U NITED S TATES S ECURITIES
      AND E XCHANGE C OMMISSION


Washington,
      D.C. 20549




FORM
      10-QSB




Quarterly
      Report of Small Business Issuers under Section 13 or 15(d) of the Securities
      Exchange Act of


1934
      for
      the quarterly period ended March 31, 2007




Commission
      File No. 000-14247




**I** **SO** **R** **AY** **,
      I** **NC.**


(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)Issuer's
                telephone number, including area code:(509)
                375-1202Check
                whether the issuer has (1) filed all reports required to be filed
                by
                Section 13 or 15(d) of the Exchange Act during the past 12 months
                (or for
                such shorter period the Company was required to file such reports),
                and
                (2) has been subject to such filing requirements for the past 90
                days.
                YesxNoo
              
              Indicate
                by check mark whether the Registrant is a shell company (as defined
                in
                Rule 12b-2 of the Exchange Act):YesoNoxNumber
                of shares outstanding of each of the issuer's classes of common
                equity:Class
            Outstanding
                as of May 9, 2007Common
                stock, $0.001 par value
            22,732,108Transitional
                Small Business Disclosure Format : YesoNox









**ISORAY,
      INC.**




**Table
      of Contents**







PagePART
                I FINANCIAL INFORMATION
            
            
            1Item
                1. Consolidated Unaudited Financial Statements
            
            
            1Consolidated
                Balance Sheets
            
            
            1Consolidated
                Unaudited Statements of Operations
            
            
            2Consolidated
                Unaudited Statements of Cash Flows
            
            
            3Notes
                to Consolidated Unaudited Financial Statements
            
            
            4Item
                2. Management's Discussion and Analysis of Financial
                Conditionand
                Results of Operations
            
            
            9Item
                3. Controls and Procedures
            
            
            19PART
                II OTHER INFORMATIONItem
                2. Unregistered Sales of Equity Securities
            
            
            20Item
                4. Submission of Matters to a Vote of Security Holders
            
            
            20Item
                6. Exhibits and Reports on Form 8-K
            
            
            20SIGNATURES
            
            
            22













PART
      I
      FINANCIAL INFORMATION


Item
      1.
      Consolidated Unaudited Financial Statements





**IsoRay,
                Inc. and Subsidiary****Consolidated
                Balance Sheets****March
                31,****2007**
            
            **June
                30,****(Unaudited)**
            
            **2006****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            22,214,256
            
            $
            2,207,452Accounts
                receivable, net of allowance for doubtful accountsof
                $111,421 and $85,183, respectively
            
            
            1,243,316
            
            
            596,447Inventory
            
            
            270,782
            
            
            161,381Prepaid
                expenses
            
            
            405,910
            
            
            161,546Total
                current assets
            
            
            24,134,264
            
            
            3,126,826Fixed
                assets, net of accumulated depreciation
            
            
            2,145,485
            
            
            1,642,293Deferred
                financing costs, net of accumulated amortization
            
            
            208,789
            
            
            274,358Licenses,
                net of accumulated amortization
            
            
            258,307
            
            
            273,475Other
                assets, net of accumulated amortization
            
            
            347,994
            
            
            338,987Total
                assets
            
            $
            27,094,839
            
            $
            5,655,939**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            807,206
            
            $
            584,296Accrued
                payroll and related taxes
            
            
            412,945
            
            
            614,645Accrued
                interest payable
            
            
            13,456
            
            
            11,986Notes
                payable, due within one year
            
            
            44,330
            
            
            51,351Capital
                lease obligations, due within one year
            
            
            204,448
            
            
            183,554Convertible
                debentures payable, due within one year
            
            
            355,000
            
            
            455,000Total
                current liabilities
            
            
            1,837,385
            
            
            1,900,832Notes
                payable, due after one year
            
            
            543,278
            
            
            581,557Capital
                lease obligations, due after one year
            
            
            64,356
            
            
            220,415Asset
                retirement obligation
            
            
            72,115
            
            
            67,425Total
                liabilities
            
            
            2,517,134
            
            
            2,770,229Shareholders'
                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 and 144,759 shares issued andoutstanding
            
            
            59
            
            
            145Common
                stock, $.001 par value; 100,000,000 shares authorized;22,732,108
                and 15,157,901 shares issued and outstanding
            
            
            22,732
            
            
            15,158Subscriptions
                receivable
            
            
            -
            
            
            (6,122,007
            )Additional
                paid-in capital
            
            
            44,971,147
            
            
            22,538,675Accumulated
                deficit
            
            
            (20,416,233
            )
            
            (13,546,261
            )Total
                shareholders' equity
            
            
            24,577,705
            
            
            2,885,710Total
                liabilities and shareholders' equity
            
            $
            27,094,839
            
            $
            5,655,939





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





1


**IsoRay,
                Inc. and Subsidiary****Consolidated
                Statements of Operations****(Unaudited)****Three
                months ended March 31,**
            
            **Nine
                months ended March 31,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Product
                sales
            
