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 December 31, 2007





or





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




For
      the
      transition period from __________ to ____________





Commission
      File 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)
                375-1202Indicate
                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 xNo
                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 oAccelerated filer oNon-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 oNo
                xNumber
                of shares outstanding of each of the issuer's classes of common equity
                as
                of the latest practicable date:Class
            
            Outstanding
                as of February 4, 2007Common
                stock, $0.001 par value
            
            23,090,200









**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
              
              11Item
                  3
              
              Quantitative
                  and Qualitative Disclosures About Market Risk
              
              18Item
                  4
              
              Controls
                  and Procedures
              
              19PART
                  II
              
              OTHER
                  INFORMATIONItem
                  1A
              
              Risk
                  Factors
              
              19Item
                  6
              
              Exhibits
                  and Reports on Form 8-K
              
              19Signatures
              
              
              
              20









**PART
      I - FINANCIAL INFORMATION**




**IsoRay,
        Inc. and Subsidiary**
 **Consolidated
          Balance Sheets**


**December
                  31,**
              
              **June
                  30,****2007**
              
              **2007****(****Unaudited)****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              3,476,679
              
              $
              9,355,730Short-term
                  investments
              
              
              8,680,137
              
              
              9,942,840Accounts
                  receivable, net of allowance for doubtful accountsof
                  $48,479 and $99,789, respectively
              
              
              829,918
              
              
              1,092,925Inventory
              
              
              995,233
              
              
              880,834Prepaid
                  expenses
              
              
              442,993
              
              
              458,123Total
                  current assets
              
              
              14,424,960
              
              
              21,730,452Fixed
                  assets, net of accumulated depreciation
              
              
              6,521,545
              
              
              3,665,551Deferred
                  financing costs, net of accumulated amortization
              
              
              80,473
              
              
              95,725Licenses,
                  net of accumulated amortization
              
              
              467,457
              
              
              262,074Restricted
                  cash
              
              
              172,500
              
              
              -Other
                  assets, net of accumulated amortization
              
              
              328,421
              
              
              322,360Total
                  assets
              
              $
              21,995,356
              
              $
              26,076,162**LIABILITIES
                  AND SHAREHOLDERS' EQUITY**Current
                  liabilities:Accounts
                  payable and accrued expenses
              
              $
              1,183,082
              
              $
              1,946,042Accrued
                  payroll and related taxes
              
              
              508,960
              
              
              459,068Accrued
                  interest payable
              
              
              1,695
              
              
              1,938Deferred
                  revenue
              
              
              -
              
              
              23,874Notes
                  payable, due within one year
              
              
              47,189
              
              
              49,212Capital
                  lease obligations, due within one year
              
              
              109,484
              
              
              194,855Asset
                  retirement obligation, current portion
              
              
              -
              
              
              131,142Total
                  current liabilities
              
              
              1,850,410
              
              
              2,806,131Notes
                  payable, due after one year
              
              
              504,444
              
              
              528,246Capital
                  lease obligations, due after one year
              
              
              8,774
              
              
              25,560Asset
                  retirement obligation
              
              
              483,821
              
              
              -Total
                  liabilities
              
              
              2,847,449
              
              
              3,359,937Commitments
                  and contingencies (see Note 9)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
              
              
              47,221,918
              
              
              45,844,793Accumulated
                  deficit
              
              
              (28,097,160
              )
              
              (23,151,416
              )Total
                  shareholders' equity
              
              
              19,147,907
              
              
              22,716,225Total
                  liabilities and shareholders' equity
              
              $
              21,995,356
              
              $
              26,076,162


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




1





**IsoRay,
      Inc. and Subsidiary** **Consolidated
        Statements of Operations**
 
  **Three
                  months ended**
                **December
                  31,**
              
              **Six
                  months ended**
                **December
                  31,****2007**
              
              **2006**
              
              **2007**
              
              **2006**Product
                  sales
              
              $
              1,758,344
              
              $
              1,414,155
              
              $
              3,614,063
              
              $
              2,439,599Cost
                  of product sales
              
              
              2,241,795
              
              
              1,387,394
              
              
              4,247,297
              
              
              2,675,539Gross
                  loss
              
              
              (483,451
              )
              
              26,761
              
              
              (633,234
              )
              
              (235,940
              )Operating
                  expenses:Research
                  and development
              
