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, 2010




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





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





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period 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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or such shorter period that the
registrant was required to submit and post such files).


Yes x     No
 ̈





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 February 8, 2011Common
      stock, $0.001 par value
            
            25,816,476





ISORAY,
INC.





Table
of Contents





PART
      I
                  FINANCIAL
      INFORMATIONItem
      1
                  Consolidated
      Unaudited Financial Statements
                  1Consolidated
      Balance Sheets (Unaudited)
                  1Consolidated
      Statements of Operations (Unaudited)
                  2Consolidated
      Statements of Cash Flows (Unaudited)
                  3Notes
      to Unaudited Consolidated Financial Statements
                  4Item
      2
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  10Item
      3
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  23Item
      4
                  Controls
      and Procedures
                  23PART
      II
                  OTHER
      INFORMATIONItem
      1A
                  Risk
      Factors
                  23Item
      2
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  27Item
      6
                  Exhibits
                  30Signatures
                  
                  31





PART
I – FINANCIAL INFORMATION





IsoRay,
Inc. and Subsidiaries


Consolidated
Balance Sheets





(Unaudited)December 31,
                                
                                
                                June 30,2010
                                
                                
                                2010ASSETSCurrent
      assets:Cash
      and cash equivalents
                                
                                $
                                2,770,366
                                
                                
                                $
                                1,678,869Accounts
      receivable, net of allowance for doubtful accountsof
      $32,153 and $36,390, respectively
                                
                                
                                1,008,779
                                
                                
                                
                                896,266Inventory
                                
                                
                                775,167
                                
                                
                                
                                681,677Prepaid
      expenses and other current assets
                                
                                
                                245,613
                                
                                
                                
                                259,975Total
      current assets
                                
                                
                                4,799,925
                                
                                
                                
                                3,516,787Fixed
      assets, net of accumulated depreciation and amortization
                                
                                
                                3,546,219
                                
                                
                                
                                3,959,983Deferred
      financing costs, net of accumulated amortization
                                
                                
                                156,144
                                
                                
                                
                                13,277Restricted
      cash
                                
                                
                                180,556
                                
                                
                                
                                180,154Other
      assets, net of accumulated amortization
                                
                                
                                275,206
                                
                                
                                
                                272,594Total
      assets
                                
                                $
                                8,958,050
                                
                                
                                $
                                7,942,795LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
                                
                                $
                                454,715
                                
                                
                                $
                                404,401Accrued
      protocol expense
                                
                                
                                69,528
                                
                                
                                
                                242,029Accrued
      radioactive waste disposal
                                
                                
                                84,060
                                
                                
                                
                                60,060Accrued
      payroll and related taxes
                                
                                
                                135,675
                                
                                
                                
                                186,513Acccued
      vacation
                                
                                
                                71,172
                                
                                
                                
                                68,525Notes
      payable, due within one year
                                
                                
                                52,985
                                
                                
                                
                                49,445Total
      current liabilities
                                
                                
                                868,135
                                
                                
                                
                                1,010,973Notes
      payable, due after one year
                                
                                
                                101,677
                                
                                
                                
                                130,550Warrant
      liabilities
                                
                                
                                1,304,000
                                
                                
                                
                                -Asset
      retirement obligation
                                
                                
                                633,149
                                
                                
                                
                                605,391Total
      liabilities
                                
                                
                                2,906,961
                                
                                
                                
                                1,746,914Commitments
      and contingencies (Note 6)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;25,829,325
      and 23,048,754 shares issued and outstanding
                                
                                
                                25,829
                                
                                
                                
                                23,049Treasury
      stock, at cost, 13,200 shares
                                
                                
                                (8,390
                                )
                                
                                
                                (8,390
                                )Additional
      paid-in capital
                                
                                
                                49,037,162
                                
                                
                                
                                48,084,783Accumulated
      deficit
                                
                                
                                (43,003,571
                                )
                                
                                
                                (41,903,620
                                )Total
      shareholders' equity
                                
                                
                                6,051,089
                                
                                
                                
                                6,195,881Total
      liabilities and shareholders' equity
                                
                                $
                                8,958,050
                                
                                
                                $
                                7,942,795





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




1


IsoRay,
Inc. and Subsidiaries


Consolidated
Statements of Operations


(Unaudited)





Three months ended December 31,
                      
                      
                      Six months ended December 31,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Product
      sales
                      
                      $
                      1,244,922
                      
                      
                      $
                      1,368,347
                      
                      
                      $
                      2,572,049
                      
                      
                      $
                      2,747,434Cost
      of product sales
                      
                      
                      1,117,005
                      
                      
                      
                      1,100,193
                      
                      
                      
                      2,228,532
                      
                      
                      
                      2,260,282Gross
      income
                      
                      
                      127,917
                      
                      
                      
                      268,154
                      
                      
                      
                      343,517
                      
                      
                      
                      487,152Operating
      expenses:Research
      and development expenses
                      
                      
                      15,612
                      
                      
                      
                      59,078
                      
                      
                      
                      130,133
                      
                      
                      
                      127,960Sales
      and marketing expenses
                      
                      
                      335,612
                      
                      
                      
                      603,980
                      
                      
                      
                      709,038
                      
                      
                      
                      1,046,879General
      and administrative expenses
                      
                      
                      561,208
                      
                      
                      
                      550,009
                      
                      
                      
                      1,157,341
                      
                      
                      
                      1,152,440Total
      operating expenses
                      
                      
                      912,432
                      
                      
                      
                      1,213,067
                      
                      
                      
                      1,996,512
                      
                      
                      
                      2,327,279Operating
      loss
                      
                      
                      (784,515
                      )
                      
                      
                      (944,913
                      )
                      
                      
                      (1,652,995
                      )
                      
                      
                      (1,840,127
                      )Non-operating
      income (expense):Interest
      income
                      
                      
                      979
                      
                      
                      
                      2,944
                      
                      
                      
                      2,040
                      
                      
                      
                      8,811Gain
      on fair value of warrant liability
                      
                      
                      420,000
                      
                      
                      
                      -
                      
                      
                      
                      420,000
                      
                      
                      
                      -Other
      income
                      
                      
                      149,879
                      
                      
                      
                      
                      
                      
                      
                      149,879Financing
      and interest expense
                      
                      
                      (14,412
                      )
                      
                      
                      (7,898
                      )
                      
                      
                      (18,875
                      )
                      
                      
                      (25,259
                      )Non-operating
      income (expense), net
                      
                      
                      556,446
                      
                      
                      
                      (4,954
                      )
                      
                      
                      553,044
                      
                      
                      
                      (16,448
                      )Net
      loss
                      
                      
                      (228,069
                      )
                      
                      
                      (949,867
                      )
                      
                      
                      (1,099,951
                      )
                      
                      
                      (1,856,575
                      )Preferred
      stock dividends
                      
                      
                      (2,658
                      )
                      
                      
                      (36,679
                      )
                      
                      
                      (5,316
                      )
                      
                      
                      (36,679
                      )Net
      loss applicable to common shareholders
                      
                      $
                      (230,727
                      )
                      
                      $
                      (986,546
                      )
                      
                      $
                      (1,105,267
                      )
                      
                      $
                      (1,893,254
                      )Basic
      and diluted loss per share
                      
                      $
                      (0.01
                      )
                      
                      $
                      (0.04
                      )
                      
                      $
                      (0.05
                      )
                      
                      $
                      (0.08
                      )Weighted
      average shares used in computing net loss per share:Basic
      and diluted
                      
                      
                      25,070,992
                      
                      
                      
                      22,942,088
                      
                      
                      
                      24,059,873
                      
                      
                      
                      22,942,088




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




2


IsoRay,
Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


(Unaudited)





Six months ended December 31,2010
                            
                            
                            2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                            
                            $
                            (1,099,951
                            )
                            
                            $
                            (1,856,575
                            )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization of fixed assets
                            
                            
                            446,740
                            
                            
                            
                            484,572Amortization
      of deferred financing costs and other assets
                            
                            
                            26,702
                            
                            
                            
                            29,100Gain
      on fair value of warrant liabilities
                            
                            
                            (420,000
                            )
                            
                            
                            -Accretion
      of asset retirement obligation
                            
                            
                            27,758
                            
                            
                            
                            25,378Share-based
      compensation
                            
                            
                            48,250
                            
                            
                            
                            80,477Changes
      in operating assets and liabilities:Accounts
      receivable, net
                            
                            
                            (112,513
                            )
                            
                            
                            (174,867
                            )Inventory
                            
                            
                            (93,490
                            )
                            
                            
                            35,361Prepaid
      expenses and other current assets
                            
                            
                            35,232
                            
                            
                            
                            (3,972
                            )Accounts
      payable and accrued expenses
                            
                            
                            50,314
                            
                            
                            
                            18,817Accrued
      protocol expense
                            
                            
                            (172,501
                            )
                            
                            
                            11,878Accrued
      radioactive waste disposal
                            
                            
                            24,000
                            
                            
                            
                            (23,940
                            )Accrued
      payroll and related taxes
                            
                            
                            (50,838
                            )
                            
                            
                            16,552Accrued
      vacation
                            
                            
                            2,647
                            
                            
                            
                            (17,702
                            )Net
      cash used by operating activities
                            
                            
                            (1,287,650
                            )
                            
                            
                            (1,374,921
                            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of fixed assets
                            
                            
                            (32,976
                            )
                            
                            
                            (18,000
                            )Change
      in restricted cash
                            
                            
                            (402
                            )
                            
                            
                            (1,049
                            )Proceeds
      from the sale or maturity of short-term investments
                            
                            
                            -
                            
                            
                            
                            1,679,820Net
      cash  provided (used) by investing activities
                            
                            
                            (33,378
                            )
                            
                            
                            1,660,771CASH
      FLOWS FROM FINANCING ACTIVITIES:Principal
      payments on notes payable
                            
                            
                            (25,333
                            )
                            
                            
                            (134,331
                            )Preferred
      dividends paid
                            
                            
                            (10,632
                            )
                            
                            
                            (36,679
                            )Proceeds
      from sales of common stock and warrants, net of offering
    costspursuant
      to registered public offering
                            
                            
                            1,998,040
                            
                            
                            
                            -Proceeds
      from sales of common stock, net of offering costspursuant
      to at the market offering
                            
                            
                            250,632
                            
                            
                            
                            -Proceeds
      from sales of common stock, pursuant to exercise of
    warrants
                            
                            
                            199,818
                            
                            
                            
                            -Net
      cash used by financing activities
                            
                            
                            2,412,525
                            
                            
                            
                            (171,010
                            )Net
      increase (decrease) in cash and cash equivalents
                            
                            
                            1,091,497
                            
                            
                            
                            114,840Cash
      and cash equivalents, beginning of period
                            
                            
                            1,678,869
                            
                            
                            
                            2,990,744CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                            
                            $
                            2,770,366
                            
                            
                            $
                            3,105,584Supplemental
      disclosures of cash flow information:Non-cash
      investing and financing activities:Initial
      measurement of warrant liabilities
                            
                            $
                            1,724,000
                            
                            
                            $
                            -




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


3




IsoRay,
Inc.