            $
            1,645,694
            
            $
            479,225
            
            $
            4,085,293
            
            $
            1,176,387Cost
                of product sales
            
            
            1,456,978
            
            
            791,457
            
            
            4,132,518
            
            
            2,427,897Gross
                margin (loss)
            
            
            188,716
            
            
            (312,232
            )
            
            (47,225
            )
            
            (1,251,510
            )Operating
                expenses:Research
                and development expenses
            
            
            437,143
            
            
            86,194
            
            
            898,995
            
            
            208,813Sales
                and marketing expenses
            
            
            849,744
            
            
            325,858
            
            
            2,412,691
            
            
            981,429General
                and administrative expenses
            
            
            937,905
            
            
            738,494
            
            
            3,492,565
            
            
            2,374,887Total
                operating expenses
            
            
            2,224,792
            
            
            1,150,546
            
            
            6,804,251
            
            
            3,565,129Operating
                loss
            
            
            (2,036,076
            )
            
            (1,462,778
            )
            
            (6,851,476
            )
            
            (4,816,639
            )Non-operating
                income (expense):Interest
                income
            
            
            68,760
            
            
            25,472
            
            
            158,947
            
            
            35,624Financing
                expense
            
            
            (56,772
            )
            
            (81,149
            )
            
            (177,443
            )
            
            (432,257
            )Debt
                conversion expense
            
            
            -
            
            
            (141,414
            )
            
            -
            
            
            (385,511
            )Non-operating
                income (expense), net
            
            
            11,988
            
            
            (197,091
            )
            
            (18,496
            )
            
            (782,144
            )Net
                loss
            
            $
            (2,024,088
            )
            $
            (1,659,869
            )
            $
            (6,869,972
            )
            $
            (5,598,783
            )Basic
                and Diluted loss per share
            
            $
            (0.12
            )
            $
            (0.11
            )
            $
            (0.42
            )
            $
            (0.49
            )Shares
                used in computing net loss per share:Basic
                and Diluted
            
            
            17,400,355
            
            
            14,567,672
            
            
            16,198,067
            
            
            11,502,400





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





2


**IsoRay,
                Inc. and Subsidiary****Consolidated
                Statements of Cash Flows****(Unaudited)****Nine
                months ended March 31,****2007**
            
            **2006****CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                loss
            
            $
            (6,869,972
            )
            $
            (5,598,783
            )Adjustments
                to reconcile net loss to net cash used by operating activities:Depreciation
                and amortization of fixed assets
            
            
            283,422
            
            
            174,751Amortization
                of deferred financing costs and other assets
            
            
            99,387
            
            
            185,634Accretion
                of asset retirement obligation
            
            
            4,690
            
            
            -Noncash
                share-based compensation
            
            
            1,022,241
            
            
            -Merger
                consulting fees paid by issuance of common stock
            
            
            -
            
            
            330,000Consulting
                and repair fees paid by issuance of common stock
            
            
            -
            
            
            39,752Rent
                expense paid by issuance of common stock
            
            
            -
            
            
            60,018Debt
                conversion expense
            
            
            -
            
            
            385,511Changes
                in operating assets and liabilities:Accounts
                receivable, net
            
            
            (646,869
            )
            
            (543,341
            )Inventory
            
            
            (109,401
            )
            
            (229,414
            )Prepaid
                expenses
            
            
            (244,364
            )
            
            66,285Accounts
                payable and accrued expenses
            
            
            222,910
            
            
            (324,560
            )Accrued
                payroll and related taxes
            
            
            (56,700
            )
            
            128,768Accrued
                interest payable
            
            
            1,470
            
            
            (41,325
            )Net
                cash used by operating activities
            
            
            (6,293,186
            )
            
            (5,366,704
            )**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchases
                of fixed assets
            
            
            (786,614
            )
            
            (374,273
            )Additions
                to licenses and other assets
            
            
            (27,657
            )
            
            (352,815
            )Cash
                acquired in reverse acquisition
            
            
            -
            
            
            32,587Net
                cash used by investing activities
            
            
            (814,271
            )
            
            (694,501
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Borrowings
                on bank line of credit
            
            
            -
            
            
            200,000Repayments
                on bank line of credit
            
            
            -
            
            
            (200,000
            )Proceeds
                from issuance of notes payable
            
            
            -
            
            
            250,000Proceeds
                from sales of convertible debentures payable
            
            
            -
            
            
            550,000Principal
                payments on notes payable
            
            
            (95,301
            )
            
            (486,700
            )Principal
                payments on capital lease obligations
            
            
            (135,165
            )
            
            (115,693
            )Proceeds
                from cash sales of common stock, net of offering costs
            
            
            19,819,962
            
            
            6,516,413Proceeds
                from cash sales of preferred stock, pursuant to exercise of warrants
            
            
            8,709
            
            
            6,985Proceeds
                from cash sales of common stock, pursuant to exercise of warrants
            
            
            6,448,181
            
            
            49,950Proceeds
                from cash sales of common stock, pursuant to exercise of options
            