              
              395,545
              
              
              216,254
              
              
              651,915
              
              
              461,852Sales
                  and marketing expenses
              
              
              1,142,827
              
              
              890,018
              
              
              2,202,643
              
              
              1,562,948General
                  and administrative expenses
              
              
              919,164
              
              
              821,529
              
              
              1,821,189
              
              
              2,554,661Total
                  operating expenses
              
              
              2,457,536
              
              
              1,927,801
              
              
              4,675,747
              
              
              4,579,461Operating
                  loss
              
              
              (2,940,987
              )
              
              (1,901,040
              )
              
              (5,308,981
              )
              
              (4,815,401
              )Non-operating
                  income (expense):Interest
                  income
              
              
              179,855
              
              
              50,004
              
              
              418,551
              
              
              90,187Financing
                  expense
              
              
              (25,211
              )
              
              (67,413
              )
              
              (55,314
              )
              
              (120,670
              )Non-operating
                  income (expense), net
              
              
              154,644
              
              
              (17,409
              )
              
              363,237
              
              
              (30,483
              )Net
                  loss
              
              $
              (2,786,343
              )
              $
              (1,918,449
              )
              $
              (4,945,744
              )
              $
              (4,845,884
              )Basic
                  and diluted loss per share
              
              $
              (0.12
              )
              $
              (0.12
              )
              $
              (0.21
              )
              $
              (0.31
              )Weighted
                  average shares used in computing net loss per share:Basic
                  and diluted
              
              
              23,072,272
              
              
              15,919,236
              
              
              23,036,657
              
              
              15,609,992


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




2


**IsoRay,
        Inc. and Subsidiary**
 **Consolidated
        Statements of Cash Flows**
 **(Unaudited)**
  **Six
                  months ended December 31,****2007**
              
              **2006****CASH
                  FLOWS FROM OPERATING ACTIVITIES:**Net
                  loss
              
              $
              (4,945,744
              )
              $
              (4,845,884
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation
                  and amortization of fixed assets
              
              
              586,866
              
              
              184,510Amortization
                  of deferred financing costs and other assets
              
              
              90,541
              
              
              69,580Amortization
                  of discount on short-term investments
              
              
              (119,149
              )
              
              -Loss
                  on settlement of ARO liability (Note 7)
              
              
              (135,120
              )Accretion
                  of asset retirement obligation
              
              
              14,703
              
              
              3,091Noncash
                  share-based compensation
              
              
              354,613
              
              
              897,887Changes
                  in operating assets and liabilities:Accounts
                  receivable, net
              
              
              263,007
              
              
              (385,554
              )Inventory
              
              
              (114,399
              )
              
              (68,518
              )Prepaid
                  expenses
              
              
              15,130
              
              
              (51,060
              )Accounts
                  payable and accrued expenses
              
              
              (762,960
              )
              
              258,288Accrued
                  payroll and related taxes
              
              
              49,892
              
              
              154,338Accrued
                  interest payable
              
              
              (243
              )
              
              (780
              )Deferred
                  revenue
              
              
              (23,874
              )
              
              -Net
                  cash used by operating activities
              
              
              (4,726,737
              )
              
              (3,784,102
              )**CASH
                  FLOWS FROM INVESTING ACTIVITIES:**Purchases
                  of fixed assets
              
              
              (2,969,764
              )
              
              (487,456
              )Additions
                  to licenses and other assets
              
              
              (286,733
              )
              
              (27,657
              )Change
                  in restricted cash
              
              
              (172,500
              )
              
              -Purchases
                  of short-term investments
              
              
              (10,593,828
              )
              
              -Proceeds
                  from the sale or maturity of short-term investments
              
              
              11,975,680
              
              
              -Net
                  cash used by investing activities
              
              
              (2,047,145
              )
              
              (515,113
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Principal
                  payments on notes payable
              
              
              (25,825
              )
              
              (33,745
              )Principal
                  payments on capital lease obligations
              
              
              (102,157
              )
              
              (88,484
              )Proceeds
                  from cash sales of common shares pursuant to private placement,
                  net of
                  offering costs
              
              
              -
              
              
              4,702,931Proceeds
                  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
              
              
              611,997Proceeds
                  from cash sales of common stock, pursuant to exercise of
                  options
              
              
              11,900
              
              
              590,463Net
                  cash provided by financing activities
              
              
              894,831
              
              
              5,791,871Net
                  (decrease) increase in cash and cash equivalents
              
              
              (5,879,051
              )
              