Notes
to the Unaudited Consolidated Financial Statements


For
the three and six months ended December 31, 2010 and 2009





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-K
for the fiscal year ended June 30, 2010.  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-K for the fiscal
year ended June 30, 2010.





Certain
amounts in the prior-year financial statements have been reclassified to conform
to the current year presentation.





2.           New
Accounting Pronouncements





From time
to time, new accounting pronouncements are issued by the Financial Accounting
Standards Board (the “FASB”) or other standards setting bodies that are adopted
by us as of the specified effective dates.  Unless otherwise
discussed, we believe the impact of recently issued standards that are not yet
effective will not have a material impact on our consolidated financial
position, results of operations and cash flows upon adoption.





3.           Loss
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 and options
to purchase the Company's common stock, are excluded from the calculations when
their effect is antidilutive.  At December 31, 2010 and 2009, the
calculation of diluted weighted average shares did not include preferred stock,
common stock warrants, or options that are potentially convertible into common
stock as those would be antidilutive due to the Company’s net loss
position.





Securities
not considered in the calculation of diluted weighted average shares, but that
could be dilutive in the future as of December 31, 2010 and 2009, were as
follows:





December
      31,2010
                  
                  
                  2009Preferred
      stock
                  
                  
                  59,065
                  
                  
                  
                  59,065Common
      stock warrants
                  
                  
                  5,173,945
                  
                  
                  
                  3,216,644Common
      stock options
                  
                  
                  2,146,372
                  
                  
                  
                  2,412,236Total
      potential dilutive securities
                  
                  
                  7,379,382
                  
                  
                  
                  5,687,945


4


4.           Inventory





Inventory
consisted of the following at December 31, 2010 and June 30, 2010:





December 31,
                  
                  
                  June 30,2010
                  
                  
                  2010Raw
      materials
                  
                  $
                  654,580
                  
                  
                  $
                  546,080Work
      in process
                  
                  
                  103,323
                  
                  
                  
                  130,840Finished
      goods
                  
                  
                  17,264
                  
                  
                  
                  4,757$
                  775,167
                  
                  
                  $
                  681,677





5.           Share-Based
Compensation





The
following table presents the share-based compensation expense recognized during
the three and six months ended December 31, 2010 and 2009:





Three months
                  
                  
                  Six monthsended December 31,
                  
                  
                  ended December 31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Cost
      of product sales
                  
                  $
                  8,470
                  
                  
                  $
                  5,375
                  
                  
                  $
                  16,940
                  
                  
                  $
                  11,272Research
      and development expenses
                  
                  
                  5,410
                  
                  
                  
                  174
                  
                  
                  
                  10,820
                  
                  
                  
                  336Sales
      and marketing expenses
                  
                  
                  3,847
                  
                  
                  
                  27,460
                  
                  
                  
                  7,694
                  
                  
                  
                  51,085General
      and administrative expenses
                  
                  
                  5,930
                  
                  
                  
                  (10,459
                  )
                  
                  
                  12,795
                  
                  
                  
                  17,784Total
      share-based compensation
                  
                  $
                  23,657
                  
                  
                  $
                  22,550
                  
                  
                  $
                  48,249
                  
                  
                  $
                  80,477





As of
December 31, 2010, total unrecognized compensation expense related to
stock-based options was $194,792 and the related weighted-average period over
which it is expected to be recognized is approximately 1.12 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 with graded vesting terms, the Company recognizes compensation cost on a
straight-line basis over the requisite service period for the entire
award.


5


A summary
of stock options within the Company’s share-based compensation plans as of
December 31, 2010 was as follows:





WeightedWeighted
                  
                  
                  AverageAverage
                  
                  
                  Remaining
                  
                  
                  AggregateNumber
      of
                  
                  
                  Exercise
                  
                  
                  Contractual
                  
                  
                  IntrinsicOptions
                  
                  
                  Price
                  
                  
                  Term
                  
                  
                  ValueOutstanding
      at December 31, 2010
                  
                  
                  2,146,372
                  
                  
                  $
                  1.87
                  
                  
                  
                  6.8
                  
                  
                  $
                  645,522Vested
      and expected to vest at December 31, 2010
                  
                  
                  2,059,546
                  
                  
                  $
                  1.93
                  
                  
                  
                  6.7
                  
                  
                  $
                  587,179Vested
      and exercisable at December 31, 2010
                  
                  
                  1,614,293
                  
                  
                  $
                  2.27
                  
                  
                  
                  6.3
                  
                  
                  $
                  355,198





There
were no options exercised during the six months ended December 31, 2010 and
2009, respectively.  The Company’s current policy is to issue new
shares to satisfy option exercises.





The
weighted average fair value of stock option awards granted and the key
assumptions used in the Black-Scholes fair value model to calculate the fair
value are as follows:





Three months
                  
                  
                  Six monthsended December 31,
                  
                  
                  ended December 31,2010(a)
                  
                  
                  2009(b)
                  
                  
                  2010(c)
                  
                  
                  2009(d)Weighted
      average fair value of options granted
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  0.51Key
      assumptions used in determining fair value:Weighted
      average risk-free interest rate
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  2.50
                  %Weighted
      average life of the option (in years)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4.00Weighted
      average historical stock price volatility
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  132.21
                  %Expected
      dividend yield
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  0.00
                  %





(a)
            During
      the three months ended December 31, 2010, the Company did not grant any
      stock options.


(b)
            During
      the three months ended December 31, 2009, the Company did not grant any
      stock options.


(c)
            During
      the six months ended December 31, 2010, the Company did not grant any
      stock options.


(d)
            During
      the six months ended December 31, 2009, the Company granted 10,000 stock
      options.





The
Black-Scholes fair value 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.  Although the Company is using the Black-Scholes fair
value model, management believes that because changes in the subjective input
assumptions can materially affect the fair value estimate, this valuation model
does not necessarily provide a reliable single measure of the fair value of its
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 option lives, volatility, and forfeiture assumptions are based on
historical data of the Company.


6


6.           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 that 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.  After additional settlement discussions, which ended in April
2008, the parties failed to reach a settlement.  The parties may
demand binding arbitration at any time.





7.           Fair
Value Measurements




Effective
July 1, 2008, for the financial assets and liabilities of the Company, and
effective July 1, 2009, for the non-financial assets and liabilities of the
Company, disclosure requirements were expanded to include the following
information for each major category of assets and liabilities that are measured
at fair value on a recurring basis: financial assets of the Company include cash
and cash equivalents, short-term investments, accounts receivable, net of
allowance and restricted cash - these are measured using level 1
inputs.  Financial liabilities of the Company include accounts payable
and accrued liabilities, accrued payroll and related taxes, notes payable, due
within one year and notes payable, due after one year - these are measured using
level 1 inputs.  Non-financial assets of the Company include
inventory, prepaid and other current assets, fixed assets, deferred financing
costs, licenses and other assets which are measured using level 2
inputs.  The Financial liabilities of the Company include the three
warrant liabilities measured using level 2 inputs. The non-financial
liability of the Company includes the asset retirement obligation measured using
level 3 inputs.




8.           Preferred
Dividends




On
December 8, 2010, the Board of Directors declared a dividend on the Series B
Preferred Stock of all currently payable and accrued outstanding and cumulative
dividends through December 31, 2010 in the amount of
$10,632.  Dividends on the Series B Preferred Stock were last paid on
December 31, 2009 as declared by the Board of Directors on December 11, 2009 in
the amount of $36,679.  The dividends outstanding and cumulative
through December 31, 2010 of $10,632 and through December 31, 2009 of $36,679
were paid as of those dates.




7


9.           Shareholders’
Equity





On
November 22, 2010, the Company entered into a Securities Purchase Agreement (as
amended on December 27, 2010) as part of the Company’s registered offering with
Hudson Bay Master Fund and closed the transaction on November 24, 2010 for the
sale of 2,250,000 shares of common stock and four series of
warrants.  The total warrants exercisable in series A, series B and
series C will be a maximum aggregate of 2,168,026 for a maximum number of below
market securities issued, together with the shares of common stock sold in the
offering, of no greater than 4,418,026 shares of common stock, which is the
maximum issuable under the NYSE AMEX requirements without obtaining shareholder
approval for the issuance.  Series D Warrants, which are not below
market securities, are expected to be issued to purchase 1,873,641 shares of
common stock, assuming the Series A Warrants are exercisable for the maximum
number of shares of common stock.





The
exercise price of each of the Series A, B and C Warrants will be equal to the
lower of (i) $1.50 and (ii) 90% of the average of the 3 lowest volume weighted
average prices out of the 15 trading days preceding the exercise date, but in no
event will the exercise price of the Series A Warrants be less than $0.75 per
share.  The Warrants will have terms varying from one hundred twenty
days from the offering closing date for the Series A Warrants to six months from
the offering closing date for the Series B Warrants to five years from the
initial exercisability date for the Series C and D Warrants.  The
Series A, B and C Warrants were immediately exercisable following the closing of
the offering.  The Series D Warrants will not be exercisable until six
months after the closing and will have an exercise price equal to
$1.56.





The
Shares and warrants were issued pursuant to the Company's shelf registration
statement (the "Registration Statement") on Form S-3 (File No. 333-162694),
which became effective on November 13, 2009, and prospectus supplements filed on
November 24, 2010 and on December 29, 2010.





By letter
agreement dated October 27, 2010, LifeTech Capital, a division of Aurora
Capital, LLC, acted as placement agent in connection with the placement of the
securities in this offering.  LifeTech received a cash fee of 5% of
the gross proceeds received under the offering (excluding proceeds received on
the exercise of C or D Warrants), and will also receive warrants to purchase 3%
of the common stock sold in the offering and 3% of the Series A, B and
C Warrants exercised at any time, which warrants issued to
LifeTech shall not be exercisable for six months following the closing,
shall have a five year term, and an exercise price of $1.56 per
share.





The
Series A warrants will be eligible to be exercised at the option of the Company
on the expiration date subject to the exercise price being above $0.75 for the
15 day period prior to expiration and to meeting other equity
conditions.





All of the Series B warrants and
562,500 of the Series C warrants will be eligible to be exercised at the option
of the Company at any time on or before 6 months after their issuance provided
the common stock is trading at or above $2.45 for 20 cumulative trading days and
to meeting other equity conditions.





Based on
the guidance contained in ASC 815 management has concluded that the warrants in
Series A, Series B, and Series C should be classified a liability and has
recorded a liability at fair value.  The Company determined the fair
value of the warrants using the Black-Scholes fair value model.  The
Company determined the fair value of the warrants to be $1,724,000 on the date
of the offering.  The Company has recognized a gain on the change in
fair value of $420,000 in the three months ended December 31, 2010.