            
            1,106,333
            
            
            110,058Payment
                of dividend to preferred shareholders
            
            
            (38,458
            )
            
            -Payments
                to common shareholders in lieu of issuing fractional shares
            
            
            -
            
            
            (734
            )Net
                cash provided by financing activities
            
            
            27,114,261
            
            
            6,880,279Net
                increase in cash and cash equivalents
            
            
            20,006,804
            
            
            819,074Cash
                and cash equivalents, beginning of period
            
            
            2,207,452
            
            
            1,653,144**CASH
                AND CASH EQUIVALENTS, END OF PERIOD**
            
            $
            22,214,256
            
            $
            2,472,218Non-cash
                investing and financing activities:Cashless
                exercise of common stock options
            
            $
            145,000
            
            $
            -Exchange
                of convertible debentures payable for shares of common stock
            
            
            49,999
            
            
            3,682,875Fixed
                assets acquired by capital lease obligations
            
            
            -
            
            
            507,947Issuance
                of common shares as partial payment for production equipment
            
            
            -
            
            
            25,248Issuance
                of common shares as partial payment of notes payable
            
            
            -
            
            
            48,313Liabilities
                acquired in acquisition
            
            
            -
            
            
            21,355Prepaid
                rent paid by issuance of common stock
            
            
            -
            
            
            120,036Issuance
                of warrants as an inducement for a note payable
            
            
            -
            
            
            60,000




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





3


**IsoRay,
      Inc.**


**Notes
      to the Unaudited Consolidated Financial Statements**


**For
      the three and nine month periods ended March 31, 2007 and
      2006**








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





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





The
      accompanying interim consolidated financial statements have been prepared in
      conformity with U.S. generally accepted accounting principles, consistent in
      all
      material respects with those applied in the Company’s Annual Report on Form
      10-KSB for the fiscal year ended June 30, 2006, except for the July 1, 2006
      adoption of Statement of Financial Accounting Standards No. 123R,
“Share-Based Payment” (“SFAS No. 123R”) — See Note 2. 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-QSB should be read in conjunction with the Company’s
      Annual Report on Form 10-KSB for the fiscal year ended June 30,
      2006.





**2.**  **Share-Based
      Compensation**





Effective
      July 1, 2006, the Company adopted SFAS No. 123R using the modified-prospective
      method. Prior to July 1, 2006, the Company accounted for share-based
      employee compensation, including stock options, using the method prescribed
      in
      Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* and
      related interpretations (“APB 25”). No share-based employee compensation cost
      was reflected in the statement of operations prior to the adoption of SFAS
      No.
      123R. Results for prior periods have not been restated.





The
      following table presents the share-based compensation expense recognized in
      accordance with SFAS No. 123R during the three and nine months ended March
      31,
      2007 and in accordance with APB 25 during the three and nine months ended March
      31, 2006:





Three
                months
            
            Nine
                monthsended
                March 31,
            
            ended
                March 31,2007
            
            2006
            
            2007
            
            2006Cost
                of product sales
            
            $
            21,076
            
            $
            --
            
            $
            92,401
            
            $
            --Research
                and development
            
            
            8,418
            
            
            --
            
            
            28,132
            
            
            --Sales
                and marketing
            
            
            54,737
            
            
            --
            
            
            153,974
            
            
            --General
                and administrative
            
            
            40,123
            
            
            --
            
            
            747,734
            
            
            --Total
                share-based compensation
            
            $
            124,354
            
            $
            --
            
            $
            1,022,241
            
            $
            --





The
      adoption of SFAS No. 123R increased net loss for the three and nine months
      ended
      March 31, 2007 by $124,354 and $1,022,241, respectively. Basic loss per common
      share for the three and nine months ended March 31, 2007 would have been $0.11
      and $0.36, respectively, if the Company had not adopted SFAS No. 123R, compared
      to reported basic loss per common share of $0.12 and $0.42, respectively. The
      total value of the stock option awards is expensed ratably over the service
      period of the employees receiving the awards. As of March 31, 2007, total
      unrecognized compensation cost related to stock-based options and awards was
      $1,201,747 and the related weighted-average period over which it is expected
      to
      be recognized is approximately 1.05 years.


4








The
      Company currently provides stock-based compensation under three equity incentive
      plans approved by the Board of Directors: the Amended and Restated 2005 Employee
      Stock Option Plan, the Amended and Restated 2005 Stock Option Plan, and the
      Amended and Restated 2006 Director Stock Option Plan. Stock option awards
      granted from these plans are granted at the fair market value on the date of
      grant, and vest over a period determined at the time the options are granted,
      generally ranging from zero to three years, and generally have a maximum term
      of
      ten years. For stock options with graded vesting terms, the Company recognizes
      compensation cost on a straight-line basis over the requisite service period
      for
      each separately vesting portion of the award as if the award was, in substance,
      multiple awards.