              1,492,656Cash
                  and cash equivalents, beginning of period
              
              
              9,355,730
              
              
              2,207,452**CASH
                  AND CASH EQUIVALENTS, END OF PERIOD**
              
              $
              3,476,679
              
              $
              3,700,108Non-cash
                  investing and financing activities:Increase
                  in fixed assets related to asset retirement obligation
              
              $
              473,096
              
              $
              -Cashless
                  exercise of common stock options
              
              
              -
              
              
              50,000


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 six-month periods ended December 31, 2007 and
      2006**





**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 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 is subject to examination of its 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
      six
      months ended December 31, 2007 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 Statement
      of Financial Accounting Standard (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 and
      common stock issuable upon the conversion of notes payable, are excluded from
      the calculations when their effect is antidilutive. At December 31, 2007 and
      2006, 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 December 31, 2007 and 2006 are as
      follows:


December
                  31,2007
              
              2006Preferred
                  stock
              
              
              59,065
              
              
              77,080Preferred
                  stock warrants
              
              
              -
              
              
              28,614Common
                  stock warrants
              
              
              3,255,774
              
              
              4,707,131Common
                  stock options
              
              
              3,210,981
              
              
              3,184,639Convertible
                  debentures
              
              
              -
              
              
              109,639Total
                  potential dilutive securities
              
              
              6,525,820
              
              
              8,107,103




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





The
      Company’s short-term investments are classified as available-for-sale and
      recorded at fair market value. As of December 31, 2007 and June 30, 2007, the
      amortized cost of the Company’s short-term investments equaled their fair market
      value. Accordingly, there were no unrealized gains or losses as of December
      31,
      2007 or June 30, 2007.





The
      Company’s short-term investments consisted of the following at December 31, 2007
      and June 30, 2007:


December
                  31,
              
              June
                  30,2007
              
              2007Municipal
                  debt securities
              
              $
              4,000,000
              
              $
              3,000,000Corporate
                  debt securities
              
              
              4,680,137
              
              
              6,942,840$
              8,680,137
              
              $
              9,942,840




**5.**  **Inventory**





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


December
                  31,
              
              June
                  30,2007
              
              2007Raw
                  materials
              
              $
              732,516
              
              $
              682,327Work
                  in process
              
              
              214,757
              
              
              120,242Finished
                  goods
              
              
              47,960
              
              
              78,265$
              995,233
              
              $
              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 established 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.
      These
      funds are to be used to settle the Company’s remaining asset retirement
      obligations (Note 7).




5




**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.





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 six month periods ended December 31, 2007 and 2006, the asset retirement
      obligation changed as follows:


Six
                  months ended December 31,2007
              
              2006Beginning
                  balance
              
              $
              131,142
              
              $
              67,425New
                  obligations
              
              
              473,096
              
              
              -Settlement
                  of existing obligation
              
              
              (135,120
              )
              
              -Accretion
                  of discount
              
              
              14,703
              
              
              3,091Ending
                  balance
              
              $
              483,821
              
              $
              70,516




**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 six months ended December 31, 2007 and 2006:


Three
                  months
              
              Six
                  monthsended
                  December 31,
              
              ended
                  December 31,2007
              
              2006
              
              2007
              
              2006Cost
                  of product sales
              
              $
              36,827
              
              $
              20,492
              
              $
              73,830
              
              $
              71,325Research
                  and development
              
              
              11,550
              
              
              7,879
              
              
              23,100
              
              
              19,714Sales
                  and marketing expenses
              
              
              59,557
              
              
              52,456
              
              
              119,114
              
              
              99,237General
                  and administrative expenses
              
              
              59,072
              
              
              35,617
              
              
              138,569
              
              
              707,611Total
                  share-based compensation
              
              $
              167,006
              
              $
              116,444
              
              $
              354,613
              
              $
              897,887




6




As
      of
      December 31, 2007, total unrecognized compensation expense related to
      stock-based options was $1,229,517 and the related weighted-average period
      over
      which it is expected to be recognized is approximately 1.02 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 six months ended December 31, 2007 is as follows:


WeightedWeighted
              
              AverageAverage
              
              Remaining
              
              AggregateNumber
                  of
              
              Exercise
              
              Contractual
              
              IntrinsicOptions
              
              Price
              
              Term
              
              ValueOutstanding
                  at December 31, 2007
              
              
              3,210,981
              
              $
              2.68
              
              
              8.04
              
              $
              863,361Vested
                  and expected to vest atDecember
                  31, 2007
              
              
              3,171,547
              
              $
              2.66
              
              
              8.04
              
              $
              863,361Vested
                  and exercisable atDecember
                  31, 2007
              
              
              2,463,800
              
              $
              2.28
              
              
              7.77
              
              $
              863,361




The
      aggregate intrinsic value of options exercised during the six months ended
      December 31, 2007 and 2006 was $25,300 and $1,557,600, respectively. The
      Company’s current policy is to issue new shares to satisfy option
      exercises.





