		$	3.67		7.64
Options exercisable at September 30, 2006		1,965,342		$	4.37		6.13
Options vested and expected to vest at September 30, 2006		3,487,113		$	3.68

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

Unvested Shares	Number of Options			Weighted average Grant date Fair Value
Unvested shares at December 31, 2005		200,000		$	5.88
Granted		117,750		$	1.75
Vested		(187,550	)	$	3.95
Canceled/forfeited		(100,000	)	$	5.88
Unvested shares at September 30, 2006		30,200		$	1.75

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

B. Acquisition of New Class of Molecules, ICARMs™

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

12

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

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

The costs associated with the acquisition were as follows:

Cash	$	390,000
Fair Market Value of the Company's common stock issued (1)		7,764,000
Transaction costs		242,000
Liabilities assumed		75,000
In-process research and development costs	$	8,471,000

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

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

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

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

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

On September 14, 2006, the Company notified Quintiles that the Company would not offer for sale or issue to Quintiles the shares contemplated in the Third Closing. Accordingly, the Company has no further right to request Quintiles purchase shares of its common stock and Quintiles has no further obligation to purchase such shares under the agreements.

Summary of the stock sale transactions:

	February 27, 2006		July 3, 2006
Capital stock and additional paid-in capital	$	1,913,000	$	1,463,000
Accrued transaction costs		87,000		37,000
Cash proceeds	$	2,000,000	$	1,500,000

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

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

The total cost of the milestone warrants will be charged to expense over the period of performance. The costs will be determined based on the fair market value of the milestone warrants determined by using the Black-Scholes model, revalued at each Company reporting date until fully vested. The fair market value of the milestone warrants using the Black-Scholes model, 67% volatility, 0% dividend yield, expected term of 9.4 years, and 4.7% interest rate was $221,000 at September 30, 2006. No costs were charged to expense at September 30, 2006 as it is not yet probable that any milestone warrants will vest.

D. Property Tax Dispute

The Company, along with similar affected property owners or Lessees, contested certain property taxes levied by Maricopa County on Salt River Project leasehold improvements. In September 2006, the Superior Court of Arizona ruled in favor of the Company. However, the court ruling is subject to appeal by Maricopa County. Given the uncertainty of the appeal process, at September 30, 2006 the Company could not determine that recovery of the amounts involved is probable, and, accordingly, expected recoveries have not been recorded at September 30, 2006. The property tax bills subject to the court’s decision, totaled $466,000 and covered tax years 2004 and 2005. The Company has also been billed $240,000 for tax year 2006 for the same taxes, of which $180,000 has been charged to expense at September 30, 2006. If the Company is successful in the recovery of the amounts for tax years 2004 and 2005, it is expected to also recover the amounts for tax year 2006. During 2006 the Arizona State Legislature repealed the property tax which is the subject of the dispute.

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

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

Overview of the Business

OrthoLogic is currently a development stage biotechnology company focused on the development and commercialization of the novel synthetic peptides Chrysalin® (TP508) and AZX100. However, we continue to evaluate other biopharmaceutical compounds that can complement our research activity internally and broaden our potential pipeline for successful products.

Chrysalin Product Platform

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

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

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Through September 30, 2006, the Company has focused most of its efforts on the development and commercialization of fracture repair and diabetic foot ulcer healing indications.

Acceleration of Fracture Repair

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

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

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

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

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The Company was assessing Chrysalin in a Phase 2b human clinical trial in distal radius fractures, which is a double-blind, randomized placebo controlled trial that explored a wider dose range of Chrysalin, including 1µg, 3 µg, 10 µg, or 30 µg doses. Our enrollment goal was 500 evaluable subjects in approximately 60 sites. On March 15, 2006, the Company temporarily interrupted enrollment in its Phase 2b fracture repair dosing human clinical trial to perform an interim analysis of the subjects enrolled up to that date.

