UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 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, 2008





or





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


For
      the
      transition period from __________ to ____________





Commission
      File No. 001-33407




**ISORAY,
      INC.**


(Exact
      name of registrant as specified in its charter)




Minnesota
            
            41-1458152(State
                or other jurisdiction of incorporation or
              organization)
            
            (I.R.S.
                Employer
              Identification
                No.)350
                Hills St., Suite 106, Richland, Washington
            
            99354(Address
                of principal executive offices)
            
            (Zip
                Code)





Registrant's
      telephone number, including area code: (509)
      375-1202





Indicate
      by check mark whether the registrant has (1) filed all reports required to
      be
      filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
      (or for such shorter period the registrant was required to file such reports),
      and (2) has been subject to such filing requirements for the past 90 days.
      Yes x No o





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





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


Smaller
      reporting company x





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





Number
      of
      shares outstanding of each of the issuer's classes of common equity as of the
      latest practicable date:





Class
            
            Outstanding
                as of May 2, 2008Common
                stock, $0.001 par value
            
            22,942,088







**ISORAY,
      INC.**




**Table
      of Contents**







PART
                I
            FINANCIAL
                INFORMATIONItem
                1
            Consolidated
                Unaudited Financial Statements
            1Consolidated
                Balance Sheets
            1Consolidated
                Statements of Operations
            2Consolidated
                Statements of Cash Flows
            3Notes
                to Consolidated Financial Statements
            4Item
                2
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            12Item
                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
            21Item
                6
            Exhibits
                and Reports on Form 8-K
            22Signatures
            23





**PART
      I – FINANCIAL INFORMATION**


**IsoRay,
      Inc. and Subsidiaries**


**Consolidated
      Balance Sheets**





**March 31,****2008**
            
            **June 30,****(Unaudited)**
            
            **2007****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            3,353,295
            
            $
            9,355,730Short-term
                investments
            
            
            6,506,859
            
            
            9,942,840Accounts
                receivable, net of allowance for doubtful accounts of $39,780 and
                $99,789,
                respectively
            
            
            808,673
            
            
            1,092,925Inventory
            
            
            862,439
            
            
            880,834Prepaid
                expenses
            
            
            400,027
            
            
            458,123Total
                current assets
            
            
            11,931,293
            
            
            21,730,452Fixed
                assets, net of accumulated depreciation
            
            
            6,401,331
            
            
            3,665,551Deferred
                financing costs, net of accumulated amortization
            
            
            72,847
            
            
            95,725Licenses,
                net of accumulated amortization
            
            
            455,539
            
            
            262,074Restricted
                cash
            
            
            174,273
            
            
            -Other
                assets, net of accumulated amortization
            
            
            341,036
            
            
            322,360Total
                assets
            
            $
            19,376,319
            
            $
            26,076,162**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            1,066,270
            
            $
            1,946,042Accrued
                payroll and related taxes
            
            
            242,234
            
            
            459,068Accrued
                interest payable
            
            
            1,111
            
            
            1,938Deferred
                revenue
            
            
            -
            
            
            23,874Notes
                payable, due within one year
            
            
            55,025
            
            
            49,212Capital
                lease obligations, due within one year
            
            
            61,390
            
            
            194,855Asset
                retirement obligation, current portion
            
            
            -
            
            
            131,142Total
                current liabilities
            
            
            1,426,030
            
            
            2,806,131Notes
                payable, due after one year
            
            
            404,019
            
            
            528,246Capital
                lease obligations, due after one year
            
            
            3,422
            
            
            25,560Asset
                retirement obligation
            
            
            494,788
            
            
            -Total
                liabilities
            
            
            2,328,259
            
            
            3,359,937Commitments
                and contingencies (see Note 11)Shareholders'
                equity:Preferred
                stock, $.001 par value; 6,000,000 shares authorized:Series
                A: 1,000,000 shares allocated; no shares issued and
                outstanding
            
            
            -
            
            
            -Series
                B: 5,000,000 shares allocated; 59,065 shares issued and
                outstanding
            
            
            59
            
            
            59Common
                stock, $.001 par value; 194,000,000 shares authorized; 23,090,200
                and
                22,789,324 shares issued and outstanding
            
            
            23,090
            
            
            22,789Additional
                paid-in capital
            
            
            47,292,395
            
            
            45,844,793Accumulated
                deficit
            
            
            (30,267,484
            )
            
            (23,151,416
            )Total
                shareholders' equity
            
            
            17,048,060
            
            
            22,716,225Total
                liabilities and shareholders' equity
            
            $
            19,376,319
            
            $
            26,076,162





The
      accompanying notes are an integral part of these financial
      statements.


1





**IsoRay,
      Inc. and Subsidiaries**


**Consolidated
      Statements of Operations**


**(Unaudited)**





**Three months ended March 31,**
            
            **Nine months ended March 31,****2008**
            
            **2007**
            
            **2008**
            
            **2007**Product
                sales
            
            $
            1,783,642
            
            $
            1,645,694
            
            $
            5,397,705
            
            $
            4,085,293Cost
                of product sales
            
            
            1,682,981
            
            
            1,456,978
            
            
            5,930,278
            
            
            4,132,518Gross
                margin (loss)
            
            
            100,661
            
            
            188,716
            
            
            (532,573
            )
            
            (47,225
            )Operating
                expenses:Research
                and development
            
            
            434,418
            
            
            437,143
            
            
            1,086,333
            
            
            898,995Sales
                and marketing expenses
            
            
            888,448
            
            
            849,744
            
            
            3,091,091
            
            
            2,412,691General
                and administrative expenses
            
            
            869,435
            
            
            937,905
            
            
            2,690,624
            
            
            3,492,565Total
                operating expenses
            
            
            2,192,301
            
            
            2,224,792
            
            
            6,868,048
            
            
            6,804,251Operating
                loss
            
            
            (2,091,640
            )
            
            (2,036,076
            )
            
            (7,400,621
            )
            
            (6,851,476
            )Non-operating
                income (expense):Interest
                income
            
            
            131,442
            
            
            68,760
            
            
            549,993
            
            
            158,947Unrealized
                loss on short-term investments (see Note 4)
            
            
            (187,300
            )
            
            -
            
            
            (187,300
            )
            
            -Financing
                expense
            
            
            (22,826
            )
            
            (56,772
            )
            
            (78,140
            )
            
            (177,443
            )Non-operating
                income (expense), net
            
            
            (78,684
            )
            
            11,988
            
            
            284,553
            
            
            (18,496
            )Net
                loss
            
            $
            (2,170,324
            )
            $
            (2,024,088
            )
            $
            (7,116,068
            )
            $
            (6,869,972
            )Basic
                and diluted loss per share
            
            $
            (0.09
            )
            $
            (0.12
            )
            $
            (0.31
            )
            $
            (0.42
            )Weighted
                average shares used in computing net loss per share:Basic
                and diluted
            
            
            23,090,200
            
            
            17,400,355
            
            
            23,054,375
            
            
            16,198,067





The
      accompanying notes are an integral part of these financial
      statements. ****


2





**IsoRay,
      Inc. and Subsidiaries**


**Consolidated
      Statements of Cash Flows**


**(Unaudited)**





**Nine months ended March 31,****2008**
            
            **2007****CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                loss
            
            $
            (7,116,068
            )
            $
            (6,869,972
            )Adjustments
                to reconcile net loss to net cash used by operating activities:Depreciation
                and amortization of fixed assets
            
            
            849,716
            
            
            283,422Amortization
                of deferred financing costs and other assets
            
            
            61,521
            
            
            99,387Amortization
                of discount on short-term investments
            
            
            (145,165
            )
            
            -Unrealized
                loss on short-term investments
            
            
            187,300
            
            
            -Loss
                on settlement of ARO liability (Note 7)
            
            
            (135,120
            )
            
            -Accretion
                of asset retirement obligation
            
            
            25,670
            
            
            4,690Noncash
                share-based compensation
            
            
            425,090
            
            
            1,022,241Changes
                in operating assets and liabilities:Accounts
                receivable, net
            
            
            284,252
            
            
            (646,869
            )Inventory
            
            
            18,395
            
            
            (109,401
            )Prepaid
                expenses
            
            
            58,095
            
            
            (244,364
            )Accounts
                payable and accrued expenses
            
            
            (879,772
            )
            
            222,910Accrued
                payroll and related taxes
            
            
            (216,834
            )
            
            (56,700
            )Accrued
                interest payable
            
            
            (827
            )
            
            1,470Deferred
                revenue
            
            
            (23,874
            )
            
            -Net
                cash used by operating activities
            
            
            (6,607,621
            )
            
            (6,293,186
            )**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchases
                of fixed assets
            
            
            (3,112,400
            )
            