A
      summary
      of stock option activity within the Company’s share-based compensation plans and
      charges for the nine months ended March 31, 2007 is as follows:





Shares
            
            Price
                (a)
            
            Life
                (b)
            
            Value
                (c)Outstanding
                at June 30, 2006
            
            
            3,129,692
            
            $
            2.05Granted
                (d)
            
            
            836,700
            
            
            3.31Cancelled
            
            
            (179,454
            )
            
            2.68Exercised
            
            
            (698,499
            )
            
            1.16Outstanding
                at March 31, 2007
            
            
            3,088,439
            
            $
            2.56
            
            
            8.37
            
            $
            4,849,883Expected
                to vest atMarch
                31, 2007
            
            
            3,029,841
            
            $
            2.55
            
            
            8.64
            
            $
            4,785,200Vested
                and exercisable atMarch
                31, 2007
            
            
            2,264,761
            
            $
            2.19
            
            
            8.48
            
            $
            4,308,198





(a)
            Weighted
                average price per share.


(b)
            Weighted
                average remaining contractual life.


(c)
            Aggregate
                intrinsic value.


(d)
            All
                options granted had exercise prices equal to the ending market price
                of
                the Company’s common stock on the grant
                date.





The
      aggregate intrinsic value of options exercised during the nine months ended
      March 31, 2007 was $2,065,450.





The
      weighted average fair value of stock option awards granted and the key
      assumptions used in the Black-Scholes valuation model to calculate the fair
      value are as follows for the three and nine months ended March 31, 2007 and
      2006:




Three
                months
            
            Nine
                monthsended
                March 31,
            
            ended
                March 31,2007
            
            2006
            
            2007
            
            2006Weighted
                average fair value of options granted
            
            $
            2.68
            
            $
            2.94
            
            $
            2.18
            
            $
            1.31Key
                assumptions used in determining fair value:Weighted
                average risk-free interest rate
            
            
            4.45
            %
            
            4.78
            %
            
            4.82
            %
            
            4.58
            %Expected
                life of the option (in years)
            
            
            4.97
            
            
            7.25
            
            
            5.50
            
            
            7.53Expected
                stock price volatility
            
            
            80.00
            %
            
            33.50
            %
            
            75.65
            %
            
            30.84
            %Expected
                dividend yield
            
            
            0.00
            %
            
            0.00
            %
            
            0.00
            %
            
            0.00
            %





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


5








The
      following table illustrates the effect on net loss and net loss per common
      share
      for the three and nine months ended March 31, 2006 as if the Company had
      applied the fair value recognition provisions of SFAS No. 123 to all outstanding
      stock option awards for periods presented prior to the Company’s adoption of
      SFAS No. 123R:





Three
                months
            
            Nine
                monthsended
            
            endedMarch
                31,
            
            March
                31,2006
            
            2006Net
                loss, as reported
            
            $
            1,659,869
            
            $
            5,598,783Stock-based
                compensation expense determinedunder
                fair value methods for all stock options
            
            
            180,000
            
            
            336,000Proforma
                net loss
            
            $
            1,839,869
            
            $
            5,934,783Net
                loss per share:Basic,
                as reported
            
            $
            0.11
            
            $
            0.49Basic,
                pro forma
            
            $
            0.13
            
            $
            0.52





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





The
      Company accounts for its income (loss) per common share according to SFAS No.
      128, *Earnings
      Per Share* .
      Under
      the provisions of SFAS No. 128, primary and fully diluted earnings per share
      are
      replaced with basic and diluted earnings per share. Basic earnings per share
      is
      calculated by dividing net income (loss) available to common shareholders by
      the
      weighted average number of common shares outstanding, and does not include
      the
      impact of any potentially dilutive common stock equivalents. Common stock
      equivalents, including warrants to purchase the Company's common stock and
      common stock issuable upon the conversion of notes payable, are excluded from
      the calculations when their effect is antidilutive. At March 31, 2007 and 2006,
      the calculation of diluted weighted average shares does not include preferred
      stock, options, or warrants that are potentially convertible into common stock
      as those would be antidilutive due to the Company’s net loss
      position.





Securities
      that could be dilutive in the future as of March 31, 2007 and 2006 are as
      follows:





March
                31,2007
            
            2006Preferred
                stock
            
            
            59,065
            
            
            199,264Preferred
                stock warrants
            
            
            -
            
            
            179,512Common
                stock warrants
            
            
            3,627,767
            
            
            2,907,533Common
                stock options
            
            
            3,088,439
            
            
            2,815,768Convertible
                debentures
            
            
            85,542
            
            
            109,638Total
                potential dilutive securities
            
            
            6,860,813
            
            
            6,211,715




6





**4.**  **Risks
      and Uncertainties**





Our
      independent auditors have noted in their reports on our financial statements
      as
      of June 30, 2006 and 2005 and for the years then ended, that there is
      substantial doubt regarding our ability to continue as a going concern. Our
      large operating losses and accumulated deficit, among other things, have raised
      substantial doubt about our ability to continue as a going concern. However, in
      March 2007, we completed a public equity offering (see Note 7) and a warrant
      call (see Note 8) that raised gross proceeds of approximately $20 million.