Weighted averageWarrants
                  
                  
                  exercise priceOutstanding
      as of June 30, 2010
                  
                  
                  3,165,768
                  
                  
                  $
                  5.550Series
      A warrants
                  
                  
                  508,130
                  
                  
                  $
                  0.984Series
      B warrants
                  
                  
                  562,500
                  
                  
                  $
                  0.984Series
      C warrants
                  
                  
                  1,096,391
                  
                  
                  $
                  0.984Warrants
      exercised
                  
                  
                  (226,344
                  )
                  
                  $
                  0.950Outstanding
      as of December 31, 2010
                  
                  
                  5,173,945
                  
                  
                  $
                  3.610


8


The
November 2010 offering yielded $1,998,040, net of offering costs of $251,960
($112,500 of commission expense, $137,142 of legal and accounting expense and
$2,318 of other costs).  Warrant liabilities that total $1,724,000 as
established related to Series A, B, and C warrants.  Deferred
financing costs of $193,051 were established related to the warrant liabilities
for Series A, B, and C warrants.





The
deferred offering costs of $193,051 as discussed above will be amortized by the
following schedule:





Series
      A deferred costs
                  
                  $
                  21,391
                  
                  4
      months
                  
                  $
                  5,348 per monthSeries
      B deferred costs
                  
                  $
                  26,431
                  
                  6
    months
                  
                  $
                  4,405 per monthSeries
      C deferred costs
                  
                  $
                  145,230
                  
                  60
      months
                  
                  $
                  2,420 per month





On April
22, 2010 we entered into a Sales Agreement (the “Agreement”) with C.K. Cooper
& Company, Inc. ( “CKCC”). Pursuant to the terms of the Agreement, the
Company may offer and sell (the “Offering”) from time to time through CKCC, as
the Company’s  sales agent, up to $4 million of shares of the
Company’s common stock, par value $0.001 per share (the “Shares”). CKCC is not
required to sell any specific number or dollar amount of Shares but will use its
commercially reasonable efforts, as the Company’s agent and subject to the terms
of the Agreement, to sell the Shares offered, as instructed by the Company.
Sales of the Shares, if any, may be made by means of ordinary brokers’
transactions on the NYSE AMEX at market prices and such other sales as agreed to
by the Company and CKCC. CKCC will receive from us a commission of 2.0% based on
the gross sales price per share for any Shares sold through it as agent under
the Agreement. Net proceeds from the sale of the Shares were used for general
corporate purposes. The Company has also agreed to reimburse CKCC for certain
expenses incurred in connection with entering into the Agreement and has
provided CKCC with customary indemnification rights.  We filed a
prospectus supplement relating to the Agreement described above on April 23,
2010.





On July
29, 2010, we entered into an amendment (the “Amendment”) to the Agreement to
extend the term of the offering of Shares by CKCC as the Company’s sales agent
through December 31, 2010. The offering of Shares pursuant to the Agreement, as
amended by the Amendment, terminated on December 31, 2010.





On
October 1, 2010 the Company instructed CKCC via placement notice permitting “at
the market” sales of common stock through October 31, 2010.  CKCC sold
304,227 shares of common stock on behalf of the Company, with the Company
receiving $250,632 in equity net of offering costs of $118,149 ($7,301 in
commissions, $110,276 in legal and accounting expenses, and $571 in other
costs).





In
October 2010, the Company offered a temporary reduction in the exercise price of
certain warrants to purchase shares of common stock previously issued, pursuant
to §4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D
promulgated thereunder, in 2005 and 2006.





On
October 20, 2010 the Company commenced soliciting warrant exercises from
existing holders at a reduced exercise price of $0.95 per warrant exercised
prior to October 31, 2010.  Warrant holders exercised warrants to
purchase 226,344 shares of common stock.  This solicitation of
warrants yielded $199,818 net of offering costs.


9


10.         Grant
Award





On
October 29, 2010, the Company received three grant awards totaling $526,510 for
qualifying therapeutic discovery projects under section 48D of the Internal
Revenue Code.  The award covers tax years 2009 (ended 06-30-2010) and
2010 (ends 06-30-2011).  The total award amount applicable to tax year
2009 was $109,316 and the payment was received during the three months ended
December 31, 2010 and was recorded in the non-operating income (expense) section
of the consolidated statement of operations as other income.  The
remaining award amount applicable to tax year 2010 is $417,194 of which $40,513
had been earned in the six months ended December 31, 2010.  The grant
award income was recorded in the non-operating income (expense) section of the
consolidated statement of operations as other income and on the balance sheet as
an other receivable in the prepaid expenses and other current assets
section.  The remaining amount of the award granted to the Company
during tax year 2010 is $376,681.





Reimbursement
from the Internal Revenue Service for expenses incurred during tax year 2010
(ends June 30, 2011) under this grant is anticipated to be received during the
month of July 2011.





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 23 below and in the “Risk
Factors” section of our Form 10-K for the fiscal year ended June 30, 2010 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.


10


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-K as filed with the Securities and Exchange Commission on September
28, 2010 are those that depend most heavily on these judgments and
estimates.  As of December 31, 2010, there had been no material
changes to any of the critical accounting policies contained
therein.





Results of
Operations





Three
months ended December 31, 2010 compared to three months ended December 31,
2009





Revenues.  The
overall decrease in revenue generated by prostate brachytherapy is consistent
with revenue decreases experienced by this segment of the industry as a whole,
however, the strategy implemented by management in the prior year in
diversifying the number of body sites being actively treated with the Proxcelan
Cs-131 brachytherapy seed has continued to mitigate the lost revenue from the
prostate segment.





Key operating
factors


Three months
                    
                    
                    Three monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Product
      Sales (Prostate)
                    
                    $
                    1,139,530
                    
                    
                    $
                    1,323,047
                    
                    
                    $
                    (183,517
                    )
                    
                    
                    (14
                    )%Product
      Sales (Other)
                    
                    $
                    105,392
                    
                    
                    $
                    45,300
                    
                    
                    $
                    60,092
                    
                    
                    
                    133
                    %Total
      product sales
                    
                    $
                    1,244,922
                    
                    
                    $
                    1,368,347
                    
                    
                    $
                    (123,425
                    )
                    
                    
                    (9
                    )%





Management
believes that the overall market for prostate brachytherapy has continued to
receive increased pressure from other treatment options with higher
reimbursement rates such as Intensity –Modulated Radiation Therapy (IMRT) and
Robotics but that combination treatments incorporating brachytherapy with other
modalities in the prostate and treatment of other body sites with brachytherapy
have the potential to continue to increase.





Cost of product
sales.





Cost of
product sales was influenced to a large degree by three key operating factors
while overall costs remain relatively unchanged for the three months ended
December 31, 2010 compared to the three months ended December 31,
2009.





The first
key operating factor that changed in the three months ended December 31, 2010 as
compared to the three months ended December 31, 2009 is materials
cost.  Materials cost increased primarily as a result of the increased
isotope cost as a result of contractual purchase requirements based on its
contract with its Russian supplier and increased ordering in December to ensure
that a sufficient supply of isotope was on hand to meet orders during periods of
inclement weather in the US and abroad that caused disruptions of shipments to
the Company.





The
second key operating factor for cost of product sales was pre-loading
services.  This operational department continues to enable the Company
to meet the requirements of our customers while providing added value to our
shareholders through improved utilization of our staff and improved
responsiveness to our customers as is evidenced by the increased number of
physicians utilizing the pre-load services of the Company in the three months
ended December 31, 2010.  The department is able to load orders to
physician specifications without the requirement of consuming additional isotope
to allow for decay during the additional shipping and loading time at a
third-party pre-loading facility, and is able to maintain better control over
the entire manufacturing process and timing of the shipment to
customers.


11




The third
key operating factor for cost of product sales was payroll expense and
benefits.  This savings was primarily the result of utilizing
production staff to support research and development efforts and transferring
the associated cost to the developmental projects to allow for recovery of the
costs through the qualifying therapeutic discovery project grants from the
Internal Revenue Service.





Key operating
factors





Three months
                    
                    
                    Three monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Material
                    
                    $
                    430,777
                    
                    
                    $
                    394,537
                    
                    
                    $
                    36,240
                    
                    
                    
                    9
                    %Pre-loading
                    
                    $
                    97,153
                    
                    
                    $
                    85,967
                    
                    
                    $
                    11,186
                    
                    
                    
                    13
                    %Payroll
      and benefits
                    
                    $
                    204,629
                    
                    
                    $
                    235,533
                    
                    
                    $
                    (30,904
                    )
                    
                    
                    (13
                    )%Cost of product sales
    (Other)
                    
                    $
                    384,447
                    
                    
                    $
                    384,156
                    
                    
                    $
                    290
                    
                    
                    
                    0
                    %Total
      cost of product sales
                    
                    $
                    1,117,005
                    
                    
                    $
                    1,100,193
                    
                    
                    $
                    16,812
                    
                    
                    
                    2
                    %





Gross margin.Gross
margin for the three month period ended December 31, 2010 decreased compared to
the three month period ended December 31, 2009 primarily as a result of the
previously discussed reduction in sales related in the prostate market coupled
with the inability to decrease fixed costs.  Management continued to
seek to control variable costs however at this time most remaining production
costs are of a fixed nature and related to minimum personnel costs to meet peak
demand orders.





Key operating
factor





Three months
                        
                        
                        Three monthsDescription
                        
                        ended 12-31-10
                        
                        
                        ended 12-31-09
                        
                        
                        Variance ($)
                        
                        
                        Variance (%)Gross
      margin
                        
                        $
                        127,917
                        
                        
                        $
                        268,154
                        
                        
                        $
                        (140,237
                        )
                        
                        
                        (52
                        )%Gross margin percentage
                        
                        
                        10
                        %
                        
                        
                        20
                        %





Research and
development.Research and development costs were influenced by
four key operating factors for the three months ended December 31, 2010 compared
to the three months ended December 31, 2009.  The first key operating
factor was other organ research expense which increased primarily due to
material costs from projects related to three key research initiatives that have
been identified by management for future growth and for which management sought
out and received grant funds from the US government to assist with the
development costs of the technologies.  The second key operating
factor was payroll and benefits which increased as a result of increased efforts
undertaken on the three key research initiatives mentioned previously as well as
the addition of a Vice-President of Research and Development in January
2010.  The third key operating factor was protocol expense which
decreased as several studies have fully enrolled and the Company has only
started limited strategic efforts going forward into fiscal year
2011.  The fourth key operating factor is travel expense which
increased with the addition of the previously discussed addition of a
Vice-President of Research and Development.


12


Key operating
factors





Three months
                  
                  
                  Three monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Other
      organ research
                  
                  $
                  23,525
                  
                  
                  $
                  20
                  
                  
                  $
                  23,505
                  
                  
                  
                  117,525
                  %Payroll
      and benefits
                  
                  $
                  78,471
                  
                  
                  $
                  3,316
                  
                  
                  $
                  75,155
                  
                  
                  
                  2,266
                  %Protocol
      expense
                  
                  $
                  (134,031
                  )
                  
                  $
                  22,500
                  
                  
                  $
                  (156,531
                  )
                  
                  
                  (696
                  )%Travel
      expense
                  
                  $
                  12,260
                  
                  
                  $
                  -
                  
                  
                  $
                  12,260
                  
                  
                  
                  100
                  %Research
      and development (Other)
                  
                  $
                  35,387
                  
                  
                  $
                  33,242
                  
                  
                  $
                  2,145
                  
                  
                  
                  6
                  %Total
      research and development
                  
                  $
                  15,612
                  
                  
                  $
                  59,078
                  
                  
                  $
                  (43,466
                  )
                  
                  
                  (74
                  )%





Sales and marketing
expenses.Sales and marketing expenses decreased in the three
months ended December 31, 2010 compared to the three months ended December 31,
2009 primarily as a result of five key operating factors.