            (786,614
            )Additions
                to licenses and other assets
            
            
            (250,783
            )
            
            (27,657
            )Change
                in restricted cash
            
            
            (174,273
            )
            
            -Purchases
                of short-term investments
            
            
            (13,273,653
            )
            
            -Proceeds
                from the sale or maturity of short-term investments
            
            
            16,667,499
            
            
            -Net
                cash used by investing activities
            
            
            (143,610
            )
            
            (814,271
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Principal
                payments on notes payable
            
            
            (118,414
            )
            
            (95,301
            )Principal
                payments on capital lease obligations
            
            
            (155,603
            )
            
            (135,165
            )Proceeds
                from cash sales of common shares pursuant to private placement, net
                of
                offering costs
            
            
            -
            
            
            19,819,962Proceeds
                from cash sales of preferred stock, pursuant to exercise of warrants
            
            
            -
            
            
            8,709Proceeds
                from cash sales of common stock, pursuant to exercise of warrants
            
            
            1,010,913
            
            
            6,448,181Proceeds
                from cash sales of common stock, pursuant to exercise of options
            
            
            11,900
            
            
            1,106,333Payment
                of dividend to preferred shareholders
            
            
            -
            
            
            (38,458
            )Net
                cash provided by financing activities
            
            
            748,796
            
            
            27,114,261Net
                (decrease) increase in cash and cash equivalents
            
            
            (6,002,435
            )
            
            20,006,804Cash
                and cash equivalents, beginning of period
            
            
            9,355,730
            
            
            2,207,452**CASH
                AND CASH EQUIVALENTS, END OF PERIOD**
            
            $
            3,353,295
            
            $
            22,214,256Non-cash
                investing and financing activities:Increase
                in fixed assets related to asset retirement obligation
            
            $
            473,096
            
            $
            -Cashless
                exercise of common stock options
            
            
            -
            
            
            145,000Exchange
                of convertible debentures payable for shares of common stock
            
            
            -
            
            
            49,999




The
        accompanying notes are an integral part of these financial
        statements. ****


3


**IsoRay,
      Inc.**


**Notes
      to the Unaudited Consolidated Financial Statements**


**For
      the three and nine-month periods ended March 31, 2008 and
      2007**





**1.** **Basis
          of Presentation**





The
      accompanying consolidated financial statements are those of IsoRay, Inc., and
      its wholly-owned subsidiaries (IsoRay or the Company). All significant
      intercompany accounts and transactions have been eliminated in
      consolidation.





The
      accompanying interim consolidated financial statements have been prepared in
      conformity with U.S. generally accepted accounting principles, consistent in
      all
      material respects with those applied in the Company’s Annual Report on Form
      10-KSB for the fiscal year ended June 30, 2007. The financial information is
      unaudited but reflects all adjustments, consisting only of normal recurring
      accruals, which are, in the opinion of the Company’s management, necessary for a
      fair statement of the results for the interim periods presented. Interim results
      are not necessarily indicative of results for a full year. The information
      included in this Form 10-Q should be read in conjunction with the Company’s
      Annual Report on Form 10-KSB for the fiscal year ended June 30,
      2007.





**2.**  **Accounting
      for Uncertainty in Income Taxes**





On
      July
      1, 2007, the Company adopted Financial Accounting Standards Board Interpretation
      No. 48 (FIN No. 48) *Accounting
      for Uncertainty in Income Taxes* .
      FIN No.
      48 clarifies the accounting for uncertainty in income taxes recognized in
      accordance with Statement of Financial Accounting Standard (SFAS) No. 109 *Accounting
      for Income Taxes* ,
      prescribing a recognition threshold and measurement attribute for the
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. In the course of its assessment, management has determined that
      the
      Company, its subsidiary, and its predecessors are subject to examination of
      their income tax filings in the United States and state jurisdictions for the
      2003 through 2006 tax years. In the event that the Company is assessed penalties
      and or interest; penalties will be charged to other operating expense and
      interest will be charged to interest expense.





The
      Company adopted FIN No. 48 using the modified prospective transition method,
      which requires the application of the accounting standard as of July 1, 2007.
      There was no impact on the financial statements as of and for the three and
      nine
      months ended March 31, 2008 as a result of the adoption of FIN No. 48. In
      accordance with the modified prospective transition method, the financial
      statements for prior periods have not been restated to reflect, and do not
      include, the impact of FIN No. 48.





**3.**  **Loss
      per Share**





The
      Company accounts for its income (loss) per common share according to SFAS No.
      128, *Earnings
      Per Share* .
      Under
      the provisions of SFAS No. 128, primary and fully diluted earnings per share
      are
      replaced with basic and diluted earnings per share. Basic earnings per share
      is
      calculated by dividing net income (loss) available to common shareholders by
      the
      weighted average number of common shares outstanding, and does not include
      the
      impact of any potentially dilutive common stock equivalents. Common stock
      equivalents, including warrants to purchase the Company's common stock, are
      excluded from the calculations when their effect is antidilutive. At March
      31,
      2008 and 2007, the calculation of diluted weighted average shares does not
      include preferred stock, options, or warrants that are potentially convertible
      into common stock as those would be antidilutive due to the Company’s net loss
      position.





4


Securities
      that could be dilutive in the future as of March 31, 2008 and 2007 are as
      follows:





March 31,2008
            
            2007Preferred
                stock
            
            
            59,065
            
            
            59,065Common
                stock warrants
            
            
            3,250,774
            
            
            3,627,767Common
                stock options
            
            
            2,831,728
            
            
            3,088,439Convertible
                debentures
            
            
            -
            
            
            85,542Total
                potential dilutive securities
            
            
            6,141,567
            
            
            6,860,813





**4.**  **Short-Term
      Investments**





The
      Company’s short-term investments are classified as available-for-sale and
      recorded at fair market value. The Company’s short-term investments consisted of
      the following at March 31, 2008 and June 30, 2007:





March 31,
            
            June 30,2008
            
            2007Municipal
                debt securities
            
            $
            3,812,700
            
            $
            3,000,000Corporate
                debt securities
            
            
            2,694,159
            
            
            6,942,840$
            6,506,859
            
            $
            9,942,840





The
      Company’s municipal debt securities consist of auction rate securities (ARS)
      that are generally long term debt instruments that provide liquidity through
      a
      modified Dutch auction process that resets the applicable interest rate at
      predetermined intervals, usually every 28 days. ARS generally trade at par
      and
      are callable at par on any interest payment date at the option of the issuer.
      Interest received during a given period is based upon the interest rate
      determined through the auction process. Although these securities are issued
      and
      rated as long term bonds, they are priced and traded as short-term instruments
      because of the liquidity provided through the interest rate reset. This
      mechanism generally allows existing investors to rollover their holdings and
      continue to own their respective securities or liquidate their holdings by
      selling their securities at par value. The Company generally invests in these
      securities for short periods of time as part of its cash management
      program.





However,
      the recent uncertainties in the credit markets have prevented the Company and
      other investors from liquidating their holdings by selling their securities
      at
      par value as the amount of securities submitted for sale at recent ARS auctions
      has exceeded the market demand. These securities continue to pay interest
      according to their stated terms. For those securities that failed to auction,
      the Company continues to hold these securities and accrues interest at a higher
      rate than similar securities for which auctions have cleared. The Company's
      ARS
      are all AAA/Aaa rated investments and consist of various student loan portfolios
      with the vast majority of the student loans guaranteed by the U.S. Government
      under the Federal Family Education Loan Program. These securities were valued
      using a model that takes into consideration the financial conditions of the
      issuer and the bond insurers as well as the current illiquidity of the
      securities. If the credit ratings of the issuers deteriorate, the Company may
      adjust the carrying value of these investments. The Company is uncertain as
      to
      when the liquidity issues relating to these investments will
      improve.





None
      of
      the ARS investments in our portfolio were backed by sub-prime mortgage
      loans.


5


Although
      insufficient demand for certain ARS may continue, we anticipate, based on
      discussions with our investment advisors, that liquidity may possibly be
      realized through the emergence of secondary markets in the near term,
      particularly considering the high default interest rates, high credit ratings,
      the backing of the Federal Family Education Loan Program, and the historically
      low default rates of these securities. As such, we believe that the primary
      impact of the failed auctions is reduced liquidity rather than impairment of
      principal. In the event that we are unable to sell the investments at or above
      our carrying value, these securities may not provide us with a liquid source
      of
      cash.





Unrealized
      gains and temporary unrealized losses on these securities are recorded in other
      comprehensive income/loss within Shareholders' Equity. Unrealized losses that
      are considered other than temporary are recorded in the Consolidated Statements
      of Operations in unrealized loss on short-term investments. The Company has
      recognized the unrealized losses on the ARS as other than temporary and recorded
      them in the statement of operations rather than in other comprehensive income
      as
      the Company may need access to these funds before the uncertainties in the
      credit markets are fully resolved.