**5.**  **Preferred
      Dividends**





On
      February 1, 2007, the Board of Directors declared a dividend on the Series
      B
      Preferred Stock of all outstanding and cumulative dividends through December
      31,
      2006. The total dividends of $38,458 were paid on February 15,
      2007.





**6.**  **Share
      Rights Plan**





On
      February 1, 2007, the Board of Directors adopted a share rights plan. The plan
      grants to the Company’s common shareholders a right to purchase a fractional
      share of preferred stock for each outstanding common share held of record at
      the
      close of business on February 16, 2007, subject to adjustment. This purchase
      right generally cannot be exercised by the Company’s common shareholders to
      purchase stock until after a person or group acquires beneficial ownership
      of
      15% or more of the Company's voting stock. However, the purchase rights held
      by
      the person or group that acquires 15% voting power will automatically become
      void and they will be unable to exercise their rights to purchase any shares
      of
      stock of the Company.




In
      addition, upon a merger or similar transaction resulting in an acquisition
      of
      the Company, each exercisable purchase right can be exercised by its holder
      to
      purchase common stock of the acquiring company with a market value of twice
      the
      right's exercise price. The purchase rights will expire on February 16, 2017.




Until
      a
      person or group acquires 15% or more of the Company's voting stock, the Board
      of
      Directors may redeem the rights for $.001 per right (subject to adjustment).
      In
      certain events, the Board of Directors may also exchange the rights for shares
      of the Company’s common stock, delay or temporarily suspend the exercisability
      of the rights or reduce the 15 percent stock ownership threshold to not less
      than 10 percent.




**7.**  **Public
      Equity Offering**





On
      March 20, 2007, the Company entered into definitive securities purchase
      agreements (the “Purchase Agreements”) with certain institutional investors
      pursuant to which the Company agreed to issue and sell an aggregate of 4,130,500
      shares of its common stock at $4.00 per share, through a registered direct
      offering, for aggregate gross proceeds of approximately $16,522,000, before
      deducting estimated fees and expenses associated with the offering (the
“Offering”). As part of the Offering, each purchaser of five shares of common
      stock received a warrant to purchase one share of common stock at an exercise
      price of $5.00 per share with a 4-year term. A total of 826,100 warrants were
      issued under these terms. The closing took place on March 22, 2007. The
      shares of common stock offered by the Company in this transaction were
      registered under the Company’s existing shelf registration statement (File
      No. 333-140246) on Form S-3, which was declared effective by the Securities
      and Exchange Commission on February 15, 2007, and the prospectus supplement
      dated March 21, 2007.


7








Punk,
      Ziegel & Company, L.P. and Maxim Group LLC (the “Placement Agents”) acted as
      the placement agents for the Offering. On March 14, 2007 and February 2, 2006,
      the Company executed placement agent agreements (the “Placement Agent
      Agreements”) by and between the Company and Punk, Ziegel & Company, L.P. and
      Maxim Group LLC, respectively. The Company paid the Placement Agents an
      aggregate fee equal to 6% of the gross proceeds of the Offering or approximately
      $991,000. In addition, the Placement Agents also received 206,526 warrants
      with
      an exercise price of $4.40 per share and a 5-year term as part of their overall
      fee.





**8.**  **Warrant
      Call**





As
      part
      of the August 2006 Stock Purchase Agreement, the Company issued warrants with
      an
      exercise price of $3.00 per share. The warrants were callable by the Company
      for
      45 days after a period of 60 trading days in which the closing price of the
      underlying stock was at or above $4.50 per share for 30 of the 60
      days.





As
      of
      February 16, 2007, the Company’s common stock had traded at or above $4.50 for
      30 of the previous 60 days. On February 21, 2007, the Company sent out notices
      to the warrant holders establishing a call date of March 26, 2007. The warrant
      holders had the option to either exercise their warrants or permit the Company
      to repurchase the warrants for $.01 per share on the call date. All of the
      remaining warrants were exercised prior to the call date.





**9.**  **Subsequent
      Events**





Listing
      on the American Stock Exchange


On
      April
      19, 2007, the Company’s common stock was listed on the American Stock Exchange
      under the ticker symbol ISR.





New
      Facility Lease


On
      May 2,
      2007, IsoRay Medical, Inc. ("Medical"), the wholly owned operating subsidiary
      of
      the Company, entered into a lease for its new production facility with Energy
      Northwest, the owner of the Applied Process Engineering Laboratory. The new
      lease provides Medical with 19,328 square feet of manufacturing and office
      space
      and the Company intends to move all manufacturing operations to this new leased
      space and vacate its leased space at the PEcoS-IsoRay Radioisotope Laboratory
      ("PIRL") when the PIRL lease expires in October of 2007. The
      APEL
      lease has a three year term expiring on April 30, 2010, an option to renew
      for
      two additional three-year terms, and monthly rent of approximately $26,700,
      subject to annual increases based on the Consumer Price Index. It is anticipated
      that it will take the Company approximately six to nine months to finish the
      necessary improvements and install the required equipment before operations
      can
      begin in the facility.