On August 29, 2006, the Company reported the results of interim analysis of data from our Phase 2b dose ranging clinical trial of the novel synthetic peptide Chrysalin (TP508) in unstable, displaced distal radius (wrist) fractures and termination of the Phase 2b study. In the dataset of 240 subjects as a group that were evaluable in the Phase 2b interim analysis, treatment with Chrysalin did not demonstrate benefit compared to placebo in the primary efficacy endpoint of time to removal of immobilization. Individual findings of efficacy in secondary endpoints, including radiographic healing, were not seen in this interim analysis and no dose response relationship was observed. The trial met the pre-specified safety endpoint by demonstrating no significant difference in the incidence of adverse events between the Chrysalin and placebo groups.

Dermal Wound Healing

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

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

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

___________

On November 2, 2006, the Company announced that it has no immediate plans to re-enter clinical trials for Chrysalin-based product candidates and a strategic shift in its development approach to its Chrysalin Product Platform. The Company currently intends to pursue development partnering or licensing opportunities for its Chrysalin-based product candidates, a change from its previous development history of independently conducting human clinical trials necessary to advance its Chrysalin-based product candidates to market.

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AZX100 - ICARMs™

On February 23, 2006, the Company entered into an agreement to purchase certain assets and assume certain liabilities of AzERx, Inc. The transaction was completed (closed) on February 27, 2006. Under the terms of the transaction, OrthoLogic acquired an exclusive license for the core intellectual property relating to AZX100, and will continue to develop the new class of compounds in the field of smooth muscle relaxation called Intracellular Actin Relaxing Molecules, or ICARMs™, based on the unique technology developed by AzERx. The acquisition provides the Company with a new technology platform that diversifies the portfolio, and may provide more than one potential product.  AzERx’s lead compound is AZX100, a 24-amino acid synthetic peptide. 

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

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

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

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

General and Administrative (“G&A”) Expenses: G&A expenses related to our ongoing development operations increased by $387,000 from $1,027,000 in the third quarter of 2005 to $1,414,000 in the third quarter of 2006. Our administrative expenses during the third quarter of 2006 were higher than the same period of 2005 primarily as a result of stock compensation, as disclosed in Note A to the unaudited condensed financial statements, and a reduction in the allocation of general and administration expenses to research and development due to the decline in clinical activity, partically offset by decreased employee related costs associated with a decrease in the number of full time employees.

Research and Development Expenses: Research and development expenses were $5,651,000 for the three months ended September 30, 2006 compared to $7,266,000 for the same period in 2005. Our research and development expenses decreased $1,615,000 in the third quarter of 2006 over the same period in 2005 primarily due to the substantial completion of our Phase 3 human clinical trial for fracture repair and the temporary interruption and later termination of our Phase 2b dose-ranging human clinical trial for fracture repair. This decrease in clinical trial costs was partially offset by recognition of a $2,100,000 Chrysalin product platform patent impairment loss. The primary focus of our research and development work was our Chrysalin-based fracture repair indication. On November 2, 2006, the Company announced that it has no immediate plans to re-enter clinical trials for Chrysalin-based product candidates and a strategic shift in its development approach to its Chrysalin Product Platform. The Company currently intends to pursue development partnering or licensing opportunities for its Chrysalin-based product candidates, a change from its previous development history of independently conducting human clinical trials necessary to advance its Chrysalin-based product candidates to market. We will continue expenditures related to ongoing regulatory requirements for the Phase 2b clinical trial for Chrysalin in fracture repair and, as disclosed in Note B to the unaudited condensed financial statements, the Company acquired and will continue pre-clinical and other development work on AZX100 in 2006.

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Interest and Other Income, Net: Interest and other income, net, increased from $700,000 in the third quarter of 2005 to $1,250,000 in the third quarter of 2006 due to the increase in interest rates between the two periods and the receipt of STTR grant income of $341,000 in 2006

Net Loss: We incurred a net loss in the three months ended September 30, 2006 of $5.8 million compared to a net loss of $7.6 million in the same period in 2005. The net loss in the three months ended September 30, 2006 includes stock compensation expense of $600,000 and recognition of a $2,100,000 Chrysalin product platform patent impairment loss. These items were offset by the decrease in fracture repair human clinical trial activity compared to the same period in 2005.