During
      the three and six months ended December 31, 2007, 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
              
              Six
                  monthsended
                  December 31,
              
              ended
                  December 31,2007
              
              2006
              
              2007
              
              2006Weighted
                  average fair value of options granted
              
              $
              -
              
              $
              2.14
              
              $
              -
              
              $
              2.11Key
                  assumptions used in determining fair value:Weighted
                  average risk-free interest rate
              
              
              -
              %
              
              4.74
              %
              
              -
              %
              
              4.88
              %Weighted
                  average life of the option (in years)
              
              
              -
              
              
              6.00
              
              
              -
              
              
              5.58Weighted
                  average historical stock price volatility
              
              
              -
              %
              
              75.00
              %
              
              -
              %
              
              75.00
              %Expected
                  dividend yield
              
              
              -
              %
              
              0.00
              %
              
              -
              %
              
              0.00
              %




7




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.**  **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 February 11, 2008,
      the parties remain in negotiations to reach a mutually agreeable 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.




8




**10.**  **Subsequent
      Events**





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.





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, to be held on February 20, 2008, and that he will
      cease
      serving as a director of the Company 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.




9





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.





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 allows 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. The 2008 Option Plan is on the Company’s proxy ballot
      to be voted on by shareholders at the annual meeting to be held on February
      20,
      2008.





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 newly formed subsidiary, IsoRay International LLC. UNONA
      Holdings, a private holding company, will have a 40% ownership interest and
      a
      30% ownership interest will be 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.


10




**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 under “Risk Factors” beginning on page 19 below and in the “Risk
      Factors” section of our Form 10-KSB for the fiscal year ended June 30, 2007 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 December 31, 2007, there have been no
      material changes to any of the critical accounting policies contained
      therein.




11





**Results
      of Operations**




**Three
      months ended December 31, 2007 compared to three months ended December 31,
      2006**





**Product
      sales.** The
      Company generated sales of $1,758,344 during the three months ended December
      31,
      2007, compared to sales of $1,414,155 for the three months ended December 31,
      2006. The increase of $344,189 or 24% is due to increased sales volume of the
      Company’s Proxcelan Cs-131 brachytherapy seeds. During the three months ended
      December 31, 2007, the Company sold its Proxcelan seeds to 53 different medical
      centers as compared to 33 medical centers during the corresponding period of
      2006.





**Cost
      of product sales.** Cost of
      product sales was $2,241,795 for the three months ended December 31, 2007
      compared to cost of product sales of $1,387,394 during the three months ended
      December 31, 2006. The major components of the increase of $854,401 or 62%
      were
      depreciation, materials, occupancy costs, personnel costs, and preload expenses.
      Depreciation expenses increased approximately $287,000 due to the depreciation
      on the new production facility and new equipment. Materials increased
      approximately $229,000 mainly due to ordering and using more isotope in the
      three months ended December 31, 2007 compared to the corresponding period of
      2006 and a higher unit price from our primary isotope supplier in 2007 compared
      to 2006. 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. Occupancy costs increased
      approximately $52,000 due to the higher rent on our new production facility
      and
      due to continued rent payments on the old facility through the middle of
      December 2007 as the Company completed its decommissioning. Personnel costs,
      including payroll, benefits, and related taxes, increased approximately $58,000
      as the number of production personnel increased. Preload expenses increased
      by
      approximately $50,000 due to the higher volume of sales and due to continued
      start-up costs of the Company’s internal preload facility. In January 2008, the
      Company’s internal preload facility began shipping preloaded strands on a
      limited basis.





During
      the quarter ended December 31, 2007, 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.