8


**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-QSB 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-QSB, 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
      revenue, 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 17 below and in the “Risk
      Factors” sections of our Form 10-KSB for the fiscal year ended June 30, 2006 and
      our Prospectus Supplement filed on March 23, 2007, that may cause actual results
      to differ materially.*





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





**Critical
      Accounting Policies and Estimates**





The
      discussion and analysis of the Company’s financial condition and results of
      operations are based upon its consolidated financial statements, which have
      been
      prepared in accordance with accounting principles generally accepted in the
      United States of America. The preparation of these financial statements requires
      management to make estimates and judgments that affect the reported amounts
      of
      assets, liabilities, revenues and expenses, and related disclosure of contingent
      liabilities. On an on-going basis, management evaluates past judgments and
      estimates, including those related to bad debts, inventories, accrued
      liabilities, and contingencies. Management bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities that are not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions. The accounting policies
      and
      related risks described in the Company’s annual report on Form 10-KSB as filed
      with the Securities and Exchange Commission on September 28, 2006 are those
      that
      depend most heavily on these judgments and estimates. As of March 31, 2007,
      there have been no material changes to any of the critical accounting policies
      contained therein except for the adoption of SFAS No. 123R as noted
      below.


9








**Share-Based
      Compensation**





As
      part
      of our adoption of SFAS No. 123R as of July 1, 2006, we were required
      to recognize the fair value of share-based compensation awards as an expense.
      We
      apply the Black-Scholes option-pricing model in order to determine the fair
      value of stock options on the date of grant, and we apply judgment in estimating
      key assumptions that are important elements in the model such as the expected
      stock-price volatility, expected stock option life and expected forfeiture
      ratios. Our estimates of these important assumptions are based on historical
      data and judgment regarding market trends and factors. If actual results are
      not
      consistent with our assumptions and judgments used in estimating these factors,
      we may be required to record additional share-based compensation expense, which
      could be material to our results of operations.





**Adoption
      of SFAS No. 123R**





During
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      SFAS No. 123R, which requires companies to measure and recognize compensation
      expense for all share-based payments at fair value. Share-based payments include
      stock option and nonvested share grants. We grant options to purchase common
      stock to some of our employees and directors under various plans at prices
      equal
      to the market value of the stock on the dates the options were granted. We
      historically have accounted for stock options using the method prescribed in
      APB
      25 whereby if stock options are granted at the current market price then no
      compensation cost is recognized, and disclosed the pro forma effect on net
      earnings assuming compensation cost had been recognized in accordance with
      SFAS
      No. 123. SFAS No. 123R, which was effective for us beginning on July 1, 2006,
      eliminates the ability to account for share-based compensation transactions
      using APB 25, and generally requires that such transactions be accounted for
      using prescribed fair-value-based methods. SFAS No. 123R permits public
      companies to adopt its requirements using one of two methods: (a) a
“modified prospective” method in which compensation costs are recognized
      beginning with the effective date based on the requirements of SFAS No. 123R
      for
      all share-based payments granted or modified after the effective date, and
      based
      on the requirements of SFAS No. 123 for all awards granted to employees prior
      to
      the effective date of SFAS No. 123R that remain unvested on the effective date
      or (b) a “modified retrospective” method which includes the requirements of
      the modified prospective method described above, but also permits companies
      to
      restate based on the amounts previously recognized under SFAS No. 123 for
      purposes of pro forma disclosures either for all periods presented or for prior
      interim periods of the year of adoption. We have decided to adopt SFAS No.
      123R
      using the modified prospective method.





The
      following table presents the share-based compensation expense recognized in
      accordance with SFAS No. 123R during the three and nine months ended March
      31,
      2007 and in accordance with APB 25 during the three and nine months ended March
      31, 2006:





Three
                months
            
            Nine
                monthsended
                March 31,
            
            ended
                March 31,2007
            
            2006
            
            2007
            
            2006Cost
                of product sales
            
            $
            21,076
            
            $
            --
            
            $
            92,401
            
            $
            --Research
                and development
            
            
            8,418
            
            
            --
            
            
            28,132
            
            
            --Sales
                and marketing
            
            
            54,737
            
            
            --
            
            
            153,974
            
            
            --General
                and administrative
            
            
            40,123
            
            
            --
            
            
            747,734
            
            
            --Total
                share-based compensation
            
            $
            124,354
            
            $
            --
            
            $
            1,022,241
            
            $
            --





10





As
      of
      March 31, 2007, total unrecognized compensation cost related to stock-based
      options and awards was $1,201,747 and the related weighted-average period over
      which it is expected to be recognized is approximately
      1.05 years.





**Results
      of Operations**





**Three
      months ended March 31, 2007 and 2006**





***Revenues.***  The
      Company generated sales of $1,645,694 during the three months ended March 31,
      2007, compared to sales of $479,225 during the three months ended March 31,
      2006. The increase of $1,166,469 or 243% is due to increased sales volume of
      the
      Company’s 131 Cs
      seed.
      During the three months ended March 31, 2007, the Company sold its 131 Cs
      seed
      to 36 different medical centers as compared to 18 centers during the
      corresponding period of 2006.