The first
key operating factor influencing the decreased sales and marketing expenses was
a reduction in consulting expense as most of the functions of this consultant
are now being performed by employees of the Company.  The second key
operating factor influencing the decrease in sales and marketing expenses was
conventions and tradeshows as management has increasingly targeted activities at
particular events to the results delivered by the Company’s presence at the
events.  The third key operating factor influencing the decrease in
sales and marketing expense is marketing and advertising expenses which
decreased primarily through management developing resources in the Company to
perform certain functions within the Company and that in the three months ended
December 31, 2009 there were physician linecards, patient brochures and other
marketing materials printed that did not recur during the three months ended
December 31, 2010.  The fourth key operating factor influencing the
decrease in sales and marketing expenses was payroll benefits and share-based
compensation which decreased primarily as a result of the compensation related
to the resignation of the Chief Operating Officer (COO) in January
2010.  The fifth key operating factor influencing the decrease in
sales and marketing expenses was travel expense which decreased as a result of
the non-recurring travel costs of the former COO in the three months ended
December 31, 2009 and the targeted reduction in travel costs through more
efficient trip planning by the sales force.





Key operating
factors





Three months
                      
                      
                      Three monthsDescription
                      
                      ended 12-31-10
                      
                      
                      ended 12-31-09
                      
                      
                      Variance ($)
                      
                      
                      Variance (%)Consulting
                      
                      $
                      220
                      
                      
                      $
                      23,749
                      
                      
                      $
                      (23,529
                      )
                      
                      
                      (99
                      )%Conventions
      and tradeshows
                      
                      $
                      12,381
                      
                      
                      $
                      78,131
                      
                      
                      $
                      (65,750
                      )
                      
                      
                      (84
                      )%Marketing
      and advertising
                      
                      $
                      22,432
                      
                      
                      $
                      62,676
                      
                      
                      $
                      (40,244
                      )
                      
                      
                      (64
                      )%Payroll,
      benefits & share comp
                      
                      $
                      231,623
                      
                      
                      $
                      322,452
                      
                      
                      $
                      (90,829
                      )
                      
                      
                      (28
                      )%Travel
                      
                      $
                      52,526
                      
                      
                      $
                      74,833
                      
                      
                      $
                      (22,307
                      )
                      
                      
                      (30
                      )%Sales and marketing (Other)
                      
                      $
                      16,430
                      
                      
                      $
                      42,139
                      
                      
                      $
                      (25,709
                      )
                      
                      
                      (61
                      )%Total
      sales and marketing
                      
                      $
                      335,612
                      
                      
                      $
                      603,980
                      
                      
                      $
                      (268,368
                      )
                      
                      
                      (44
                      )%





General and administrative
expenses.  General and administrative expenses increased in the
three months ended December 31, 2010 compared to the three months ended December
31, 2009 primarily as a result of five key operating factors.  The
first key operating factor was audit, SOX and tax expense that was reduced as
the result of reduced audit costs in the three months ended December 31, 2010 as
compared to the three months ended December 31, 2009.  The second key
operating factor was consulting expense that was increased as a result of costs
related to working with the notified body regarding approval of certain products
for sale in the European Union (EU) that have already been approved for sale in
the markets of the US and Canada.  The third key operating factor was
legal expense that decreased in the three months ended December 31, 2010
compared to December 31, 2009 which was the result of costs related to
Securities and Exchange Commission filings, and the timing of the annual
shareholder meeting.  The fourth key operating factor was payroll,
benefits and share-based compensation expense that was increased as a result of
departments returning to normal staffing levels, annual increases in pay to
staff in the three months ended December 31, 2010 and a non-recurring reversal
of share-based compensation costs that occurred in the three months ended
December 31, 2009.  The fifth key operating factor was public company
expense that increased as a result of the NYSE AMEX annual listing fee expense
associated with new shares issued in the various capital raising efforts during
the three months ended December 31, 2010.


13


Key operating
factors





Three months
                    
                    
                    Three monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Audit,
      SOX and tax
                    
                    $
                    5,710
                    
                    
                    $
                    23,456
                    
                    
                    $
                    (17,746
                    )
                    
                    
                    (76
                    )%Consulting
                    
                    $
                    85,954
                    
                    
                    $
                    72,031
                    
                    
                    $
                    13,923
                    
                    
                    
                    19
                    %Legal
                    
                    $
                    43,387
                    
                    
                    $
                    69,902
                    
                    
                    $
                    (26,515
                    )
                    
                    
                    (38
                    )%Payroll,
      benefits & share comp
                    
                    $
                    242,866
                    
                    
                    $
                    204,123
                    
                    
                    $
                    38,743
                    
                    
                    
                    19
                    %Public
      company
                    
                    $
                    82,785
                    
                    
                    $
                    69,282
                    
                    
                    $
                    13,503
                    
                    
                    
                    19
                    %General and administrative
      (Other)
                    
                    $
                    100,506
                    
                    
                    $
                    111,215
                    
                    
                    $
                    (10,709
                    )
                    
                    
                    (10
                    )%Total
      general and administrative
                    
                    $
                    561,208
                    
                    
                    $
                    550,009
                    
                    
                    $
                    11,199
                    
                    
                    
                    2
                    %





Operating
loss.  Operating loss for the three months ended December 31,
2010 was reduced compared to the three months ended December 31, 2009 despite
reduced sales as management continued to focus on a targeted reduction or
maintenance of costs in all production and overhead functions within the Company
as have been discussed in previous sections.





Key operating
factor





Three months
                  
                  
                  Three monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Operating
      loss
                  
                  $
                  (784,515
                  )
                  
                  $
                  (944,913
                  )
                  
                  $
                  160,398
                  
                  
                  
                  17
                  %





Interest
income.  Interest income for the three months ended December
31, 2010 was reduced compared to the three months ended December 31, 2009 as a
direct result of reduced cash and cash equivalent balances when coupled with
reduced short-term interest rates.





Key operating
factor





Three months
                  
                  
                  Three monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Interest
      income
                  
                  $
                  979
                  
                  
                  $
                  2,944
                  
                  
                  $
                  (1,965
                  )
                  
                  
                  (67
                  )%





Gain on fair value of warrant
liability.  During the three months ended December 31, 2010,
there was a warrant liability established upon issuance of warrants to the
purchaser in a registered public offering during November 2010.  Per
ASC 820, the warrant liability requires periodic evaluation for changes in fair
value.  As required at December 31, 2010, the Company evaluated the
fair value of the warrant liability using the Black-Scholes option pricing model
on which the original warrant liability was based and applied updated inputs at
December 31, 2010.  The resulting change in fair value was recorded as
of December 31, 2010.





Key operating
factor





Three months
                  
                  
                  Three monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Gain
      on fair value of warrant liability
                  
                  $
                  420,000
                  
                  
                  $
                  -
                  
                  
                  $
                  420,000
                  
                  
                  
                  100
                  %




14




Other income.  Other
income for the three months ended December 31, 2010 increased compared to the
three months ended December 31, 2009 as a direct result of the receipt of three
IRS Qualifying Therapeutic Device Program grants.  The grant awards
total approximately $526,510.  In the three months ended December 31,
2010, the Company recorded and received as other income reimbursement for half
of the qualifying expenses incurred in fiscal year 2010 and awarded in October
2010.  The Company has evaluated the expense associated with each
grant effort on a monthly basis and recorded half of the expense incurred until
the individual grant limits are reached as other income and in other receivables
as part of prepaid expenses and other current assets.  The Internal
Revenue Service is expected to reimburse the Company in July 2011 for the
amounts incurred in fiscal year 2011.





Key operating
factor





Three months
                    
                    
                    Three monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Other
      grant income (FY 2010)
                    
                    $
                    109,316
                    
                    
                    $
                    -
                    
                    
                    $
                    109,316
                    
                    
                    
                    100
                    %Other
      grant income (FY2011)
                    
                    $
                    40,513
                    
                    
                    $
                    -
                    
                    
                    $
                    40,513
                    
                    
                    
                    100
                    %Other income
                    
                    $
                    50
                    
                    
                    $
                    -
                    
                    
                    $
                    50
                    
                    
                    
                    100
                    %Total
      other income
                    
                    $
                    149,879
                    
                    
                    $
                    -
                    
                    
                    $
                    149,879
                    
                    
                    
                    100
                    %





Financing and interest
expense.  Financing and interest expense for the three months
ended December 31, 2010 increased when compared to the three months ended
December 31, 2009 as a direct result of the November 2010 equity offering and
the related amortization of deferred offering costs throughout the life of the
warrant liability.





Key operating
factor





Three months
                    
                    
                    Three monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Interest
      expense
                    
                    $
                    1,685
                    
                    
                    $
                    4,171
                    
                    
                    $
                    (2,486
                    )
                    
                    
                    (60
                    )%Deferred financing expense
                    
                    $
                    12,727
                    
                    
                    $
                    3,727
                    
                    
                    $
                    9,000
                    
                    
                    
                    241
                    %Total
      financing and interest expense
                    
                    $
                    14,412
                    
                    
                    $
                    7,898
                    
                    
                    $
                    6,514
                    
                    
                    
                    82
                    %





Six
months ended December 31, 2010 compared to six months ended December 31,
2009





Revenues.  The
overall decrease in revenue generated by prostate brachytherapy is consistent
with revenue decreases experienced by this segment of the industry as a whole,
however, the strategy implemented by management in the prior year in
diversifying the number of body sites being actively treated with the Proxcelan
Cs-131 brachytherapy seed has continued to mitigate the lost revenue from the
prostate segment.





Key operating
factors


Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Product
      Sales (Prostate)
                    
                    $
                    2,372,657
                    
                    
                    $
                    2,670,134
                    
                    
                    $
                    (297,477
                    )
                    
                    
                    (11
                    )%Product Sales (Other)
                    
                    $
                    199,392
                    
                    
                    $
                    77,300
                    
                    
                    $
                    122,092
                    
                    
                    
                    158
                    %Total
      product sales
                    
                    $
                    2,572,049
                    
                    
                    $
                    2,747,434
                    
                    
                    $
                    (175,385
                    )
                    
                    
                    (6
                    )%


15


Management
believes that the overall market for prostate brachytherapy has continued to
receive increased pressure from other treatment options with higher
reimbursement rates such as Intensity –Modulated Radiation Therapy (IMRT) and
Robotics but that combination treatments incorporating brachytherapy with other
modalities in the prostate field and treatment of other body sites with
brachytherapy have the potential to continue to increase.