**5.**  **Inventory**





Inventory
      consists of the following at March 31, 2008 and June 30, 2007:





March 31,
            
            June 30,2008
            
            2007Raw
                materials
            
            $
            702,210
            
            $
            682,327Work
                in process
            
            
            127,614
            
            
            120,242Finished
                goods
            
            
            32,615
            
            
            78,265$
            862,439
            
            $
            880,834





**6.**  **Restricted
      Cash**





The
      Washington Department of Health, effective October 2007, has required the
      Company to provide collateral for the decommissioning of its facility. To
      satisfy this requirement, the Company funded two CDs totaling $172,500 in
      separate banks. The CDs both have original maturities of three months but are
      classified as long-term as the Company does not anticipate decommissioning
      the
      facility until the end of the current lease plus the lease option periods.
      Interest earned on the CDs is rolled-over at the maturity of each CD and becomes
      part of the restricted cash balance. Interest earned and added to restricted
      cash during the quarter ended March 31, 2008 was $1,773. These funds will be
      used to settle a portion of the Company’s remaining asset retirement obligations
      (Note 7).





**7.**  **Asset
      Retirement Obligations**





SFAS
      No.
      143, *Asset
      Retirement Obligations* ,
      establishes standards for the recognition, measurement and disclosure of legal
      obligations associated with the costs to retire long-lived assets. Accordingly,
      under SFAS No. 143, the fair value of the future retirement costs of the
      Company’s leased assets are recorded as a liability on a discounted basis when
      they are incurred and an equivalent amount is capitalized to property and
      equipment. The initial recorded obligation, which was discounted using the
      Company’s credit-adjusted risk-free rate, is reviewed periodically to reflect
      the passage of time and changes in the estimated future costs underlying the
      obligation. The Company amortizes the initial amount capitalized to property
      and
      equipment and recognizes accretion expense in connection with the discounted
      liability over the estimated remaining useful life of the leased
      assets.


6


In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represented the discounted cost of cleanup that the Company
      anticipated it would have to incur at the end of its equipment and property
      leases in its old production facility. This amount was determined based on
      discussions with qualified production personnel and on historical evidence.
      During fiscal year 2007, the Company reevaluated its obligations based on
      discussions with the Washington Department of Health and determined that the
      initial asset retirement obligation should be increased by an additional
      $56,120. During the second quarter of fiscal year 2008, the Company removed
      all
      radioactive residuals and tenant improvements from its old production facility
      and returned the facility to the lessor. The Company had an asset retirement
      obligation of $135,120 accrued for this facility but total costs incurred to
      decommission the facility were $274,163 resulting in an additional expense
      of
      $139,043 that is included in cost of products sold. The additional expense
      is
      mainly due to unanticipated construction costs to return the facility to its
      previous state. The Company originally believed that the lessor would retain
      many of the leasehold improvements in the building, but the lessor instead
      required their removal.





In
      September 2007, a new asset retirement obligation of $473,096 was established
      representing the discounted cost of the Company’s obligations to remove any
      residual radioactive materials and any unwanted leasehold improvements at the
      end of the lease term at its new production facility. The estimate was developed
      by qualified production personnel and the general contractor of the new
      facility. The Company has reviewed the estimate again based on its experience
      with decommissioning its old facility and believes that the original estimate
      continues to be applicable.





During
      the nine month periods ended March 31, 2008 and 2007, the asset retirement
      obligation changed as follows:





Nine monthsended March 31,2008
            
            2007Beginning
                balance
            
            $
            131,142
            
            $
            67,425New
                obligations
            
            
            473,096
            
            
            -Settlement
                of existing obligation
            
            
            (135,120
            )
            
            -Accretion
                of discount
            
            
            25,670
            
            
            4,690Ending
                balance
            
            $
            494,788
            
            $
            72,115





**8.**  **Share-Based
      Compensation**





Effective
      July 1, 2006, the Company adopted SFAS No. 123R, *Share-Based
      Payment* ,
      using
      the modified prospective method. The following table presents the share-based
      compensation expense recognized in accordance with SFAS No. 123R during the
      three and nine months ended March 31, 2008 and 2007:





Three months
            
            Nine monthsended March 31,
            
            ended March 31,2008
            
            2007
            
            2008
            
            2007Cost
                of product sales
            
            $
            36,029
            
            $
            21,076
            
            $
            109,859
            
            $
            92,401Research
                and development
            
            
            10,971
            
            
            8,418
            
            
            34,071
            
            
            28,132Sales
                and marketing expenses
            
            
            59,557
            
            
            54,737
            
            
            178,671
            
            
            153,974General
                and administrative expenses
            
            
            (36,080
            )
            
            40,123
            
            
            102,489
            
            
            747,734Total
                share-based compensation
            
            $
            70,477
            
            $
            124,354
            
            $
            425,090
            
            $
            1,022,241


7


Each
      quarter the Company reviews its forfeiture assumptions and adjusts its
      compensation expense when the actual pre-vesting forfeiture rate differs
      materially from the estimate. During the three months ended March 31, 2008,
      the
      Company recognized a credit to compensation expense due to a significant
      variation between the estimated pre-vesting forfeiture rate and the actual
      pre-vesting forfeiture rate.





As
      of
      March 31, 2008, total unrecognized compensation expense related to stock-based
      options was $762,148 and the related weighted-average period over which it
      is
      expected to be recognized is approximately 0.89 years.





The
      Company currently provides stock-based compensation under three equity incentive
      plans approved by the Board of Directors. Options granted under each of the
      plans have a ten year maximum term, an exercise price equal to at least the
      fair
      market value of the Company’s common stock on the date of the grant, and varying
      vesting periods as determined by the Board. For stock options that vest over
      time, the Company recognizes compensation cost on a straight-line basis over
      the
      requisite service period for the entire award.





A
      summary
      of stock option activity within the Company’s share-based compensation plans for
      the nine months ended March 31, 2008 is as follows:





WeightedWeighted
            
            AverageAverage
            
            Remaining
            
            AggregateNumber of
            
            Exercise
            
            Contractual
            
            IntrinsicOptions
            
            Price
            
            Term
            
            ValueOutstanding
                at March 31, 2008
            
            
            2,831,728
            
            $
            2.72
            
            
            7.83
            
            $
            0.00Vested
                and expected to vest at March 31, 2008
            
            
            2,793,342
            
            $
            2.70
            
            
            7.83
            
            $
            0.00Vested
                and exercisable at March 31, 2008
            
            
            2,294,642
            
            $
            2.42
            
            
            7.65
            
            $
            0.00





The
      aggregate intrinsic value of options exercised during the nine months ended
      March 31, 2008 and 2007 was $25,300 and $2,065,450, respectively. The Company’s
      current policy is to issue new shares to satisfy option exercises.





During
      the three and nine months ended March 31, 2008, the Company did not grant any
      stock options. The weighted average fair value of stock option awards granted
      and the key assumptions used in the Black-Scholes valuation model to calculate
      the fair value are as follows:





Three months
            
            Nine monthsended March 31,
            
            ended March 31,2008
            
            2007
            
            2008
            
            2007Weighted
                average fair value of options granted
            
            $
            -
            
            $
            2.68
            
            $
            -
            
            $
            2.18Key
                assumptions used in determining fair value:Weighted
                average risk-free interest rate
            
            
            -
            %
            
            4.45
            %
            
            -
            %
            
            4.82
            %Weighted
                average life of the option (in years)
            
            
            -
            
            
            4.97
            
            
            -
            
            
            5.5Weighted
                average historical stock price volatility
            
            
            -
            %
            
            80.00
            %
            
            -
            %
            
            75.65
            %Expected
                dividend yield
            
            
            -
            %
            
            0.00
            %
            
            -
            %
            
            0.00
            %


8


The
      Black-Scholes option valuation model was developed for use in estimating the
      fair value of traded options which have no vesting restrictions and are fully
      transferable. In addition, option valuation models require the input of highly
      subjective assumptions, including the expected stock price volatility. Because
      changes in the subjective input assumptions can materially affect the fair
      value
      estimate, in management’s opinion, the existing models do not necessarily
      provide a reliable single measure of the fair value of its employee stock
      options. The risk-free interest rate is based on the U.S. treasury security
      rate
      in effect as of the date of grant. The expected lives of options and the stock
      price volatility are based on historical data of the Company.