***Cost
      of product sales.*** Cost of
      product sales was $1,456,978 for the three months ended March 31, 2007 compared
      to cost of product sales of $791,457 during the three months ended March 31,
      2006. The increase of $665,521 or 84% was due to the higher production levels
      during the three months ended March 31, 2007 which were related to the increase
      in sales volume over the corresponding period from 2006. The major components
      of
      the increase were wages, benefits and related taxes, materials, depreciation,
      preload expenses, and share-based compensation. Wages, benefits, and related
      taxes increased about $211,000 for the three months ended March 31, 2007 due
      to
      the hiring of additional production employees to support the higher production
      levels. Materials costs increased about $335,000 in 2007, due to increased
      sales
      volumes. Depreciation expense increased about $22,000 in 2007 due to the
      addition of equipment that was placed in service during the second half of
      the
      fiscal year ended June 30, 2006 and during fiscal year 2007. Preload expenses
      also increased by about $107,000 for the three months ended March 31, 2007
      due
      to the higher volume of sales. Share-based compensation expense was
      approximately $21,000 and $0 for the three months ended March 31, 2007 and
      2006,
      respectively, as the Company implemented SFAS No. 123R on July 1, 2006. These
      increases were partially offset by a decrease in payments to Pacific Northwest
      National Laboratory (“PNNL”). For the three months ended March 31, 2006, the
      Company used PNNL for manufacturing and other ancillary services. The Company
      stopped using PNNL to produce the seeds during fiscal year 2006 but continues
      to
      use PNNL for certain analytical support functions.





***Gross
      margin (loss).***  Gross
      margin was $188,716 for the three month period ended March 31, 2007. This
      represents an improvement of $500,948 or 160% over the corresponding period
      of
      2006’s gross loss of $312,232. The improvement in gross margin is due to higher
      revenues offsetting fixed production costs and increased production
      efficiency.





***Research
      and development.*** **** Research
      and development expenses for the three month period ended March 31, 2007 were
      $437,143 which represents an increase of $350,949 or 407% over the research
      and
      development expenses of $86,194 for the corresponding period of 2006. The major
      components of the increase were wages, benefits and related taxes, patent legal
      expenses, consulting, share-based compensation, and protocols expense. Wages,
      benefits and related taxes increased by about $68,000 for the three months
      ended
      March 31, 2007 as the Company employed more research personnel than in the
      corresponding period of 2006. During the three months ended March 31, 2007,
      the
      Company incurred about $111,000 of legal expenses related to patents and
      trademarks that were expensed. Consulting expenses were approximately $129,000
      and $0 for the three months ended March 31, 2007 and 2006, respectively. The
      Company’s consulting expenses increase in the three month period ended March 31,
      2007 relates to its on-going project to increase the efficiency of production.
      Share-based compensation expense was approximately $8,000 and $0 for the three
      months ended March 31, 2007 and 2006, respectively, as the Company implemented
      SFAS No. 123R on July 1, 2006. Clinical study protocol expenses increased about
      $31,000 for the three months ended March 31, 2007 due to additional payments
      to
      clinics for participation in the Company’s protocols.


11








***Sales
      and marketing expenses.*** **** Sales
      and
      marketing expenses were $849,744 for the three months ended March 31, 2007.
      This
      represents an increase of $523,886 or 161% compared to the three months ended
      March 31, 2006’s expenditures of $325,858 for sales and marketing. Wages,
      including payroll-related taxes, travel, office and other support expenses
      on
      behalf of our sales and marketing and customer service staff increased in 2007
      as the Company has expanded its sales and marketing force to better service
      the
      various doctors and clinics throughout the United States and to increase usage
      of its products. Conventions, tradeshows, and consulting expenses for 2007
      increased due to the Company’s continued efforts to expand its market share and
      increase brand and market awareness. Also included in sales and marketing
      expenses for 2007 is share-based compensation expense of approximately $55,000
      due to the Company’s implementation of SFAS No. 123R on July 1,
      2006.




***General
      and administrative expenses.*** General
      and administrative expenses for the three months ended March 31, 2007 were
      $937,905 compared to general and administrative expenses of $738,494 for the
      corresponding period of 2006. The increase of $199,411 or 27% is primarily
      due
      to approximately $40,000 of share-based compensation expense related to the
      implementation of SFAS No. 123R on July 1, 2006, approximately $118,000 of
      increased payroll costs due to a higher headcount, and approximately $81,000
      relating to investor relations and other public company expenses, and an
      increase in the bad debt expense of $62,000 as the Company increased its
      allowance for doubtful accounts during the three months ended March 31, 2007.
      These increased expenses were partially offset by a reduction in consulting
      fees
      as the prior year included consulting costs related to the 2006 private
      placement offerings, and a decrease in audit and legal fees as the Company
      had
      more regulatory and other filings in 2006 relating to various private placements
      and stock registration statements.