Cost of product
sales.  Cost of product sales was decreased to a large degree
by four key operating factors while overall costs remain relatively unchanged
for the six months ended December 31, 2010 compared to the six months ended
December 31, 2009.  The first key operating factor that changed in the
six months ended December 31, 2010 as compared to the six months ended December
31, 2009 is materials cost.  Materials cost increased primarily as a
result of an increased cost of isotope through meeting required contractual
purchasing requirements for the Company’s contract with its Russian supplier
when combined with the ordering of additional isotope to ensure a sufficient
inventory on hand to meet orders during periods of inclement weather in the US
and abroad that caused disruptions and delays of shipments to the
Company.





The
second key operating factor for cost of product sales was depreciation and
amortization expense.  This operational expense has continued to
decrease in fiscal year 2011 as equipment reached the end of its depreciable
life and has not required replacement or significant repair as a result of the
diligent maintenance process implemented by management and executed by the staff
of the Company.





The third
key operating factor for cost of product sales was occupancy
expense.  The increase in occupancy expense in the six months ended
December 31, 2010 as compared to the six months ended December 31, 2009 was the
result of a non-recurring reduction in electrical expense in the six months
ended December 31, 2009 as the result of resolving a billing issue that was
properly accrued for in the period incurred and relieved when
resolved.





The
fourth key operating factor for cost of product sales was payroll expense and
benefits.  The Company has utilized existing staff to support research
and development efforts that have been undertaken and the related labor cost has
been included in research and development expense as appropriate.





Key operating
factors





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Depreciation
      and amortization
                    
                    $
                    444,075
                    
                    
                    $
                    467,081
                    
                    
                    $
                    (23,006
                    )
                    
                    
                    (5
                    )%Material
                    
                    $
                    859,353
                    
                    
                    $
                    816,510
                    
                    
                    $
                    42,843
                    
                    
                    
                    5
                    %Occupancy
                    
                    $
                    148,006
                    
                    
                    $
                    129,567
                    
                    
                    $
                    18,439
                    
                    
                    
                    14
                    %Payroll
      and benefits
                    
                    $
                    411,662
                    
                    
                    $
                    483,185
                    
                    
                    $
                    (71,523
                    )
                    
                    
                    (15
                    )%Cost of product sales
    (Other)
                    
                    $
                    365,436
                    
                    
                    $
                    363,939
                    
                    
                    $
                    1,497
                    
                    
                    
                    0
                    %Total
      cost of product sales
                    
                    $
                    2,228,532
                    
                    
                    $
                    2,260,282
                    
                    
                    $
                    (31,750
                    )
                    
                    
                    (1
                    )%





Gross margin.Gross
margin for the six month period ended December 31, 2010 decreased compared to
the six month period ended December 31, 2009 primarily as a result of the
previously discussed reduction in sales related in the prostate market and
inability to decrease fixed costs required regardless of revenue
levels.  Management continued to seek to control variable costs as
sales did not improve over the same period in the prior year, however at this
time most remaining production costs are of a fixed nature and related to
minimum personnel costs to meet peak demand orders.


16


Key operating
factor





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Gross
      margin
                    
                    $
                    343,517
                    
                    
                    $
                    487,152
                    
                    
                    $
                    (143,635
                    )
                    
                    
                    (29
                    )%Gross margin percentage
                    
                    
                    13
                    %
                    
                    
                    18
                    %





Research and
development.Research and development costs were influenced by
four key operating factors for the six months ended December 31, 2010 compared
to the six months ended December 31, 2009.  The first key operating
factor was other organ research expense which increased primarily due to
material costs from projects related to three key research initiatives that have
been identified by management for future growth and for which management sought
out and received grant funds from the US government to assist with the
development costs of the technologies.  The second key operating
factor was payroll and benefits which increased as a result of the cost of
production staff used in research and development on three qualifying
therapeutic discovery project grants that were awarded to the Company as well as
the addition of a Vice-President of Research and Development in January
2010.  The third key operating factor was protocol expense which
decreased as the result of the Company determining that several protocols were
accrued beyond the now expected costs.  Additionally, the Company has
only started limited strategic protocol efforts going forward into fiscal year
2011.  The fourth key operating factor is travel expense which
increased with the addition of the previously discussed addition of a
Vice-President of Research and Development.





Key operating
factors





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Other
      organ research
                    
                    $
                    25,850
                    
                    
                    $
                    3,171
                    
                    
                    $
                    22,679
                    
                    
                    
                    715
                    %Payroll
      and benefits
                    
                    $
                    138,414
                    
                    
                    $
                    5,134
                    
                    
                    $
                    133,280
                    
                    
                    
                    2,596
                    %Protocol
      expense
                    
                    $
                    (123,063
                    )
                    
                    $
                    46,700
                    
                    
                    $
                    (24,762
                    )
                    
                    
                    (364
                    )%Travel
      expense
                    
                    $
                    24,637
                    
                    
                    $
                    13
                    
                    
                    $
                    24,624
                    
                    
                    
                    189,415
                    %Research and
      development  (Other)
                    
                    $
                    64,295
                    
                    
                    $
                    72,942
                    
                    
                    $
                    (8,647
                    )
                    
                    
                    (12
                    )%Total
      research and development
                    
                    $
                    130,133
                    
                    
                    $
                    127,960
                    
                    
                    $
                    2,173
                    
                    
                    
                    2
                    %





Sales and marketing
expenses.Sales and marketing expenses decreased in the six
months ended December 31, 2010 compared to the six months ended December 31,
2009 primarily as a result of five key operating factors.  The first
key operating factor influencing the decreased sales and marketing expenses was
a reduction in consulting expense as most of the functions of this consultant
are now being performed by employees of the Company.  The second key
operating factor influencing the decrease in sales and marketing expenses was
conventions and tradeshows as management has increasingly targeted activities at
particular events to the results delivered by the Company’s presence at the
events.  The third key operating factor influencing the decrease in
sales and marketing expense is marketing and advertising expenses which
decreased primarily through management developing resources in the Company to
perform certain functions within the Company and that in the six months ended
December 31, 2009 there were physician linecards, patient brochures and other
marketing materials printed that did not recur during the six months ended
December 31, 2010.  The fourth key operating factor influencing the
decrease in sales and marketing expenses was payroll benefits and share-based
compensation which decreased primarily as a result of the compensation related
to the resignation of the Chief Operating Officer (COO) in January
2010.  The fifth key operating factor influencing the decrease in
sales and marketing expenses was travel expense which decreased as a result of
the non-recurring travel costs of the former COO in the three months ended
December 31, 2009 and the targeted reduction in travel costs through more
efficient trip planning by the sales force.


17




Key operating
factors





Six months
                  
                  
                  Six monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Consulting
                  
                  $
                  16,720
                  
                  
                  $
                  39,649
                  
                  
                  $
                  (22,929
                  )
                  
                  
                  (58
                  )%Conventions
      and tradeshow
                  
                  $
                  18,714
                  
                  
                  $
                  103,002
                  
                  
                  $
                  (84,288
                  )
                  
                  
                  (82
                  )%Marketing
      and advertising
                  
                  $
                  36,749
                  
                  
                  $
                  107,734
                  
                  
                  $
                  (70,985
                  )
                  
                  
                  (66
                  )%Payroll,
      benefits & share comp
                  
                  $
                  492,288
                  
                  
                  $
                  582,682
                  
                  
                  $
                  (90,394
                  )
                  
                  
                  (16
                  )%Travel
                  
                  $
                  114,955
                  
                  
                  $
                  132,783
                  
                  
                  $
                  (17,828
                  )
                  
                  
                  (13
                  )%Sales
      and marketing (Other)
                  
                  $
                  29,612
                  
                  
                  $
                  81,029
                  
                  
                  $
                  (51,417
                  )
                  
                  
                  (63
                  )%Total
      sales and marketing
                  
                  $
                  709,038
                  
                  
                  $
                  1,046,879
                  
                  
                  $
                  (337,841
                  )
                  
                  
                  (32
                  )%





General and administrative
expenses.  General and administrative expenses increased in the
six months ended December 31, 2010 compared to the six months ended December 31,
2009 primarily as a result of five key operating factors.  The first
key operating factor was audit, SOX and tax expense that was reduced as the
result of reduced audit costs in the six months ended December 31, 2010 as
compared to the six months ended December 31, 2009.  The second key
operating factor was consulting expense that was increased as a result of
increased consulting expense as a result of costs related to working with the
notified body regarding approval of certain products for sale in the European
Union (EU) that have already been approved for sale in the markets of the US and
Canada.  The third key operating factor was legal expense that
decreased as a result of costs related to Securities and Exchange Commission
filings, and the timing of the annual shareholder meeting which was held in the
six months ended December 31, 2009 but not in the six months ended December 31,
2010.  The fourth key operating factor was payroll, benefits and
share-based compensation expense that was increased as a result of departments
returning to normal staffing levels, annual increases in pay to staff in the
three months ended December 31, 2010 and a non-recurring reversal of share-based
compensation costs that occurred in the three months ended December 31,
2009.  The fifth key operating factor was public company expense that
increased as a result of the NYSE AMEX annual listing fee expense associated
with new shares issued in the various capital raising efforts during the three
months ended December 31, 2010.





Key operating
factors





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Audit,
      SOX and tax
                    
                    $
                    58,582
                    
                    
                    $
                    63,463
                    
                    
                    $
                    (4,881
                    )
                    
                    
                    (8
                    )%Consulting
                    
                    $
                    159,183
                    
                    
                    $
                    147,529
                    
                    
                    $
                    11,654
                    
                    
                    
                    8
                    %Legal
                    
                    $
                    78,316
                    
                    
                    $
                    123,298
                    
                    
                    $
                    (44,982
                    )
                    
                    
                    (36
                    )%Payroll,
      benefits & share comp
                    
                    $
                    487,526
                    
                    
                    $
                    461,897
                    
                    
                    $
                    25,629
                    
                    
                    
                    6
                    %Public
      company
                    
                    $
                    134,128
                    
                    
                    $
                    117,779
                    
                    
                    $
                    16,349
                    
                    
                    
                    14
                    %General and
      administrative  (Other)
                    
                    $
                    239,606
                    
                    
                    $
                    238,474
                    
                    
                    $
                    6,120
                    
                    
                    
                    0
                    %Total
      general and administrative
                    
                    $
                    1,157,341
                    
                    
                    $
                    1,152,440
                    
                    
                    $
                    4,901
                    
                    
                    
                    0
                    %





Operating
loss.  Operating loss for the six months ended December 31,
2010 was reduced compared to  the six months ended December 31, 2009
despite reduced sales as management continued to focus on a targeted reduction
or maintenance of costs in all production and overhead functions within the
Company as have been discussed in previous sections.





Key operating
factor





Six months
                  
                  
                  Six monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Operating
      loss
                  
                  $
                  (1,652,995
                  )
                  
                  $
                  (1,840,127
                  )
                  
                  $
                  187,132
                  
                  
                  
                  (10
                  )%


18


Interest
income.  Interest income for the six months ended December 31,
2010 was reduced compared to the six months ended December 31, 2009 as a direct
result of reduced cash and cash equivalent balances when coupled with reduced
short-term interest rates.