**9.**  **Shareholders’
      Equity**





Extension
      of Warrants





On
      January 8, 2008, the Board of Directors retroactively extended the expiration
      dates of warrants issued pursuant to its private placement memoranda dated
      October 17, 2005 and February 1, 2006 for an additional one year period. These
      warrants began expiring in October 2007. Based on the extension, the warrants
      will now expire between October 2008 and February 2009. No other terms or
      conditions of the warrants were changed. The change in expiration dates affected
      outstanding warrants to purchase 2,102,142 shares of common stock. Of these
      outstanding warrants there were warrants to purchase 18,000 shares held by
      two
      directors of the Company. Prior to the extension, warrants to purchase 1,186,219
      shares of common stock had passed their original expiration dates.





For
      the
      non-director warrants, the change in expiration date was a modification of
      the
      original warrant based on market conditions and was accounted for as a financing
      transaction similar to an extension of time in the offering of shares in a
      stock
      sale. Therefore there was no effect on the statement of operations as the
      Company had previously determined that under SFAS 133 and EITF 00-19 these
      warrants were equity instruments rather than derivatives.





The
      Company viewed the change in the director warrants as a modification of an
      existing warrant in accordance with SFAS 123R. The fair value of the modified
      warrant was calculated using the Black-Scholes valuation model as $0.30 per
      warrant. The fair value of the original warrant immediately before the
      modification was calculated as zero as all of their warrants had previously
      expired. Total compensation cost of $5,400 was recorded in January 2008 relating
      to the modification of the warrants held by the two directors.





2008
      Employee Stock Option Plan





On
      January 8, 2008, the Board of Directors unanimously adopted, subject to
      shareholder approval, the 2008 Employee Stock Option Plan (2008 Option Plan).
      The 2008 Option Plan would have allowed the Board of Directors to grant options
      to purchase up to 2,000,000 shares of common stock to selected employees,
      consultants, and advisors of the Company. Shareholder approval was not obtained
      for the 2008 Plan at the Company’s annual meeting held on February 20, 2008, and
      thus no grants have been or will be made under the 2008 Option
      Plan.





**10.**  **Russian
      Agreement**





On
      January 23, 2008, the Company announced that it had become a 30% owner in a
      Russian limited liability company, UralDial, LLC, a new medical isotope
      manufacturing and distribution company based in Yekaterinburg, Russia. Under
      the
      terms of the UralDial Charter, the Company will own a 30% share in the new
      company, through its subsidiary, IsoRay International LLC. UNONA Holdings,
      a
      private holding company, has a 40% ownership interest and a 30% ownership
      interest is held by Russian engineers and scientists involved in the new
      company. All capital investments for the new manufacturing plant and the
      development of centers of excellence are expected to be provided by UNONA
      Holdings in support of the Russian government’s new men’s health
      initiatives.


9


**11.**  **Commitments
      and Contingencies**





Patent
      and Know-How Royalty License Agreement





The
      Company is the holder of an exclusive license to use certain “know-how”
developed by one of the founders of a predecessor to the Company and licensed
      to
      the Company by the Lawrence Family Trust, a Company shareholder. The terms
      of
      this license agreement require the payment of a royalty based on the Net Factory
      Sales Price, as defined in the agreement, of licensed product sales. Because
      the
      licensor’s patent application was ultimately abandoned, only a 1% “know-how”
royalty based on Net Factory Sales Price, as defined in the agreement, remains
      applicable. To date, management believes there have been no product sales
      incorporating the “know-how” and therefore no royalty is due pursuant to the
      terms of the agreement. Management believes that ultimately no royalties should
      be paid under this agreement as there is no intent to use this “know-how” in the
      future.





The
      licensor of the “know-how” has disputed management’s contention that it is not
      using this “know-how”. On September 25, 2007 and again on October 31, 2007, the
      Company participated in nonbinding mediation regarding this matter; however,
      no
      settlement was reached with the Lawrence Family Trust. As of May 1, 2008, the
      parties still have not reached a settlement. If no settlement is reached, the
      parties may demand binding arbitration.





License
      Agreement with IBt





In
      February 2006, the Company signed a license agreement with International
      Brachytherapy SA (IBt), a Belgian company, covering North America and providing
      the Company with access to IBt’s Ink Jet production process and its proprietary
      polymer seed technology for use in brachytherapy procedures using Cs-131. Under
      the original agreement royalty payments were to be paid on net sales revenue
      incorporating the technology.





On
      October 12, 2007, the Company entered into Amendment No. 1 (the Amendment)
      to
      its License Agreement dated February 2, 2006 with IBt. The Company paid license
      fees of $275,000 (under the original agreement) and $225,000 (under the
      Amendment) during fiscal years 2006 and 2007, respectively. The Amendment
      eliminates the previously required royalty payments based on net sales revenue,
      and the parties intend to negotiate terms for future payments by the Company
      for
      polymer seed components to be purchased at IBt's cost plus a to-be-determined
      profit percentage. No agreement has been reached on these terms and there is
      no
      assurance that the parties will consummate an agreement pursuant to such
      terms.





Perma-Fix
      Lease





On
      October 10, 2007, the Company executed a Lease Agreement with Perma-Fix
      Northwest Richland, Inc. (Perma-Fix).  The Lease Agreement had an effective
      date of September 1, 2007, and provided for the continuation of the Company's
      lease of its PIRL facility located at 2025 Battelle Boulevard, Richland,
      Washington.  The Company originally leased this facility from Nuvotec USA,
      Inc. under a Lease Agreement dated February 9, 2005, but Nuvotec USA, Inc.
      subsequently sold the facility to Perma-Fix.  The new lease term was
      through January 31, 2008, with early termination permitted upon 45 days prior
      written notice. The Company terminated this lease in mid-December 2007.


10


**12.**  **Management
      and Other Corporate Changes**





Resignation
      of CEO


On
      February 26, 2008, Roger Girard, Chairman, President and CEO of the Company,
      resigned from all positions held with the Company and its subsidiaries,
      including resigning from Board service. There was no disagreement, as defined
      in
      17 CFR 240.3b-7, between the Company and Mr. Girard at the time of Mr. Girard's
      resignation from the Board of Directors.





In
      connection with Mr. Girard's resignation, and in lieu of the severance
      arrangements contained in his Employment Agreement with the Company dated
      October 6, 2005, the Company made a one time payment to Mr. Girard of $250,000
      (less payroll and withholding taxes) in March 2008. The Company has also agreed
      to release Mr. Girard from certain personal guarantees of Company debt and
      cancel 148,112 shares of common stock either issued in connection with the
      guarantees or contingent on his employment through August 2008, continue
      providing him with certain benefits for one year, and extend the exercise period
      for Mr. Girard's vested options to purchase 547,173 shares of common stock
      until
      May 31, 2009. All unvested options held by Mr. Girard terminated upon his
      resignation as provided in the Company's applicable stock option plans. Mr.
      Girard has also agreed to provide consulting services on request through May
      15,
      2008.





Also
      on
      February 26, 2008, the Company's Board appointed Dwight Babcock, one of the
      Company's directors, as interim CEO and as Chairman of the Board, and appointed
      Lori Woods, who previously served as Vice President, as Chief Operating
      Officer.





Mr.
      Babcock does not have any employment agreement or other compensatory agreement
      in place with the Company, although he is compensated $4,000 per month for
      his
      service as interim CEO and $3,000 per month for his service as Chairman in
      addition to $3,000 per month for service on the Board. Ms. Woods' existing
      Employment Agreement, dated February 14, 2007, was not modified or amended
      in
      connection with her promotion to Chief Operating Officer.





Director
      Not Standing for Re-Election


On
      January 8, 2008, Stephen Boatwright, one of the Company's directors, informed
      the Company that he would not stand for re-election at the Company's 2008 Annual
      Meeting of Shareholders, that was held on February 20, 2008, and he resigned
      on
      that date. There was no disagreement, as defined in 17 CFR 240.3b-7, between
      the
      Company and Mr. Boatwright that resulted in Mr. Boatwright's decision not to
      stand for re-election.





By-Law
      Amendments


On
      January 8, 2008, the Board of Directors of the Company adopted Amended and
      Restated By-Laws, which were effective immediately. The Board of Directors
      amended and restated Section 1 of Article III of the By-Laws to give the Board
      of Directors the right to determine the number of directors, within a range
      of 1
      to 10, that will serve on the Board at any given time, and to remove the term
      limit for directors. Prior to the amendment, shareholders had the ability to
      determine the number of directors, within a range of 1 to 10, that would serve
      on the Board at any given time, and directors were subject to a five year term
      limit.





The
      Board
      of Directors also amended and restated Section 3.B. of Article III of the
      By-Laws to shorten the required notice of Board meetings to five days. Prior
      to
      the amendment, fourteen days notice was required for Board meetings.





Shareholders
      have the right to change or repeal any of the By-Laws as described in Section
      4
      of Article VII.