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

General and Administrative (“G&A”) Expenses: G&A expenses related to our ongoing development operations increased by $2,357,000 from $3,210,000 in the nine month period of 2005 to $5,567,000 in the nine month period of 2006. Our administrative expenses during the nine month period of 2006 were higher than the same period of 2005 primarily as a result of stock compensation expense of $1,649,000, as disclosed in Note A to the unaudited condensed financial statements, and a reduction in the allocation of general and administrative expenses to research and development due to the decline in clinical activity.

Research and Development Expenses: Research and development expenses were $16,575,000 for the first nine months in 2006 and compared to the $18,660,000 of expenses incurred in the first nine months in 2005. This decrease is primarily due to the decrease in clinical trial activity in 2006 when compared to 2005 but was partially offset by recognition of a $2,100,000 Chrysalin product platform patent impairment loss. The primary focus of our research and development work in 2005 and 2006 was our Chrysalin-based fracture repair indication.

Interest and Other Income, Net: Interest and other income, net increased from $1,906,000 in the nine month period of 2005 to $2,879,000 in the nine month period of 2006 due to the increase in interest rates between the two periods and the receipt of STTR grant income of $341,000.

Net Loss: We incurred a net loss in the first nine months of 2006 of $28.8 million compared to a net loss of $19.7 million in the first nine months of 2005. The $9.1 million increase in the net loss in the nine months ended September 30, 2006 compared to the same period in 2005, results primarily from $2.2 million of stock compensation expense, recognition of a $2.1 million Chrysalin product platform patent impairment loss, $8.4 million of in-process research and development costs related to the acquisition of the AZX100 technology platform, as disclosed in Note B to the unaudited condensed financial statements, and recognition of income tax expense related to the recording of a valuation allowance of $1.1 million for a deferred tax asset related to a Alternative Minimum Tax credit carryover. These items were offset by the decrease in fracture repair human clinical trial activity compared to the same period in 2005.

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With the adoption of SFAS 123 (R), as disclosed in Note A to the unaudited condensed financial statements, we recorded a non-cash compensation expense related to restricted stock and stock options granted to our employees and members of our Board of Directors of $2.2 million for the nine months ended September 30, 2006 and currently estimate the expense for the year ended December 31, 2006 will be approximately $2.8 million.

Liquidity and Capital Resources

We have historically financed our operations through operating cash flows and the public and private sales of equity securities. However, with the sale of our Bone Device Business in November 2003, we sold all of our revenue producing operations. Since that time, we have relied on our cash and investments to finance all our operations, the focus of which was research and development of our Chrysalin Product Platform. We received approximately $93.0 million in cash from the sale of our Bone Device Business. On December 1, 2005, we received the additional $7.2 million, including interest, from the escrow balance related to the sale of the Bone Device Business. On February 27, 2006, the Company entered into an agreement with Quintiles (see Note C to the unaudited condensed financial statements), which provided an investment by Quintiles in the Company’s common stock, of which $2,000,000 was received on February 27, 2006 and $1,500,000 was received on July 3, 2006. The Company also received net proceeds of $2,962,000 from the exercise of stock options during the nine months ended September 30, 2006. At September 30, 2006, we had cash and cash equivalents of $36.9 million, short-term investments of $27.3 million and long-term investments of $9.9 million.

We do not expect to make significant capital investments in 2006. On November 2, 2006 the Company announced that it has no immediate plans to re-enter clinical trials for Chrysalin-based product candidates and a strategic shift in its development approach to its Chrysalin Product Platform. The Company currently intends to pursue development partnering or licensing opportunities for its Chrysalin-based product candidates, a change from its previous development history of independently conducting human clinical trials necessary to advance its Chrysalin-based product candidates to market. We will continue expenditures related to ongoing regulatory requirements for the Phase 2b clinical trial for Chrysalin in fracture repair, and we will also continue research and development expenditures for further pre-clinical studies for AZX100.