Key operating
factor





Six months
                  
                  
                  Six monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Interest
      income
                  
                  $
                  2,040
                  
                  
                  $
                  8,811
                  
                  
                  $
                  (6,771
                  )
                  
                  
                  (77
                  )%





Gain on fair value of warrant
liability.  During the six months ended December 31, 2010,
there was a warrant liability established upon issuance of warrants to the
purchaser in a registered public offering during November 2010.  Per
ASC 820, the warrant liability requires periodic evaluation for changes in fair
value.  As required at December 31, 2010, the Company evaluated the
fair value of the warrant liability using the Black-Scholes fair value model on
which the original warrant liability was based and applied updated inputs at
December 31, 2010.  The resulting change in fair value was recorded as
of December 31, 2010.





Key operating
factor





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Gain
      on fair value of warrant liability
                    
                    $
                    420,000
                    
                    
                    $
                    -
                    
                    
                    $
                    420,000
                    
                    
                    
                    100
                    %





Other income.  Other
income for the six months ended December 31, 2010 increased compared to the six
months ended December 31, 2009 as a direct result of the receipt of three IRS
Qualifying Therapeutic Device Program grants.  The grant awards total
approximately $526,510.  In the six months ended December 31, 2010,
the Company recorded and received as other income reimbursement for half of the
qualifying expenses incurred in fiscal year 2010 and awarded in October
2010.  The Company has evaluated the expense associated with each
grant effort on a monthly basis and recorded half of the expense incurred until
the individual grant limits are reached as other income and in other receivables
as part of prepaid expenses and other current assets.  The Internal
Revenue Service is expected to reimburse the Company in July 2011 for the
amounts incurred in fiscal year 2011.





Key operating
factor





Six
      months
                    
                    
                    Six
      monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Other
      grant income (FY 2010)
                    
                    $
                    109,316
                    
                    
                    $
                    -
                    
                    
                    $
                    109,316
                    
                    
                    
                    100
                    %Other
      grant income (FY2011)
                    
                    $
                    40,513
                    
                    
                    $
                    -
                    
                    
                    $
                    40,513
                    
                    
                    
                    100
                    %Other income
                    
                    $
                    50
                    
                    
                    $
                    -
                    
                    
                    $
                    50
                    
                    
                    
                    100
                    %Total
      other income
                    
                    $
                    149,879
                    
                    
                    $
                    -
                    
                    
                    $
                    149,879
                    
                    
                    
                    100
                    %





Financing and interest
expense.  Financing and interest expense for the six months
ended December 31, 2010 increased when compared to the six months ended December
31, 2009 as a direct result of the November 2010 equity offering and the related
amortization of deferred offering costs throughout the life of the warrant
liability.


19




Key operating
factor





Six months
                    
                    
                    Six monthsDescription
                    
                    ended 12-31-10
                    
                    
                    ended 12-31-09
                    
                    
                    Variance ($)
                    
                    
                    Variance (%)Interest
      expense
                    
                    $
                    5,596
                    
                    
                    $
                    11,457
                    
                    
                    $
                    (5,861
                    )
                    
                    
                    (51
                    )%Deferred financing expense
                    
                    $
                    13,279
                    
                    
                    $
                    13,802
                    
                    
                    $
                    (523
                    )
                    
                    
                    (4
                    )%Total
      financing and interest expense
                    
                    $
                    18,875
                    
                    
                    $
                    25,259
                    
                    
                    $
                    (6,384
                    )
                    
                    
                    (25
                    )%





Liquidity and capital
resources.  The Company has historically financed its
operations through cash investments from shareholders.  During the six
months ended December 31, 2010, the Company primarily used existing cash
reserves to fund its operations and capital expenditures.





Cash
flows from operating activities





Cash used
by operating activities is the net loss adjusted for non-cash items and changes
in operating assets and liabilities.  Management continued to reduce
cash consumed in operating activities through a combination of cost reductions
and operational efficiencies identified in the results of operations that
resulted in a reduction in net loss which was then reduced by the non-cash items
and changes in operating assets and liabilities for the six months ended
December 31, 2010 when compared to the six months ended December 31,
2009.





Key operating
factor





Six months
                          
                          
                          Six monthsDescription
                          
                          ended 12-31-10
                          
                          
                          ended 12-31-09
                          
                          
                          Variance ($)
                          
                          
                          Variance (%)Net
      loss
                          
                          $
                          (1,099,951
                          )
                          
                          $
                          (1,856,575
                          )
                          
                          $
                          756,624
                          
                          
                          
                          (41
                          )%Non-cash
      items
                          
                          $
                          129,450
                          
                          
                          $
                          619,527
                          
                          
                          $
                          (490,077
                          )
                          
                          
                          (79
                          )%Non-cash changes in operating assets and
      liabilities
                          
                          $
                          (317,149
                          )
                          
                          $
                          (137,873
                          )
                          
                          $
                          (179,276
                          )
                          
                          
                          130
                          %Net
      cash used by operating activities
                          
                          $
                          (1,287,650
                          )
                          
                          $
                          (1,374,921
                          )
                          
                          $
                          87,271
                          
                          
                          
                          (6
                          )%





Cash
flows from investing activities





Cash used
by investing activities during the six months ended December 31, 2010 was
primarily the result of the investment in equipment related to research and
development activities in support of the IRS Qualifying Therapeutic Device
Program grant research.  Cash provided in the six months ended
December 31, 2009 was primarily the result of short-term investments maturing
and being liquidated and offset by minor investments in fixed
assets.  The amounts recorded to restricted cash in both periods are
the accrual of interest earned on certificates of deposit with two financial
institutions that are a requirement of the Washington State Department of
Health.





Key operating
factor





Six months
                  
                  
                  Six monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Purchases
      of fixed assets
                  
                  $
                  (32,976
                  )
                  
                  $
                  (18,000
                  )
                  
                  $
                  (14,976
                  )
                  
                  
                  83
                  %Change
      in restricted cash
                  
                  $
                  (402
                  )
                  
                  $
                  (1,049
                  )
                  
                  $
                  647
                  
                  
                  
                  (62
                  )%Proceeds
      from the sale or maturity of short-term investments
                  
                  $
                  -
                  
                  
                  $
                  1,679,820
                  
                  
                  $
                  1,678,820
                  
                  
                  
                  100
                  %Net
      cash provided (used) by investing activities
                  
                  $
                  (33,378
                  )
                  
                  $
                  1,660,771
                  
                  
                  $
                  (1,694,149
                  )
                  
                  
                  (102
                  )%


20


Cash
flows from financing activities





Cash
provided by financing activities in the six months ended December 31, 2010 was
the result of sales of common stock in at-the-market transactions, through
warrant exercises and in a registered public offering.  Cash used
during the six months ended December 31, 2009 was the result of dividend
payments to the preferred shareholders and payments on the lone remaining debt
facility with Hanford Area Economic Investment Fund (HAEIFC).





Cash used
during the six months ended December 31, 2009 was the result of dividend
payments to the preferred shareholders and payments on the debt facility with
the HAEIFC, and the extinguishment of the debt facility with the Benton-Franklin
Council of Governments (BFEDD).





Key operating
factor





Six months
                  
                  
                  Six monthsDescription
                  
                  ended 12-31-10
                  
                  
                  ended 12-31-09
                  
                  
                  Variance ($)
                  
                  
                  Variance (%)Principal
      payments on notes payableHAEIFC
                  
                  $
                  (25,333
                  )
                  
                  $
                  (18,433
                  )
                  
                  $
                  6,900
                  
                  
                  
                  37
                  %BFEDD
                  
                  $
                  -
                  
                  
                  $
                  (115,898
                  )
                  
                  $
                  (115,898
                  )
                  
                  
                  (100
                  )%Preferred
      dividend payments
                  
                  $
                  (10,632
                  )
                  
                  $
                  (36,679
                  )
                  
                  $
                  26,047
                  
                  
                  
                  (71
                  )%Proceeds
      from sale of common stock
                  
                  $
                  2,448,490
                  
                  
                  $
                  -
                  
                  
                  $
                  2,448,490
                  
                  
                  
                  100
                  %Net
      cash provided (used) byfinancing
      activities
                  
                  $
                  2,412,525
                  
                  
                  $
                  (171,010
                  )
                  
                  $
                  2,583,535
                  
                  
                  
                  (1,511
                  )%





Projected
Fiscal Year 2011 Liquidity and Capital Resources





At
December 31, 2010, the Company held cash and cash equivalents of $2,770,366 as
compared to $1,678,869 of cash and cash equivalents at June 30,
2010.





The
Company had approximately $2.53 million of cash and cash equivalents and no
short-term investments as of February 8, 2011.  The Company’s monthly
required cash operating expenditures were approximately $215,000 in the six
months ended December 31, 2010, which represents a 6% decrease of approximately
$15,000 from average monthly cash operating expenditures in fiscal year 2010,
which is primarily a result of improved operating performance from fiscal year
2010 to fiscal year 2011.  Management believes that less than $100,000
will be spent on capital expenditures for the fiscal year 2011, but there is no
assurance that unanticipated needs for capital equipment may not
arise.





The
Company has a single remaining loan facility outstanding with HAEIFC, with a
principal balance of approximately $155,000, of which approximately $53,000 will
be due in the next 12 months.





The
Company intends to continue its existing protocol studies and to begin new
protocol studies on lung cancer treatment using Cesium-131.  The
Company continues to believe that approximately $100,000 in expense will be
incurred during fiscal year 2011 related to protocol expenses relating to lung
cancer and dual therapy and mono therapy prostate protocols.





Based on
the foregoing assumptions, management believes cash, cash equivalents, and
short-term investments on hand at December 31, 2010 will be sufficient to
meet our anticipated cash requirements for operations, debt service, and capital
expenditure requirements through at least the next twelve
months.


21


Management
plans to attain breakeven and generate additional cash flows by increasing
revenues from both new and existing customers (through our direct sales channels
and through our distributors), expanding into other market applications which
initially will include head and neck, colorectal and lung implants
while  maintaining the Company's focus on cost
control.  However, there can be no assurance that the Company will
attain profitability or that the Company will be able to attain increases in its
revenue.  Sales in the prostate market have not shown the increases
necessary to breakeven during the past three fiscal years and did not improve
during the six months ended December 31, 2010.  As management is now
focused on expanding into head and neck, colorectal and lung applications,
management believes the Company will need to raise additional capital for
protocols, marketing staff, production staff and production equipment as it
attempts to gain market share.





The
Company expects to finance its future cash needs through sales of equity,
possible strategic collaborations, debt financing or through other sources that
may be dilutive to existing shareholders  Management anticipates that
if it raises additional financing that it will be at a discount to the market
price and it will be dilutive to shareholders. Of course, funding may not be
available to it on acceptable terms, or at all. If the Company is unable to
raise additional funds, it may be unable to expand into new applications and may
need to curtail operations.