11


**ITEM
      2 – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS**





***Caution
      Regarding Forward-Looking Information***





*In
      addition to historical information, this Form 10-Q contains certain
“forward-looking statements” within the meaning of the Private Securities
      Litigation Reform Act of 1995 (“PSLRA”). This statement is included for the
      express purpose of availing IsoRay, Inc. of the protections of the safe harbor
      provisions of the PSLRA.*





*All
      statements contained in this Form 10-Q, other than statements of historical
      facts, that address future activities, events or developments are
      forward-looking statements, including, but not limited to, statements containing
      the words "believe," "expect," "anticipate," "intends," "estimate," "forecast,"
      "project," and similar expressions . All statements other than statements of
      historical fact are statements that could be deemed forward-looking statements,
      including any statements of the plans, strategies and objectives of management
      for future operations; any statements concerning proposed new products,
      services, developments or industry rankings; any statements regarding future
      economic conditions or performance; any statements of belief; and any statements
      of assumptions underlying any of the foregoing. These statements are based
      on
      certain assumptions and analyses made by us in light of our experience and
      our
      assessment of historical trends, current conditions and expected future
      developments as well as other factors we believe are appropriate under the
      circumstances. However, whether actual results will conform to the expectations
      and predictions of management is subject to a number of risks and uncertainties
      described in the “Risk Factors” section of our Form 10-KSB for the fiscal year
      ended June 30, 2007 and under Part II, Item 1A below that may cause actual
      results to differ materially.*





*Consequently,
      all of the forward-looking statements made in this Form 10-Q are qualified
      by
      these cautionary statements and there can be no assurance that the actual
      results anticipated by management will be realized or, even if substantially
      realized, that they will have the expected consequences to or effects on our
      business operations. Readers are cautioned not to place undue reliance on such
      forward-looking statements as they speak only of the Company's views as of
      the
      date the statement was made. The Company undertakes no obligation to publicly
      update or revise any forward-looking statements, whether as a result of new
      information, future events or otherwise.*





**Critical
      Accounting Policies and Estimates**





The
      discussion and analysis of the Company’s financial condition and results of
      operations are based upon its consolidated financial statements, which have
      been
      prepared in accordance with accounting principles generally accepted in the
      United States of America. The preparation of these financial statements requires
      management to make estimates and judgments that affect the reported amounts
      of
      assets, liabilities, revenues and expenses, and related disclosure of contingent
      liabilities. On an on-going basis, management evaluates past judgments and
      estimates, including those related to bad debts, inventories, accrued
      liabilities, and contingencies. Management bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities that are not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions. The accounting policies
      and
      related risks described in the Company’s annual report on Form 10-KSB for the
      fiscal year ended June 30, 2007, as filed with the Securities and Exchange
      Commission on September 28, 2007, are those that depend most heavily on these
      judgments and estimates. As of March 31, 2008, there have been no material
      changes to any of the critical accounting policies contained
      therein.


12


**Results
      of Operations**




**Three
      months ended March 31, 2008 compared to three months ended March 31,
      2007**





**Product
      sales.** The
      Company generated sales of $1,783,642 during the three months ended March 31,
      2008, compared to sales of $1,645,694 for the three months ended March 31,
      2007.
      The increase of $137,948 or 8% is due to increased sales volume of the Company’s
      Proxcelan Cs-131 brachytherapy seeds. During the three months ended March 31,
      2008, the Company sold its Proxcelan seeds to 57 different medical centers
      as
      compared to 36 medical centers during the corresponding period of 2007. The
      increase in the number of centers ordering was tempered by a lower average
      invoice price due to the expanded use of the Company’s seeds in dual therapy
      cases which typically use fewer seeds.





**Cost
      of product sales.** Cost of
      product sales was $1,682,981 for the three months ended March 31, 2008 compared
      to cost of product sales of $1,456,978 during the three months ended March
      31,
      2007. The major components of the increase of $226,003 or 16% were depreciation,
      materials, and occupancy costs. Depreciation expenses increased approximately
      $163,000 as a result of moving operations into the new production facility
      and
      purchasing new equipment. This new production facility allowed the Company
      to
      increase its available capacity by approximately 300% using its current
      production techniques and should fulfill the Company’s production needs for the
      near future. Materials increased approximately $42,000 mainly due to ordering
      and using more isotope in the three months ended March 31, 2008 compared to
      the
      corresponding period of 2007 due to higher production levels and a higher unit
      price from our primary isotope supplier compared to the previous year. The
      increase in pricing came as a result of a price increase effective in February
      2007 coupled with the Company’s failure to order sufficient volume of isotope to
      obtain more favorable pricing. The Company renegotiated with its main isotope
      vendors and reached agreements that reduced the Company’s isotope costs
      beginning in late March 2008. Occupancy costs increased approximately $75,000
      due to the higher rent on our new production facility and associated increased
      utility costs. In January 2008, the Company’s internal preload facility began
      shipping preloaded strands on a limited basis and increased its activity during
      the quarter. This led to a decrease in preload expenses of approximately
      $12,000.





**Gross
      margin.** Gross
      margin was $100,661 for the three month period ended March 31, 2008. This
      represents a decrease in the Company’s gross profit margin of $88,055 or 47%
      over the corresponding period of 2007’s gross margin of $188,716. The decrease
      in gross margin is due to the Company’s higher revenues being more than offset
      by higher production costs.





**Research
      and development expenses.** Research
      and development expenses for the three month period ended March 31, 2008 were
      $434,418 which represents a decrease of $2,725 or 1% over research and
      development expenses of $437,143 for the three month period ended March 31,
      2007. Consulting expenses increased approximately $106,000 due to the Company’s
      ongoing project to increase the efficiency of isotope production. This was
      offset by a decrease of approximately $101,000 in legal expenses as the Company
      has focused on its key patents and trademarks in significant countries and
      deemphasized the protection of patents and trademarks in other
      countries.





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $888,448 for the three months ended March 31, 2008.
      This represents an increase of $38,704 or 5% compared to expenditures in the
      three months ended March 31, 2007 of $849,744 for sales and marketing.
      Consulting expenses increased approximately $54,000 related to a payment for
      assistance with certain technical and clinical papers. Travel expenses increased
      approximately $11,000 mainly due to the first annual national sales meeting
      held
      in January 2008 that was used to further train the sales force. These increases
      were offset by decreases in hiring costs, marketing and advertising, and
      personnel expenses. Hiring costs decreased approximately $21,000 as the Company
      was actively building its direct sales force during the period ended March
      31,
      2007 but the sales force has remained constant during the three months ended
      March 31, 2008. Marketing and advertising decreased approximately $17,000 due
      to
      new article reprints and other marketing materials purchased during the three
      months ended March 31, 2007. Personnel expenses decreased approximately $15,000
      due to a decrease in the sales force that occurred at the beginning of January
      2008. The Company currently has a direct sales force of seven people in various
      geographic regions.


13


**General
      and administrative expenses.** General
      and administrative expenses for the three months ended March 31, 2008 were
      $869,435 compared to general and administrative expenses of $937,905 for the
      corresponding period of 2007. The decrease of $68,470 or 7% is mainly due to
      reduced share-based compensation of approximately $76,000 as the Company
      reversed the expense for unvested and forfeited options of Mr. Girard, reduced
      bad debt expense of approximately $71,000 due to improved collections, reduced
      consulting expenses of approximately $50,000 due to a payment in the previous
      year related to design work for a potential new production facility, reduced
      payroll expenses of approximately $48,000 due to a lower headcount, reduced
      public company expenses of approximately $20,000 due to lower investor relations
      cost partially offset by increased director compensation, and reduced travel
      expenses of approximately $13,000. These decreases were partially offset by
      a
      one-time accrual paid upon Mr. Girard’s resignation of $250,000 plus payroll
      taxes less previously accrued vacation of approximately $69,000.





**Operating
      loss.** The
      Company continues to focus its resources on marketing and sales and retaining
      the administrative infrastructure to increase the level of demand for the
      Company’s product. These costs coupled with an increase in production costs, and
      significant research and development expenditures has resulted in operating
      losses since its inception. In the three months ended March 31, 2008, the
      Company had an operating loss of $2,091,641 which is an increase of $55,565
      or
      3% over the operating loss of $2,036,076 for the three months ended March 31,
      2007.





**Interest
      income.** Interest
      income was $131,442 for the three months ended March 31, 2008. This represents
      an increase of $62,682 or 91% compared to interest income of $68,760 for the
      three months ended March 31, 2007. Interest income is mainly derived from excess
      funds held in money market accounts and invested in short-term
      investments.