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

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

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

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

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

Item 4. Controls and Procedures

Disclosure Controls and Procedures

Our principal executive officer and chief financial officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-Q. Based on their evaluation, the principal executive officer and chief financial officer have each concluded that, as of the end of such period, our disclosure controls and procedures are effective and provide reasonable assurance that we record, process, summarize, and report information required to be disclosed in the reports we file under the Securities Exchange Act of 1934 within the time periods specified by the Securities and Exchange Commission’s rules and forms.

Internal Control Over Financial Reporting

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

Part II - Other Information

Item 1A. Risk Factors

Forward looking statements

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

· unfavorable results of our product candidate development efforts;

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

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

· increased regulation by the FDA and other agencies;

· the introduction of competitive products;

· impairment of license, patent or other proprietary rights;

· failure to achieve market acceptance of our products;

· the impact of present and future collaborative agreements; and

· failure to successfully implement our drug development strategy.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary significantly from what we projected. Any forward-looking statement you read in this Quarterly Report on Form 10-Q reflects our current views with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, business strategy and liquidity. We assume no obligation to publicly update or revise these forward-looking statements for any reason, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

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

Certain results from our Phase 3 and Phase 2b clinical trials showed that the differences in the primary endpoint analyses between our lead compound, Chrysalin, and the placebo were not statistically significant, which will make it more difficult to obtain FDA approval and result in a substantial delay in our ability to generate revenue.

On March 15, 2006, we reported results of our Phase 3 fracture repair human clinical trial. For the primary endpoint, time to removal of immobilization , no statistically significant difference was observed between placebo and a single injection of Chrysalin. Consistent with the Phase 1/2 human clinical trial results, a statistically significant difference for a secondary endpoint, radiographic evidence of radial cortical bridging, was achieved. However, no statistically significant difference was noted in the study’s other secondary endpoints. On March 15, 2006, we temporarily halted our Phase 2b fracture repair dosing clinical trial to perform an interim analysis of the data of the subjects enrolled to that date.

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On August 29, 2006, we reported the results of interim analysis of data from our Phase 2b dose-ranging clinical trial of the novel synthetic peptide Chrysalin^® (TP508) in unstable, displaced distal radius (wrist) fractures and termination of the Phase 2b study. In the dataset of 240 subjects as a group that were evaluable in the Phase 2b interim analysis, treatment with Chrysalin did not demonstrate benefit compared to placebo in the primary efficacy endpoint of time to removal of immobilization. Individual findings of efficacy in secondary endpoints, including radiographic healing, were not seen in this interim analysis and no dose response relationship was observed. The trial met the pre-specified safety endpoint by demonstrating no significant difference in the incidence of adverse events between the Chrysalin and placebo groups.

On November 2, 2006, the Company announced a strategic shift in its development approach to its Chrysalin Product Platform. The Company currently intends to pursue development partnering or licensing opportunities for its Chrysalin-based product candidates, a change from its previous development history of independently conducting human clinical trials necessary to advance its Chrysalin-based product candidates to market.

This increases the risk that we will not be successful and there will be a substantial delay in obtaining FDA approval and may lead to the termination of development efforts for the Chrysalin fracture repair or other Chrysalin-based product candidates, will result in a delay in our ability to generate revenue, will change the amount of revenue we may generate and could have a material adverse effect on our business going forward.

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

Our stock price has varied significantly in the past (from a high of $8.96 to a low of $1.25 from January 1, 2003 to August 31, 2006) and may vary in the future due to a number of factors, including:

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

· fluctuations in our operating results;

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

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

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

· FDA and other regulatory actions;

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

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

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

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

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Item 6 Exhibits

See Exhibit List following this report

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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/ John M. Holliman, III	Executive Chairman	November 8, 2006
John Mn, Holliman, III	(Principal Executive Officer)
/s/ Les M. Taeger	Senior Vice-President and Chief	November 8, 2006
Les M. Taeger	Financial Officer
	(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 September 30, 2006

ExhibitNo.	Description	Incorporated by Reference To:	Filed Herewith
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		X
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002		X
32	Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002		X

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