Long-Term
Debt





IsoRay
has a single loan facility in place as of December 31, 2010 from the Hanford
Area Economic Investment Fund Committee (HAEIFC), which 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 five and one-half percent and
the principal balance owed as of December 31, 2010 was $154,662.  This
loan is secured by receivables, equipment, materials and inventory, and certain
life insurance policies and also required personal guarantees.





Other
Commitments and Contingencies





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 believes that if it relocates its current
production facilities then certain decommissioning expenses will be
incurred.  An asset retirement obligation was established in the first
quarter of fiscal year 2008 for the Company’s obligations at its current
production facility.  This asset retirement obligation will be for
obligations to remove any residual radioactive materials and to remove all
leasehold improvements.





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 previously disclosed a contingency related to its research and
development project underway in the Ukraine to develop a proprietary separation
process to manufacture enriched barium.  As the prototype has not been
successfully demonstrated and is not expected to be, the Company does not intend
to make the final payment to the contractor, as the final payment was only due
following a successful demonstration of the prototype.





The
Company has no off-balance sheet arrangements.


22


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 December 31, 2010.  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.  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.





The
Company is continuing the process of developing and implementing the remediation
plan to address the material weakness and significant deficiency identified in
its Form 10-K for the fiscal year ended June 30, 2010.


This plan
is as follows:





·
            The
      Company continues to assess opportunities to further segregate duties
      within a limited staff.


·
            The
      staff is utilizing continuing professional education opportunities to
      enhance their knowledge.


·
            Management
      is conducting ongoing reviews of all significant and non-routine
      transactions.





As a
result of ongoing reviews of all significant and non-routine transactions,
management believes that there are no material inaccuracies or omissions of
material fact and to the best of its knowledge believes that the consolidated
financial statements for the quarter ended December 31, 2010 fairly present in
all material respects the financial condition and results of operations for the
Company in conformity with U.S generally accepted accounting
principles.





PART
II - OTHER INFORMATION





ITEM
1A – RISK FACTORS





There
have been no material changes for the risk factors disclosed in the “Risk
Factors” section of our Annual Report on Form 10-K for the year ended June 30,
2010, except for the changes to the following risk factors that were included in
the Form 10-K:





Failure to Comply with NYSE Amex
Listing Standards And Any Resulting Delisting Could Adversely Affect The Market
For Our Common Stock.  Our common stock is presently listed on
the NYSE Amex. The NYSE Amex will consider delisting a company's securities if,
among other things, the company fails to maintain minimum stockholder's equity
or the company has sustained losses which are so substantial in relation to its
overall operations or its existing financial resources, or its financial
condition has become so impaired that it appears questionable, in the opinion of
the NYSE Amex, as to whether such issuer will be able to continue operations
and/or meet its obligations as they mature. As of the quarter ended December 31,
2010, IsoRay met the minimum stockholder’s equity requirement of $6 million
needed to maintain its listing, but will need to amend a provision in its
outstanding amended and restated Series C warrant to meet the minimum equity
requirement for the quarter ending March 31, 2011.


23


Management intends
to negotiate a revision to the cash settlement terms of its outstanding
amended and restated Series C warrant to classify this warrant as equity instead
of a liability.  Although management believes it can reach a
satisfactory revision to its Series C warrant, there can be no assurance that we
will be able to reach a satisfactory resolution of this negotiation to maintain
our listing on the NYSE Amex or that additional concessions will not have to be
granted to the holder of this warrant. In the event that our common stock is
delisted from the NYSE Amex, trading, if any, in the common stock would be
conducted in the over-the-counter market. As a result, our shareholders would
likely find it more difficult to dispose of, or to obtain accurate quotations as
to the market value of, our common stock.





The Price Of Our Common Stock May Be
Adversely Affected By The Future Issuance And Sale Of Shares Of Our Common Stock
Or Other Equity Securities, Or By Our Announcement That Such Issuances And Sales
May Occur.We cannot predict the size of future issuances or
sales of our common stock or other equity securities, including those made
pursuant to the Company's November 2010 securities purchase agreement with an
investor who purchased 2.25 million shares and warrants to purchase up to
4,041,667 shares of common stock, future acquisitions or capital raising
activities, or the effect, if any, that such issuances or sales may have on the
market price of our common stock. The issuance and sale of substantial amounts
of common stock or other equity securities, or announcement that such issuances
and sales may occur, could adversely affect the market price of our common
stock.




Future Sales By Shareholders, Or The
Perception That Such Sales May Occur, May Depress The Price Of Our Common
Stock.The sale or availability for sale of substantial
amounts of our shares in the public market, including shares issuable upon
conversion of outstanding preferred stock or exercise of common stock warrants
and options, or the perception that such sales could occur, could adversely
affect the market price of our common stock and also could impair our ability to
raise capital through future offerings of our shares.  As of February
8, 2011, we had 25,816,476 outstanding shares of common stock, and the following
additional shares were reserved for issuance: 2,146,372 shares upon exercise of
outstanding options, 5,173,945 shares upon exercise of outstanding warrants, and
59,065 shares upon conversion of preferred stock.  Any decline in the
price of our common stock may encourage short sales, which could place further
downward pressure on the price of our common stock and may impair our ability to
raise additional capital through the sale of equity securities.





The Issuance Of Shares Upon Exercise
Of Derivative Securities May Cause Immediate And Substantial Dilution To Our
Existing Shareholders.The issuance of shares upon conversion of the
preferred stock and the exercise of common stock warrants and options may result
in substantial dilution to the interests of other shareholders since these
selling shareholders may ultimately convert or exercise and sell all or a
portion of the full amount issuable upon exercise.  If all derivative
securities were converted or exercised into shares of common stock, including
the maximum number of warrants issuable in our November 2010 offering, there
would be approximately 7,379,382 additional shares of common stock outstanding
as a result.  The issuance of these shares will have the effect of
further diluting the proportionate equity interest and voting power of holders
of our common stock.





We Have Ongoing Cash
Requirements.IsoRay has generated
material operating losses since inception.  We expect to continue to
experience significant net operating losses.  Due to recent capital
investments and substantial cost reductions, management believes cash and cash
equivalents on hand will be sufficient to meet our anticipated cash requirements
for operations, debt service, and capital expenditure requirements through
December 31, 2011.  Management now estimates that operational cashflow
breakeven will be achieved at approximately $700,000in monthly
revenue.  However, there is no assurance as to when break-even will
occur.  If we are unable to generate profits and unable to obtain
additional financing to meet our working capital requirements, we may have to
curtail our business.


24


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.  In fiscal 2010,
approximately sixty-eight percent (68%) of our Cs-131 was supplied through
UralDial from reactors located in Russia.  Unless the Company
substantially increases its purchase requirements resulting from significant
increases in demand for its product, the cost of Cs-131 in Russia could increase
from current pricing.





If the
development of barium enrichment capabilities is successful, the Company plans
to expand Cs-131 manufacturing capability at the MURR reactor in the United
States. Reliance on any single supplier increases the risks associated with
concentrating isotope production at a single reactor facility which can be
subject to unanticipated shutdowns. Failure to obtain deliveries of Cs-131 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, Accellent Corporation.  We currently obtain a key component of
our seed core from another single supplier.  We do not have formal
written agreements with Accellent 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.





We Have Entered Into An Agreement
With A Single Distributor For Our Cesium-131 From Russia.  In
December 2009, the Company entered into a new agreement with UralDial, which has
been renewed through December 31, 2011, to purchase Cs-131 directly from
UralDial instead of directly from Institute of Nuclear Materials (INM) and
Research Institute of Atomic Reactors (RIAR) as the Company had done prior to
the original agreement with UralDial in December 2008.  As a result,
the Company continues to rely on UralDial to obtain Cs-131 from Russian
sources.  UralDial has agreed to maintain at least two Russian sources
of its Cs-131 and through the UralDial agreement we have obtained set
pricing for our Russian Cs-131 through the end of 2011.  There can be
no guarantee that UralDial will always be able to supply us with sufficient
Cs-131 or will renew our existing contract on favorable terms in December 2011,
which could be due in part to risks associated with foreign operations and
beyond our and UralDial's control.  If we were unable to obtain
supplies of isotopes from Russia in the future, our overall supply of Cs-131
would be reduced significantly unless we have a source of enriched barium for
utilization in domestic reactors.





We Are Subject To Uncertainties
Regarding Reimbursement For Use Of Our Products.Hospitals and
freestanding clinics may be less likely to purchase our products if they cannot
be assured of receiving favorable reimbursement for treatments using our
products from third-party payers, such as Medicare and private health insurance
plans.  Currently, Medicare reimburses hospitals at fixed rates that
cover the cost of stranded and loose seeds.  Clinics and physicians
performing procedures in a free standing center are reimbursed at the actual
cost of the seeds.  It is expected that CMS will continue to reimburse
providers using this same methodology throughout 2011.


25


In 2003,
IsoRay applied to the CMS and received a reimbursement code for our Cs-131
seed.  On July 1, 2007, CMS revised the coding system for brachytherapy
seeds and separated the single code into two codes – one code for loose seeds
and a second code for stranded seeds.  This methodology was applied to all
companies manufacturing brachytherapy seeds.  Reimbursement amounts are
reviewed and revised annually based upon information submitted to CMS on claims
by providers.  Adjustments can be made to reimbursement amounts or coverage
policies, which could result in changes to reimbursement for brachytherapy
services.  These changes can positively or negatively affect market demand
for our products.   We monitor these changes and provide comments, as
permitted, when changes are proposed, prior to implementation.





There
were improvements in CMS reimbursement for our product for 2011 but there
is no assurance this will continue to occur and is subject to revision
annually.




Historically,
private insurers have followed Medicare guidelines in establishing reimbursement
rates.  However, third-party payers are increasingly challenging the
pricing of certain medical services or devices, and we cannot be sure that they
will reimburse our customers at levels sufficient for us to maintain favorable
sales and price levels for our products.  There is no uniform policy
on reimbursement among third-party payers, and we can provide no assurance that
our products will continue to qualify for reimbursement from all third-party
payers or that reimbursement rates will not be reduced.  A reduction
in or elimination of third-party reimbursement for treatments using our products
would likely have a material adverse effect on our revenues.





Furthermore,
any federal and state efforts to reform government and private healthcare
insurance programs, such as those passed by the federal government in 2010,
could significantly affect the purchase of healthcare services and products in
general and demand for our products in particular.  Medicare is the
payer in approximately 70% of all U.S. prostate brachytherapy cases and
management anticipates this percentage to increase annually.  We are
unable to predict whether potential healthcare reforms will be enacted, whether
other healthcare legislation or regulations affecting the business may be
proposed or enacted in the future or what effect any such legislation or
regulations would have on our business, financial condition or results of
operations.