**Unrealized
      loss on short-term investments.** The
      unrealized loss for the three months ended March 31, 2008 is due to the recent
      uncertainties in the credit markets particularly for certain auction rate
      securities held by the Company. The loss represents the amount to write-down
      these securities to their estimated fair market value. The Company has elected
      to recognize these losses as other than temporary and record them in the
      statement of operations rather than in other comprehensive income as the Company
      may need access to these funds before the uncertainties in the credit markets
      are fully resolved.





**Financing
      expense.** Financing expense for the three months ended March 31, 2008 was $22,826 or
      a
      decrease of $33,946 or 60% from financing expense of $56,772 for the
      corresponding period in 2007. Included in financing expense is interest expense
      of approximately $15,000 and $35,000 for the three months ended March 31, 2008
      and 2007, respectively. The decrease in interest expense is due to the maturity
      and payoff of the convertible debentures during the fiscal year ended June
      30,
      2007. The remaining balance of financing expense represents the amortization
      of
      deferred financing costs which decreased due to the write-off in fiscal year
      2007 of the deferred financing costs relating to the Columbia River Bank line
      of
      credit.


14




**Nine
      months ended March 31, 2008 compared to nine months ended March 31,
      2007**





**Product
      sales.** Sales
      for the nine months ended March 31, 2008 were $5,397,705 compared to sales
      of
      $4,085,293 for the nine months ended March 31, 2007. The increase of $1,312,412
      or 32% was due to increased sales volume of the Company’s Proxcelan Cs-131
      brachytherapy seeds. During the nine months ended March 31, 2008 the Company
      sold its Cs-131 seeds to 79 different medical centers as compared to 44 centers
      during the corresponding period of 2007. The increase in the number of centers
      ordering was tempered by a lower average invoice price due to the expanded
      use
      of the Company’s seeds in dual therapy cases which typically use less
      seeds.





**Cost
      of product sales.** Cost of
      product sales was $5,930,278 for the nine months ended March 31, 2008 which
      represents an increase of $1,797,760 or 44% compared to cost of product sales
      of
      $4,132,518 during the nine months ended March 31, 2007. Materials expense
      increased approximately $528,000 mainly due to ordering and using more isotope
      in the nine months ended March 31, 2008 compared to the corresponding period
      of
      2007 and a higher unit price from our main supplier in 2008 compared to 2007.
      The Company renegotiated with its main isotope vendors and reached agreements
      that reduced the Company’s isotope costs beginning in late March 2008.
      Depreciation expense increased approximately $568,000 as a result of moving
      operations into a new production facility and purchasing new production
      equipment in the past nine months. This new production facility allowed the
      Company to increase its available capacity by approximately 300% using its
      current production techniques and should fulfill the Company’s production needs
      for the near future. Preload expenses increased approximately $184,000 due
      to
      higher sales volumes and due to the start-up costs of the Company’s internal
      preload facility. The Company began shipping preloaded strands during January
      2008 and has slowly increased the amount of preload activity completed in-house.
      Personnel expenses, including payroll, benefits, and related taxes, increased
      approximately $149,000 due to the hiring of additional production personnel
      to
      support higher production levels. Occupancy costs increased approximately
      $169,000 as the Company entered into a lease for a new production facility
      in
      March 2007 and continued to pay rent on its old production facility through
      mid-December 2007.





The
      Company also experienced increases in cost of product sales expenditures
      directly related to the new facility that was opened in September 2007. To
      ensure a smooth transition with no missed order shipments, the Company ordered
      an additional $38,000 of isotope in September 2007 that was not utilized as
      the
      removal and transportation of the isotope from the old facility to the new
      facility presented logistical challenges that made it cost prohibitive. As
      part
      of opening the new facility, the Company incurred approximately $20,000 of
      wages
      and related taxes for personnel to perform equipment set-up and validation.
      The
      Company also expensed approximately $82,000 of production materials and small
      tools for the new facility, none of which individually exceeded the $2,500
      threshold the Company uses in determining whether to capitalize production
      equipment.





The
      Company removed all radioactive residuals and tenant improvements from its
      old
      production facility and returned the facility to the lessor. The Company had
      an
      asset retirement obligation of $135,120 accrued for this facility but total
      costs incurred to decommission the facility were $274,163 resulting in an
      additional expense of $139,043 that is included in cost of products sold. The
      additional expense is mainly due to unanticipated construction costs to return
      the facility to its previous state. The Company originally believed that the
      lessor would retain many of the leasehold improvements in the building, but
      instead required their removal.





**Gross
      loss.** Gross
      loss was $532,573 for the nine month period ended March 31, 2008. This
      represents an increase of $485,348 or 1,028% over the corresponding period
      of
      2007’s gross loss of $47,225. The increase is due to the increase in production
      costs more than offsetting the increase in revenues as discussed
      above.


15





**Research
      and development expenses.** Research
      and development expenses for the nine months ended March 31, 2008 were
      $1,086,333 which represents an increase of $187,338 or 21% over the research
      and
      development expenses of $898,995 for the corresponding period of 2007. The
      major
      components of the increase were consulting, personnel, protocol, and travel
      expenses. Consulting expenses increased approximately $172,000 which is mainly
      due to the Company’s ongoing project to increase the efficiency of isotope
      production. Personnel expenses, including payroll, benefits, and related taxes,
      increased approximately $25,000 due to higher salaries for research and
      development personnel, which was partially offset by a decrease in headcount
      during the third quarter ended March 31, 2008. Protocol expenses increased
      approximately $24,000 mainly due to payments for the Company’s randomized
      prospective clinical study, its dual-therapy study, and its continued monitoring
      and updating of the mono-therapy study. Travel expenses increased approximately
      $30,000 due to increased trips to Russia for the Company’s interest
      in the new Russian entity that
      was
      announced in January 2008 and to Belgium to review work on the polymer
      technology licensed from IBt. These increases were partially offset by a
      decrease in legal expenses of approximately $96,000 as the Company has focused
      on its key patents and trademarks in significant countries and deemphasized
      the
      protection of patents and trademarks in other countries.





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $3,091,091 for the nine months ended March 31,
      2008.
      This represents an increase of $678,400 or 28% compared to expenditures in
      the
      nine months ended March 31, 2007 of $2,412,691 for sales and marketing.
      Personnel expenses, including payroll, benefits, and related taxes, increased
      approximately $439,000 due to higher commissions paid due to higher revenues
      and
      an increase in average headcount. Travel expenses increased approximately
      $81,000 due to the increase in average headcount. Consulting expenses increased
      approximately $151,000, mainly due to payments to consultants to develop
      technical publications and other materials, to represent the Company at
      professional society meetings, to serve as members of the Company’s Cesium
      Advisory Group (a new advisory group comprised of radiation oncologists and
      physicists that met for the first time in December 2007), and increased expenses
      for a lobbying group. Dues and subscriptions increased approximately $35,000
      mainly due to the purchase of market research reports and the purchase of
      subscriptions for US medical residents. Marketing and advertising increased
      approximately $66,000 as the Company created new brochures and other marketing
      aids. These increases were partially offset by a decrease of approximately
      $112,000 in convention and tradeshow expenses as the Company reduced its overall
      budget for ASTRO and the smaller tradeshows and a decrease of approximately
      $26,000 in hiring costs.





**General
      and administrative expenses.** General
      and administrative expenses for the nine months ended March 31, 2008 were
      $2,690,624 compared to general and administrative expenses of $3,492,565 for
      the
      corresponding period of 2007. The decrease of $801,941 or 23% is primarily
      due
      to a decrease in share-based compensation of approximately $645,000. Components
      of this decrease were comprised of no option grants in 2008 and the reversal
      of
      the expense for unvested and forfeited options of Mr. Girard, reduced bad debt
      expense of approximately $86,000, reduced consulting expenses of approximately
      $46,000, and reduced travel expenses of approximately $79,000. Personnel costs
      also decreased approximately $77,000 primarily as a result of a lower severance
      accrual of approximately $187,000 in the nine months ended March 31, 2008
      compared to a severance accrual of approximately $288,000 in the nine months
      ended March 31, 2007. These decreases were partially offset by increases in
      legal expenses and public company expenses. Legal expenses increased by
      approximately $87,000 due to costs incurred for contract drafting and review
      of
      the Company’s interest in the new Russian entity, the IBt strategic global
      alliance agreements, and mediation costs with the Lawrence Family Trust. Without
      these fees, legal expenses would have decreased by approximately $150,000.
      Public company expenses increased approximately $95,000 owing to the new
      director compensation plan instituted in fiscal year 2008.


16





**Operating
      loss.** The
      Company continues to focus its resources on marketing and sales and retaining
      the administrative infrastructure to increase the level of demand for the
      Company’s product. These costs coupled with product revenues not covering
      production costs, and significant research and development expenditures, has
      resulted in operating losses since its inception. In the nine months ended
      March
      31, 2008, the Company had an operating loss of $7,400,622 which is an increase
      of $549,146 or 8% over the operating loss of $6,851,476 for the nine months
      ended March 31, 2007.