**Gross
      loss / margin.** Gross
      loss was $483,451 for the three month period ended December 31, 2007. This
      represents a decrease in the Company’s gross profit margin of $510,212 or 1,907%
      over the corresponding period of 2006’s gross margin of $26,761. The increase in
      gross loss is due to the Company’s higher revenues being more than offset by
      higher production costs and the costs of decommissioning the old production
      facility.





**Research
      and development expenses.** Research
      and development expenses for the three month period ended December 31, 2007
      were
      $395,545 which represents an increase of $179,291 or 83% over research and
      development expenses of $216,254 for the three month period ended December
      31,
      2006. The increase is due to higher personnel, protocol, consulting, and other
      miscellaneous expenses. Personnel costs, including payroll, benefits, and
      related taxes, increased approximately $29,000 due to higher salaries to
      research and development personnel. Protocol expenses increased approximately
      $76,000 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. Consulting expenses increased approximately $58,000 which
      is
      mainly due to the Company’s ongoing project to increase the efficiency of
      isotope production. Various miscellaneous expenses increased by approximately
      $29,000.




12





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $1,142,827 for the three months ended December
      31,
      2006. This represents an increase of $252,809 or 28% compared to expenditures
      in
      the three months ended December 31, 2006 of $890,018 for sales and marketing.
      Personnel expenses, including payroll, benefits, and related taxes, increased
      approximately $209,000 due to higher commissions paid due to higher revenues
      and
      an increase in sales force. Travel expenses increased approximately $38,000
      due
      to the increase in sales force. Consulting expenses increased approximately
      $37,000 mainly due to payments to consultants to develop technical publications
      and other materials, to represent the Company at professional society meetings,
      and to serve as members of the Company’s Cesium Advisory Group. The latter is a
      new advisory group comprised of radiation oncologists and physicists that met
      for the first time in December 2007. The purchase of market research reports
      and
      the purchase of subscriptions for US medical residents and development of new
      brochures and other marketing aids increased expenses by approximately $49,000.
      These increases were partially offset by decreases of approximately $49,000
      in
      convention and tradeshow expenses and $31,000 in hiring costs.





**General
      and administrative expenses.** General
      and administrative expenses for the three months ended December 31, 2007 were
      $919,164 compared to general and administrative expenses of $821,529 for the
      corresponding period of 2006. The increase of $97,635 or 12% is mainly due
      to
      increased legal, share-based compensation, and personnel expenses partially
      offset by decreased travel expenses. Legal expenses increased by approximately
      $79,000 due to costs incurred for contract drafting and review of the Company’s
      interest in the new Russian entity and the IBt strategic global alliance
      agreements and for mediation costs with the Lawrence Family Trust. Without
      these
      fees, legal expenses would have decreased by approximately $42,000. Share-based
      compensation increased approximately $23,000 as a result of additional grants
      of
      stock options that occurred in March and June 2007. Personnel expenses,
      including payroll, benefits, and related taxes, increased approximately $20,000
      owing to a slight increase in headcount and salary increases. These increases
      were partially offset by a decrease in travel and related expenses of
      approximately $34,000.





**Operating
      loss.** Due to
      the Company’s rapid structural growth and related marketing costs and sales
      force needed to capture additional market share, an increase in production
      costs, and significant research and development expenditures, the Company has
      not been profitable and has generated operating losses since its inception.
      In
      the three months ended December 31, 2007, the Company had an operating loss
      of
      $2,940,987 which is an increase of 1,039,947 or 55% over the operating loss
      of
      $1,901,040 for the three months ended December 31, 2006.





**Interest
      income.** Interest
      income was $179,856 for the three months ended December 31, 2007. This
      represents an increase of $129,852 or 260% compared to interest income of
      $50,004 for the three months ended December 31, 2006. Interest income is mainly
      derived from excess funds held in money market accounts and invested in
      short-term investments.





**Financing
      expense.** Financing expense for the three months ended December 31, 2007 was $25,211
      or a
      decrease of $42,202 or 63% from financing expense of $67,413 for the
      corresponding period in 2006. Included in financing expense is interest expense
      of approximately $18,000 and $46,000 for the three months ended December 31,
      2007 and 2006, 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.




13





**Six
      months ended December 31, 2007 compared to six months ended December 31,
      2006**





**Product
      sales.** Sales
      for the six months ended December 31, 2007 were $3,614,063 compared to sales
      of
      $2,439,599 for the six months ended December 31, 2005. The increase of
      $1,174,464 or 48% was due to increased sales volume of the Company’s Proxcelan
      Cs-131 brachytherapy seeds. During the six months ended December 31, 2007 the
      Company sold its Cs-131 seeds to 65 different medical centers as compared to
      35
      centers during the corresponding period of 2006.