If We Are Unable To Successfully
Address The Material Weakness In Our Internal Controls, Our Ability To Report
Our Financial Results On A Timely And Accurate Basis May Be Adversely
Affected.Effective
internal controls are necessary for us to provide reliable financial reports and
effectively prevent fraud. If we cannot provide reliable financial reports or
prevent fraud, our reputation and operating results could be harmed. We have in
the past discovered, and may in the future discover, areas of our internal
controls that need improvement. In its assessment of the effectiveness in
internal control over financial reporting as of June 30, 2010, the Company
determined that there were deficiencies that constituted a material weakness.
Specifically, the Company did not maintain a sufficient complement of personnel
with the appropriate level of knowledge, experience and training to analyze,
review and monitor the accounting of complex financial
transactions.  As a result, the Company did not prepare adequate
contemporaneous documentation that would provide a sufficient basis for an
effective evaluation and review of the accounting for complex transactions that
are significant or non-routine.  This material weakness resulted in
errors in the preliminary June 30, 2010 consolidated financial statements and
more than a remote likelihood that a material misstatement of the Company's
annual or interim financial statements would not be prevented or
detected.  The Company is in the process of developing and
implementing a remediation plan to address the material weakness described
above, along with the deficiencies also identified in the assessment, which are
described in our Annual Report on Form 10-K filed with the SEC on September 28,
2010.  Specifically, the Company continues to assess opportunities to
address issues with segregation of duties, staff has received additional
professional education, management conducts ongoing reviews of all significant
and non-routine transactions, and the Company is assessing additional steps that
may be taken in the remainder of fiscal year 2011 to improve internal
controls.  We cannot be certain that these measures will ensure that
we implement and maintain adequate controls over our financial processes and
reporting in the future and had not improved the process as of December 31,
2010. Any failure to implement required new or improved controls, or
difficulties encountered in their implementation, could harm our operating
results or cause us to fail to meet our reporting obligations. Inferior internal
controls could also cause investors to lose confidence in our reported financial
information, which could have a negative effect on the trading price of our
stock.


26


Certain Provisions of Minnesota Law
and Our Charter Documents Have an Anti-Takeover Effect.There exist
certain mechanisms under Minnesota law and our charter documents that may delay,
defer or prevent a change of control.  Anti-takeover provisions of our
articles of incorporation, bylaws and Minnesota law could diminish the
opportunity for shareholders to participate in acquisition proposals at a price
above the then-current market price of our common stock.  For example,
while we have no present plans to issue any preferred stock, our Board of
Directors, without further shareholder approval, may issue shares of
undesignated preferred stock and fix the powers, preferences, rights and
limitations of such class or series, which could adversely affect the voting
power of the common shares.  In addition, our bylaws provide for an
advance notice procedure for nomination of candidates to our Board of Directors
that could have the effect of delaying, deterring or preventing a change in
control.  Further, as a Minnesota corporation, we are subject to
provisions of the Minnesota Business Corporation Act, or MBCA, regarding
"business combinations," which can deter attempted takeovers in certain
situations.  Pursuant to the terms of a shareholder rights plan
adopted in February 2007, each outstanding share of common stock has one
attached right.  The rights will cause substantial dilution of the
ownership of a person or group that attempts to acquire the Company on terms not
approved by the Board of Directors and may have the effect of deterring hostile
takeover attempts.  We amended our shareholder rights plan to permit
the issuance of the common stock and warrants to the investor in the November
2010 offering and therefore the investor may acquire up to 25% of our
outstanding common stock.  The effect of these anti-takeover
provisions may be to deter business combination transactions not approved by our
Board of Directors, including acquisitions that may offer a premium over the
market price to some or all shareholders.  We may, in the future,
consider adopting additional anti-takeover measures.  The authority of
our Board to issue undesignated preferred or other capital stock and the
anti-takeover provisions of the MBCA, as well as other current and any future
anti-takeover measures adopted by us, may, in certain circumstances, delay,
deter or prevent takeover attempts and other changes in control of the Company
not approved by our Board of Directors.





ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS





Use of Proceeds from Registered
Securities





On
October 27, 2009, we filed a registration statement on Form S-3 to register
securities up to $15 million in value for future issuance in our capital raising
activities. The registration statement became effective on November 13, 2009,
and the commission file number assigned to the registration statement is
333-162694.





On April
22, 2010 we entered into a Sales Agreement (the “Agreement”) with C.K. Cooper
& Company, Inc. (“CKCC”). Pursuant to the terms of the Agreement, the
Company may offer and sell (the “Offering”) from time to time through CKCC, as
the Company’s  sales agent, up to $4 million of shares of the
Company’s common stock, par value $0.001 per share (the “Shares”). CKCC is not
required to sell any specific number or dollar amount of Shares but will use its
commercially reasonable efforts, as the Company’s agent and subject to the terms
of the Agreement, to sell the Shares offered, as instructed by the Company.
Sales of the Shares, if any, may be made by means of ordinary brokers’
transactions on the NYSE AMEX at market prices and such other sales as agreed to
by the Company and CKCC. CKCC will receive from us a commission of 2.0% based on
the gross sales price per share for any Shares sold through it as agent under
the Agreement. Net proceeds from the sale of the Shares will be used for general
corporate purposes. The Company has also agreed to reimburse CKCC for certain
expenses incurred in connection with entering into the Agreement and has
provided CKCC with customary indemnification rights.  We filed a
prospectus supplement relating to the Agreement described above on April 23,
2010.


27


On July
29, 2010, we entered into an amendment (the “Amendment”) to the Agreement to
extend the term of the offering of Shares by CKCC as the Company’s sales agent
through December 31, 2010. The offering of Shares pursuant to the Agreement, as
amended by the Amendment, terminated on December 31, 2010.





On
October 1, 2010 the Company instructed CKCC via placement notice permitting “at
the market” sales of common stock through October 31, 2010.  CKCC sold
304,227 shares of common stock on behalf of the Company, with the Company
receiving $250,632 in equity net of offering costs of $118,149 ($7,301 in
commissions, $110,276 in legal and accounting expenses, and $571 in other
costs).





There was
no material change in the use of proceeds from our public offering as described
in our final prospectus filed with the SEC pursuant to Rule 424(b). Through
December 31, 2010 we have maintained the proceeds as cash and cash equivalents
and did not use any of the proceeds.





No
offering expenses were paid directly or indirectly to any of our directors or
officers (or their associates) or persons owning ten percent or more of any
class of our equity securities or to any other affiliates.





On
November 22, 2010, a securities purchase agreement was executed between Hudson
Bay Master Fund and the Company for 2,250,000 shares of common stock with Aurora
Capital acting as the broker for the transaction.  As part of the
transaction, Hudson Bay Master Fund received four series of warrants
(collectively, the "Warrants") - (i) Series A Warrants in an amount equal to
$500,000 divided by the lower of $1.50 and 90% of the average of the 3 lowest
volume weighted average prices out of the 15 trading days preceding the exercise
date (with a floor of $0.75 for a maximum of 666,667 shares of common stock
issuable upon exercise of the Series A Warrants); (ii) Series B Warrants in an
amount equal to 25% of the number of shares of common stock issued at the
closing, or Series B Warrants exercisable for 562,500 shares of common stock;
(iii) Series C Warrants in an amount equal to 125% of the number of shares of
common stock issued at the closing, or Series C Warrants exercisable for
2,812,500 shares of common stock; and (iv) Series D Warrants in an amount equal
to 125% of the number of shares of common stock issued at the closing, or Series
D Warrants exercisable for 2,812,500 shares of common stock but the Series D
Warrants will only be exercisable to the extent that any of the Series C
Warrants may not be exercised due to NYSE AMEX shareholder approval requirements
limiting the number of overall below-market securities issuable to no greater
than 4,418,026 shares of common stock. As a result of this limitation, the total
number of Series A, B and C Warrants that may be issued will not exceed Warrants
exercisable for an aggregate of 2,168,026 shares of common stock, and Series D
Warrants are expected to be issued to purchase 1,873,641 shares of common stock,
assuming the Series A Warrants are exercisable for the maximum number of shares
of common stock.





The
exercise price of each of the Series A, B and C Warrants will be equal to the
lower of (i) $1.50 and (ii) 90% of the average of the 3 lowest volume weighted
average prices out of the 15 trading days preceding the exercise date, but in no
event will the exercise price of the Series A Warrants be less than $0.75 per
share. The Warrants will have terms varying from one hundred twenty days from
the offering closing date for the Series A Warrants to six months from the
offering closing date for the Series B Warrants to five years from the initial
exercisability date for the Series C and D Warrants. The Series A, B and C
Warrants will be immediately exercisable following the closing of the offering.
The Series D Warrants will not be exercisable until six months after the closing
and will have an exercise price equal to $1.56. The Series A and Series C
Warrants were amended and restated via an Amendment Agreement dated December 27,
2010.





The
Shares and Warrants were issued pursuant to the Company's shelf registration
statement (the "Registration Statement") on Form S-3 (File No. 333-162694),
which became effective on November 13, 2009, and prospectus
supplements  filed on November 24, 2010 and on December 29,
2010.


28


By letter
agreement dated October 27, 2010, LifeTech Capital, a division of Aurora
Capital, LLC, acted as placement agent in connection with the placement of the
securities in the November 2010 offering. LifeTech  received a cash
fee of 5% of the gross proceeds received under the offering (excluding proceeds
received on the exercise of C or D Warrants), and  also received
warrants to purchase 3% of the common stock sold in the offering and 3% of the
Series A, B and C Warrants exercised at any time, which warrants issued to
LifeTech shall not be exercisable for six months following the closing, shall
have a five year term, and an exercise price of $1.56 per share.





The
November 2010 offering yielded $1,998,040, net of offering costs of $251,960
($112,500 of commission expense, $137,142 of legal and accounting expense and
$2,318 of other costs).  Warrant liabilities that total $1,724,000 as
established related to Series A, B, and C warrants.  Deferred
financing costs of $193,051 were established related to the warrant liabilities
for Series A, B, and C warrants.





There was
no material change in the use of proceeds from our public offering as described
in our final prospectus filed with the SEC pursuant to Rule 424 (b). Through
December 31, 2010 we had not used any of the net proceeds and invested the net
proceeds in cash and cash equivalents.





No
offering expenses were paid directly or indirectly to any of our directors or
officers (or their associates) or persons owning ten percent or more of any
class of our equity securities or to any other affiliates.





Unregistered
Sales of Equity Securities





In
October 2010, the Company offered a temporary reduction in the exercise price of
certain warrants to purchase shares of common stock previously issued, pursuant
to §4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D
promulgated thereunder, in 2005 and 2006.





On
October 20, 2010 the Company commenced soliciting warrant exercises from
existing holders at a reduced exercise price of $0.95 per warrant exercised
prior to October 31, 2010.  Warrant holders exercised warrants to
purchase 226,344 shares of common stock.  This solicitation of
warrants yielded $199,818 net of offering costs.





No
placement or underwriting fees were paid in connection with the warrant
solicitation. Proceeds from the exercise of the warrants were used for general
working capital purposes.


29


ITEM
6. EXHIBITS





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


30


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




Dated:
      February 14, 2011ISORAY,
      INC., a Minnesota corporationBy
            /s/ Dwight
    BabcockDwight
      Babcock, Chief Executive Officer
              (Principal
      Executive Officer)





By
              /s/ Brien
      RagleBrien
      Ragle, Controller
                (Principal
      Financial and Accounting
Officer)


31