**Interest
      income.** Interest
      income was $549,993 for the nine months ended March 31, 2008. This represents
      an
      increase of $391,046 or 246% compared to interest income of $158,947 for the
      nine months ended March 31, 2007. Interest income is mainly derived from excess
      funds held in money market accounts and invested in short-term
      investments.





**Unrealized
      loss on short-term investments.** The
      unrealized loss for the three months ended March 31, 2008 is due to the recent
      uncertainties in the credit markets particularly for certain auction rate
      securities held by the Company. The loss represents the amount to write-down
      these securities to their estimated fair market value. The Company has elected
      to recognize these losses as other than temporary and record them in the
      statement of operations rather than in other comprehensive income as the Company
      may need access to these funds before the uncertainties in the credit markets
      are fully resolved.





**Financing
      expense.** Financing expense for the nine months ended March 31, 2008 was $78,140 or a
      decrease of $99,303 or 56% from financing expense of $177,443 for the
      corresponding period in 2007. Included in financing expense is interest expense
      of approximately $55,000 and $112,000 for the nine months ended March 31, 2008
      and 2007, respectively. The decrease in interest expense is due to the maturity
      and payment of the convertible debentures during the fiscal year ended June
      30,
      2007. The remaining balance of financing expense represents the amortization
      of
      deferred financing costs which decreased due to the write-off in fiscal year
      2007 of the deferred financing costs relating to the Columbia River Bank line
      of
      credit.





**Liquidity
      and capital resources** .
      The
      Company has historically financed its operations through cash investments from
      shareholders. During the nine months ended March 31, 2008, the Company’s primary
      source of cash was the exercise of common stock warrants and options for
      $1,022,813 and the Company primarily used existing cash reserves to fund its
      operations and capital expenditures.





*Cash
      flows from operating activities*





Cash
      used
      in operating activities was $6.6 million for the nine months ended March 31,
      2008 compared to $6.3 million for the nine months ended March 31, 2007. Cash
      used by operating activities is net loss adjusted for non-cash items and changes
      in operating assets and liabilities. The year-to-date increase in cash usage
      is
      mainly due to an increased net loss.





*Cash
      flows from investing activities*





Cash
      used
      in investing activities was approximately $142,000 and $814,000 for the nine
      months ended March 31, 2008 and 2007, respectively. Cash expenditures for fixed
      assets were approximately $3.1 million and $787,000 during the nine months
      ended
      March 31, 2008 and 2007, respectively. The large increase is mainly due to
      construction of our new facility and equipment purchases for the new facility.
      The Company also established restricted cash accounts of $172,500 during the
      nine months ended March 31, 2008 and these restricted cash accounts have earned
      interest of $1,773 (see Note 6). These decreases were partially offset by net
      proceeds of approximately $3.4 million from the sale of short-term
      securities.


17





*Cash
      flows from financing activities*





During
      the nine months ended March 31, 2008, the Company issued 290,876 shares of
      common stock pursuant to the exercise of common stock options and warrants.
      The
      Company received $1,022,813 in cash pursuant to these exercises.





*Projected
      2008 Liquidity and Capital Resources*





At
      March
      31, 2008, cash and cash equivalents amounted to $3,353,295 and short-term
      investments amounted to $6,506,859 compared to $9,355,730 of cash and cash
      equivalents and $9,942,840 of short-term investments at June 30,
      2007.





The
      Company had approximately $3.7 million of cash and $5.6 million of short-term
      investments as of May 8, 2008. As of that date management believed that the
      Company’s monthly required cash operating expenditures were approximately
      $600,000 excluding capital expenditure requirements. The Company’s cash
      operating expenditures were higher than this level during the nine months ended
      March 31, 2008 but this was mainly due to the additional expenditures necessary
      to make the new facility operational while maintaining operations at the
      previous facility and a one-time severance payment. Our new interim CEO has
      reemphasized certain initiatives to focus on the Company’s core business and
      strategy of increasing revenues and reducing costs of production. Based on
      these
      initiatives, the Company has implemented a short-term target of reducing its
      monthly cash burn rate to $400,000 but there can be no assurance that the
      Company will be able to achieve this level. For the month of April 2008,
      management believes that the Company’s cash expenditures decreased to
      approximately $450,000, a significant improvement from the monthly rate of
      the
      prior quarter.





Assuming
      operating costs expand proportionately with revenue increases, other
      applications are pursued for seed usage outside the prostate market, protocols
      are expanded supporting the integrity of the Company’s product and sales and
      marketing expenses continue to increase, management believes the Company will
      reach breakeven with revenues of approximately $2 million per month.
      Management’s plans to attain breakeven and generate additional cash flows
      include increasing revenues from both new and existing customers, developing
      additional therapies, and maintaining cost control. Because the quarter ended
      March 31, 2008 was relatively flat when compared to the prior quarter, our
      interim CEO has instituted greater levels of cost reductions than prior
      management had undertaken. However, there can be no assurance that the Company
      will attain profitability or that the Company will be able to attain its
      aggressive revenue targets. If the Company does not experience the necessary
      increases in sales or if it experiences unforeseen manufacturing constraints,
      the Company may need to obtain additional funding.





The
      Company has continued its focus on reducing its production costs and making
      its
      sales force more efficient. The Company has recently begun a review of our
      production process and the possibility of automating a portion of the process
      in
      order to reduce labor costs and gain better efficiencies. The Company also
      reviewed and revised its sales compensation policy. The new compensation policy
      places increased emphasis on generating new customers and organic growth from
      existing customers.





The
      Company expects to finance its future cash needs through the sale of equity
      securities, solicitation to warrant holders to exercise their warrants, and
      possibly strategic collaborations or debt financing or through other sources
      that may be dilutive to existing shareholders. If the Company needs to raise
      additional money to fund its operations, funding may not be available to it
      on
      acceptable terms, or at all. If the Company is unable to raise additional funds
      when needed, it may not be able to continue to market its products as planned
      or
      continue development and obtain regulatory approval of its future products.
      If
      the Company raises additional funds through equity sales, these sales may be
      dilutive to existing investors.


18





*Long-Term
      Debt and Capital Lease Agreements*





IsoRay
      had two loan facilities in place as of March 31, 2008. The first loan is from
      the Benton-Franklin Economic Development District (BFEDD) in an original
      principal amount of $230,000 and was funded in December 2004. It bears interest
      at eight percent and has a sixty month term with a final balloon payment. As
      of
      March 31, 2008, the principal balance owed was $149,433. This loan is secured
      by
      certain equipment, materials and inventory of the Company, and also required
      personal guarantees, for which the guarantors were issued approximately 70,455
      shares of common stock. The second loan is from the Hanford Area Economic
      Investment Fund Committee (HAEIFC) and was originated in June 2006. The loan
      originally had a total facility of $1,400,000 which was reduced in September
      2007 to the amount of the Company’s initial draw of $418,670. The loan bears
      interest at nine percent and the principal balance owed as of March 31, 2008
      was
      $309,612. This loan is secured by receivables, equipment, materials and
      inventory, and certain life insurance policies and also required personal
      guarantees.





The
      Company has certain capital leases for production and office equipment that
      expire at various times from March 2008 to April 2009. These leases currently
      call for total monthly payments of $19,361. The total of all capital lease
      obligations at March 31, 2008 was $64,813.





*Other
      Commitments and Contingencies*





On
      October 12, 2007, the Company entered into Amendment No. 1 (the Amendment)
      to
      its License Agreement dated February 2, 2006 with IBt. The original License
      Agreement provided the Company with access to IBt’s proprietary polymer based
      seed encapsulation technology for use in brachytherapy procedures using
      Cesium-131 in the United States for a fifteen year term. A payment of $225,000
      was made on October 12, 2007 pursuant to the Amendment. As the parties agreed
      that the ink jet technology was not viable for Cesium-131 seeds, the Amendment
      eliminated the previously required royalty payments based on net sales revenue,
      and the parties intend to negotiate terms for future payments by the Company
      for
      polymer seed components to be purchased from IBt at IBt's cost plus a
      to-be-determined profit percentage. No agreement has been reached on these
      terms
      and there is no assurance that the parties will consummate an agreement pursuant
      to such terms.