**Cost
      of product sales.** Cost of
      product sales was $4,247,297 for the six months ended December 31, 2007 which
      represents an increase of $1,571,758 or 59% compared to cost of product sales
      of
      $2,675,539 during the six months ended December 31, 2006. Materials expense
      increased approximately $523,000 mainly due to ordering and using more isotope
      in the six months ended December 31, 2007 compared to the corresponding period
      of 2006 and a higher unit price from our main supplier in 2007 compared to
      2006.
      Depreciation expense increased approximately $405,000 owing to the new
      production facility and new production equipment that was added in the past
      six
      months. Preload expenses increased approximately $188,000 due to higher sales
      volumes and due to continued start-up costs of the Company’s internal preload
      facility. Personnel expenses, including payroll, benefits, and related taxes,
      increased approximately $177,000 due to hiring of additional production
      personnel to support higher production levels. Occupancy costs increased
      approximately $95,000 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 had the following increases in cost of product sales expenditures
      that are directly related to the new facility that was opened in September
      2007.
      The Company ordered isotope for the old facility to ensure adequate supply
      based
      on sales forecasts while it prepared to transition into the new production
      facility. 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.





During
      the six months ended December 31, 2007, 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 $633,234 for the six month period ended December 31, 2007. This
      represents an increase of $397,294 or 168% over the corresponding period of
      2006’s gross loss of $235,940. The increase is due to the increase in production
      costs more than offsetting the increase in revenues.




14





**Research
      and development expenses.** Research
      and development expenses for the six months ended December 31, 2007 were
      $651,915 which represents an increase of $190,063 or 41% over the research
      and
      development expenses of $461,852 for the corresponding period of 2006. The
      major
      components of the increase were personnel, protocol, consulting, and travel
      expenses. Personnel expenses, including payroll, benefits, and related taxes,
      increased approximately $43,000 due to higher salaries for research and
      development personnel. Protocol expenses increased approximately $34,000 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. Consulting expenses increased approximately $67,000 which
      is
      mainly due to the Company’s ongoing project to increase the efficiency of
      isotope production. Travel expenses increased approximately $31,000 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.





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $2,202,643 for the six months ended December 31,
      2007. This represents an increase of $639,695 or 41% compared to expenditures
      in
      the six months ended December 31, 2006 of $1,562,948 for sales and marketing.
      Personnel expenses, including payroll, benefits, and related taxes, increased
      approximately $454,000 due to higher commissions paid due to higher revenues
      and
      an increase in average headcount. Travel expenses increased approximately
      $70,000 due to the increase in average headcount. Consulting expenses increased
      approximately $84,000, 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 $30,000
      mainly due to the purchase of market research reports and the purchase of
      subscriptions for US medical residents. Marketing and advertising increased
      approximately $88,000 as the Company created new brochures and other marketing
      aids. These increases were partially offset by a decrease of approximately
      $95,000 in convention and tradeshow expenses as the Company reduced its overall
      budget for ASTRO and the smaller tradeshows.





**General
      and administrative expenses.** General
      and administrative expenses for the six months ended December 31, 2007 were
      $1,821,189 compared to general and administrative expenses of $2,554,661 for
      the
      corresponding period of 2006. The decrease of $733,472 or 29% is primarily
      due
      to a decrease in share-based compensation of approximately $569,000 and a
      one-time severance accrual of $288,000 in the corresponding period of 2006.
      Travel expenses also decreased approximately $66,000. These decreases were
      partially offset by increases in legal expenses and public company expenses.
      Legal expenses increased by approximately $64,000 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 $146,000. Public company expenses increased
      approximately $89,000 owing to the new director compensation plan instituted
      in
      fiscal year 2008.





**Operating
      loss.** Due to
      the Company’s rapid structural growth and related need to capture additional
      market share, the hiring of additional sales and marketing personnel, product
      revenues not covering production costs, and significant research and development
      expenditures, the Company has not been profitable and has generated operating
      losses since its inception. In the six months ended December 31, 2007, the
      Company had an operating loss of $5,308,981 which is an increase of $493,580
      or
      10% over the operating loss of $4,815,401 for the six months ended December
      31,
      2006.