The
      Company is subject to various local, state, and federal environmental
      regulations and laws due to the isotopes used to produce the Company’s product.
      As part of normal operations, amounts are expended to ensure that the Company
      is
      in compliance with these laws and regulations. While there have been no
      reportable incidents or compliance issues, the Company incurred certain
      decommissioning expenses as part of vacating its old production facility. The
      Company has asset retirement obligations which represent the discounted cost
      of
      cleanup that the Company anticipates it will incur at the end of its equipment
      and property leases. This amount was determined based on discussions with
      qualified production personnel and on historical evidence. During the quarter
      ended December 31, 2007, the Company incurred $274,163 of expenses to complete
      the decommissioning of its old production facility. These expenses were offset
      by the asset retirement obligation of $135,120 resulting in a net expense of
      $139,043 that was recorded in cost of products sales. Another asset retirement
      obligation of $473,096 was established in the first quarter of fiscal year
      2008
      representing obligations at its new production facility. This new asset
      retirement obligation is for obligations to remove any residual radioactive
      materials and to remove any unwanted leasehold improvements at the end of the
      lease term.


19





The
      industry that the Company operates in is subject to product liability
      litigation. Through its production and quality assurance procedures, the Company
      works to mitigate the risk of any lawsuits concerning its product. The Company
      also carries product liability insurance to help protect it from this
      risk.





The
      Company has no off-balance sheet arrangements.





**New
      Accounting Standards**





In
      September 2006, the FASB issued statement SFAS No. 157, *Fair
      Value Measurements* .
      SFAS No. 157 defines fair value, establishes a framework for measuring fair
      value in accordance with accounting principles generally accepted in the United
      States, and expands disclosures about fair value measurements. SFAS No. 157
      is effective for fiscal years beginning after November 15, 2007, with
      earlier application encouraged. Any amounts recognized upon adoption as a
      cumulative effect adjustment will be recorded to the opening balance of retained
      earnings in the year of adoption. The Company does not believe the adoption
      of
      SFAS No. 157 will have a material effect on its consolidated financial
      statements.





In
      February 2007, the FASB issued statement SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities Including
      an
      Amendment of FASB Statement No. 115* .
      The
      statement allows entities to value financial instruments and certain other
      items
      at fair value. The statement provides guidance over the election of the fair
      value option, including the timing of the election and specific items eligible
      for the fair value accounting. Changes in fair values would be recorded in
      earnings. The statement is effective for fiscal years beginning after
      November 15, 2007. The Company does not believe the adoption of SFAS No.
      159 will have a material effect on its consolidated financial
      statements.





**ITEM
      3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





As
      a
      smaller reporting company, the Company is not required to provide Part I, Item
      3
      disclosure in this Quarterly Report.





**ITEM
      4 – CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**





Under
      the
      supervision and with the participation of our management, including our
      principal executive officer and principal financial officer, we conducted an
      evaluation of the design and operation of our disclosure controls and
      procedures, as such term is defined under Rules 13a-14(c) and 15d-14(c)
      promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
      Act"), as of March 31, 2008. Based on that evaluation, our principal executive
      officer and our principal financial officer concluded that the design and
      operation of our disclosure controls and procedures were effective in timely
      alerting them to material information required to be included in the Company's
      periodic reports filed with the SEC under the Exchange Act. The design of any
      system of controls is based in part upon certain assumptions about the
      likelihood of future events, and there can be no assurance that any design
      will
      succeed in achieving its stated goals under all potential future conditions,
      regardless of how remote. However, management believes that our system of
      disclosure controls and procedures is designed to provide a reasonable level
      of
      assurance that the objectives of the system will be met.


20


**Changes
      in Internal Control over Financial Reporting**





There
      have not been any changes in our internal control over financial reporting
      (as
      such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
      during the most recent fiscal quarter 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**





Except
      as
      set forth below, there have been no material changes to the risk factors
      disclosed in the “Risk Factors” section of our Annual Report on Form 10-KSB for
      the year ended June 30, 2007.





*We
      Rely Heavily On A Limited Number Of Suppliers.* Some
      materials used in our products are currently available only from a limited
      number of suppliers. Approximately (50%) of our cesium was supplied by two
      suppliers located in Russia, with the remaining fifty percent (50%) being
      supplied by a single U.S. supplier, during the quarter ended March 31, 2008.
      In
      certain prior quarters, nearly eighty percent (80%) of our cesium was supplied
      by a single Russian supplier, but the Company has begun taking steps to reduce
      its reliance on a single source for cesium.





With
      the
      development of barium enrichment capabilities, the Company plans to expand
      Cs-131 manufacturing capability at the MURR reactor in the United States. This
      strategy may increase the risk associated with concentrating isotope production
      at a single reactor facility unless the Company can continue to obtain cesium
      from multiple suppliers. Failure to obtain deliveries of cesium from multiple
      sources could have a material adverse effect on seed production and there may
      be
      a delay before we could locate alternative suppliers beyond the three currently
      used.





We
      may
      not be able to locate additional suppliers outside of Russia capable of
      producing the level of output of cesium at the quality standards we require.
      Additional factors that could cause interruptions or delays in our source of
      materials include limitations on the availability of raw materials or
      manufacturing performance experienced by our suppliers and a breakdown in our
      commercial relations with one or more suppliers. Some of these factors may
      be
      completely out of our and our suppliers’ control.





Virtually
      all titanium tubing used in brachytherapy seed manufacture comes from a single
      source, Accellant Corporation. We currently obtain a key component of our seed
      core from a single supplier. We do not have formal written agreements with
      either this key supplier or with Accellant Corporation. Any interruption or
      delay in the supply of materials required to produce our products could harm
      our
      business if we were unable to obtain an alternative supplier or substitute
      equivalent materials in a cost-effective and timely manner. To mitigate any
      potential interruptions, the Company continually evaluates its inventory levels
      and management believes that the Company maintains a sufficient quantity on
      hand
      to alleviate any potential disruptions.





**ITEM
      4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





On
      February 20, 2008, the Company held its Annual Meeting of Shareholders at which
      our shareholders elected six Directors, voted on the 2008 Employee Stock Option
      Plan, and ratified the appointment of our independent registered public
      accounting firm for the fiscal year ending June 30, 2008.




(a)
            *Election
                of Directors.*All nominees for election as Directors were unopposed and elected
                as
                follows:




21


**Director**
            
            **For**
            
            **Withhold**Dwight
                Babcock
            
            
            14,449,758
            
            
            2,726,725Roger
                E. Girard
            
            
            15,552,855
            
            
            1,623,628Robert
                R. Kauffman
            
            
            14,312,149
            
            
            2,864,334Thomas
                C. LaVoy
            
            
            14,554,589
            
            
            2,621,894Albert
                Smith
            
            
            14,554,589
            
            
            2,621,894David
                J. Swanberg
            
            
            15,816,620
            
            
            1,359,863





(b)
            *IsoRay,
                Inc. 2008 Employee Stock Option Plan.*Shareholder
                approval was not obtained due to a lack of shareholder votes for
                the 2008
                Plan at the Company’s annual meeting held on February 20, 2008, and thus
                no grants have been or will be made under the 2008 Option Plan. The
                voting
                totals were as follows:





**For**
            
            **Against**
            
            **Abstain**
            
            **Non-votes**6,787,570
            
            
            3,288,004
            
            
            393,202
            
            
            167,601





(c)
            *Appointment
                of our independent registered public accounting firm.*Proposal to ratify the appointment of DeCoria, Maichel & Teague, P.S.
                as independent registered public accounting firm of the Company for
                the
                fiscal year ending June 30, 2008 was approved as
                follows:





**For**
            
            **Against**
            
            **Abstain**16,483,868
            
            
            525,014
            
            
            167,601





**ITEM
      6 – EXHIBITS AND REPORTS ON FORM 8-K**




(a)
            Exhibits:




31.1
            Rule
                13a-14(a)/15d-14(a) Certification of Principal Executive
                Officer31.2
            Rule
                13a-14(a)/15d-14(a) Certification of Principal Financial
                Officer32
            Section
                1350 Certifications





(b)
            Reports
                on Form 8-K:





On
      January 14, 2008, the Company filed a Current Report on Form 8-K announcing
      certain amendments to its Bylaws and the decision by a director not to stand
      for
      re-election at the February 20, 2008 annual meeting of
      shareholders.





On
      February 11, 2008, the Company filed a Current Report on Form 8-K announcing
      its
      financial results for the second quarter of fiscal year 2008.





On
      February 27, 2008, the Company filed a Current Report on Form 8-K announcing
      the
      resignation of Roger Girard, Chairman, President, and CEO of the Company, from
      all positions held with the Company and its subsidiaries, the appointment of
      Dwight Babcock as interim CEO and as Chairman, and the appointment of Lori
      Woods
      as Chief Operating Officer.


22


SIGNATURES





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.





Dated:
      May 13, 2008





ISORAY,
                INC., a Minnesota corporationBy
            /s/ Dwight
                BabcockDwight
                Babcock, Interim Chief Executive OfficerBy
            /s/ Jonathan
                R. HuntJonathan
                R. Hunt, Chief Financial
                Officer


23