15





**Interest
      income.** Interest
      income was $418,551 for the six months ended December 31, 2007. This represents
      an increase of $328,364 or 364% compared to interest income of $90,187 for
      the
      three months ended December 31, 2007. Interest income is mainly derived from
      excess funds held in money market accounts and invested in short-term
      investments.





**Financing
      expense.** Financing expense for the six months ended December 31, 2007 was $55,314 or
      a
      decrease of $65,356 or 54% from financing expense of $120,670 for the
      corresponding period in 2006. Included in financing expense is interest expense
      of approximately $40,000 and $77,000 for the six months ended December 31,
      2007
      and 2006, 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 six months ended December 31, 2007, the Company’s
      primary source of cash was the exercise of common stock warrants and options
      for
      $983,000 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 $4.7 million for the six months ended December
      31,
      2007 compared to $3.8 million for the six months ended December 31, 2006. Cash
      used by operating activities is net loss adjusted for non-cash items and changes
      in operating assets and liabilities. The increase in cash usage is mainly due
      to
      an increase in operating assets and liabilities related to a large decrease
      in
      accounts payable and accrued expenses. This is due to a payment in July 2007
      for
      enriched barium that was included in the Company’s June 2007 accounts payable
      balance.





*Cash
      flows from investing activities*





Cash
      used
      in investing activities was approximately $1.9 million and $515,000 for the
      six
      months ended December 31, 2007 and 2006, respectively. Cash expenditures for
      fixed assets were approximately $3.0 million and $487,000 during the six months
      ended December 31, 2007 and 2006, respectively. The large increase is mainly
      due
      to construction of our new facility and equipment purchases for the new
      facility. This was partially offset by net proceeds of approximately $1.4
      million from the sale of short-term securities.





*Cash
      flows from financing activities*





During
      the six months ended December 31, 2007, 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
      December 31, 2007, cash and cash equivalents amounted to $3,649,179 and
      short-term investments amounted to $8,680,137 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 $3.6 million of cash and $7.6 million of short-term
      investments as of February 4, 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 six months ended
      December 31, 2007 but this was mainly due to the additional expenditures
      necessary to make the new facility operational while maintaining operations
      at
      the previous facility.




16





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. 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.
      As
      the sales for the quarter ended December 31, 2007 declined, the Company is
      now
      focusing on reducing its production costs and making its sales force more
      efficient.





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.





*Long-Term
      Debt and Capital Lease Agreements*





IsoRay
      had two loan facilities in place as of December 31, 2007. 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
      December 31, 2007, the principal balance owed was $174,491. 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 (see Note 9). The
      loan bears interest at nine percent and the principal balance owed as of
      December 31, 2007 was $377,142. 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 December 31, 2007 was $118,258.





*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.




17





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.





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 No. 157, *Fair
      Value Measurements* ,
      (SFAS 157). SFAS 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 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 157 will have a material effect on its consolidated financial
      statements.





In
      February 2007, the FASB issued statement No. 159, *The
      Fair Value Option for Financial Assets and Financial Liabilities Including
      an
      Amendment of FASB Statement No. 115* (SFAS
      159). 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 159
      will have a material effect on its consolidated financial
      statements.





**ITEM
      3 - QUANITATIVE 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.




18





**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 December 31, 2007. 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.





**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**





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.




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




(a)  Exhibits:




31.1  Rule
      13a-14(a)/15d-14(a) Certification of Principal Executive Officer





31.2  Rule
      13a-14(a)/15d-14(a) Certification of Principal Financial Officer





32  Section
      1350 Certifications





(b)  Reports
      on Form 8-K:





On
      October 16, 2007, the Company filed a Current Report on Form 8-K announcing
      its
      entry into a Lease Agreement for its prior production facility.





On
      October 17, 2007, the Company filed a Current Report on Form 8-K announcing
      its
      subsidiary's entry into Amendment No. 1 to its License Agreement with
      International Brachytherapy, SA.





On
      November 8, 2007, the Company filed a Current Report on Form 8-K announcing
      its
      financial results for the first quarter of fiscal 2008.





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.


19




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:
                February 11, 2008ISORAY,
                INC., a Minnesota corporationBy
            /s/ Roger
                E. GirardRoger
                E. Girard, Chief Executive Officer


By
            /s/ Jonathan
                R. HuntJonathan
                R. Hunt, Chief Financial Officer




20