***Operating
      loss.*** Due to
      our rapid structural growth and the related need to capture additional market
      share, and significant research and development expenditures, we have not been
      profitable, and have generated operating losses since our inception. In the
      three months ended March 31, 2007, the Company had an operating loss of
      $2,036,076 which is an increase of $573,298 or 39% over the operating loss
      of
      $1,462,778 for the three months ended March 31, 2006.





***Interest
      income.*** Interest
      income increased by $43,288 or 170% to $68,760 for the three months ended March
      31, 2007. Interest income is mainly derived from excess funds held in certain
      near-liquid accounts.





***Financing
      expense.*** Financing expense for the three months ended March 31, 2007 was $56,772 or
      a
      decrease of $24,377 or 30% from financing expense of $81,149 for the
      corresponding period in 2006. Included in financing expense is interest expense
      of approximately $35,000 and $29,000 for the three months ended March 31, 2007
      and 2006, respectively. The increase in interest expense is due to the interest
      expense related to the Hanford Area Economic Investment Fund Committee (HAEIFC)
      loan that was entered into in June 2006. The remaining balance of financing
      expense represents the amortization of deferred financing costs which decreased
      due to the write-off in fiscal year 2006 of the deferred financing costs
      relating to the debentures that were converted to common stock, partially offset
      by the amortization of the HAEIFC deferred financing costs.





***Debt
      conversion expense.*** Debt
      conversion expense for the three months ended March 31, 2006 relates to the
      one-time recognition of $141,414 expense in short-term inducement to convert
      debentures.


12





**Nine
      months ended March 31, 2007 and 2006**





***Revenues.***  Sales
      for
      the nine months ended March 31, 2007 were $4,085,293 compared to sales of
      $1,176,387 for the nine months ended March 31, 2006. The increase of $2,908,906
      or 247% is due to increased sales volume of the Company’s 131 Cs
      seed.
      During the nine months ended March 31, 2007 the Company sold its 131 Cs
      seed
      to 44 different medical centers as compared to 22 centers during the
      corresponding period of 2006.





***Cost
      of product sales.*** Cost of
      product sales was $4,132,518 for the nine months ended March 31, 2007 compared
      to cost of product sales of $2,427,897 during the nine months ended March 31,
      2006. The increase of $1,704,621 or 70% was due to the higher production levels
      during the nine months ended March 31, 2007 which were related to the increase
      in sales volume over the corresponding period from 2006. The major components
      of
      the increase were wages, benefits and related taxes, materials, depreciation,
      preload expenses, and share-based compensation.  Wages, benefits, and
      related taxes increased about $623,000 for the nine months ended March 31,
      2007
      due to the hiring of additional production employees to support the higher
      production levels. Materials costs increased about $331,000 in 2007, due to
      increased sales volumes. Depreciation and amortization expense increased about
      $132,000 in 2007 due to the addition of equipment that was placed in service
      during the second half of the fiscal year ended June 30, 2006 and during fiscal
      year 2007. Preload expenses also increased by about $236,000 for the nine months
      ended March 31, 2007 due to the higher volume of sales. Share-based compensation
      expense was approximately $92,000 and $0 for the nine months ended March 31,
      2007 and 2006, respectively, as the Company implemented SFAS No. 123R on July
      1,
      2006. These increases were partially offset by a decrease in payments to Pacific
      Northwest National Laboratory (“PNNL”). For the nine months ended March 31,
      2006, the Company used PNNL for manufacturing and other ancillary services.
      The
      Company stopped using PNNL to produce the seeds during fiscal year 2006 but
      continues during fiscal year 2007 to use PNNL for certain analytical support
      functions.





***Gross
      margin (loss).***  Gross
      loss was $47,225 for the nine month period ended March 31, 2007. This represents
      an improvement of $1,204,285 or 96% over the corresponding period of 2006’s
      gross loss of $1,251,510. The improvement in gross loss is due to higher
      revenues offsetting fixed production costs and increased production
      efficiency.





***Research
      and development.*** **** Research
      and development expenses for the nine months ended March 31, 2007 were $898,995
      which represents an increase of $690,182 or 331% over the research and
      development expenses of $208,813 for the corresponding period of 2006. The
      major
      components of the increase were wages, benefits and related taxes, consulting,
      legal expenses, share-based compensation, and protocol expenses. Wages, benefits
      and related taxes were approximately $249,000 and $37,000 for the nine months
      ended March 31, 2007 and 2006, respectively, as the Company hired research
      scientists. Consulting expenses increased during 2007 due to a fiscal year
      2007
      project to increase the efficiency of production. During the nine months ended
      March 31, 2007, the Company incurred about $130,000 of legal expenses related
      to
      patents and trademarks that were expensed. Share-based compensation expense
      was
      approximately $28,000 and $0 for the nine months ended March 31, 2007 and 2006,
      respectively, as the Company implemented SFAS No. 123R on July 1, 2006. Clinical
      study protocol expenses were higher for the nine months ended March 31, 2007
      than in the corresponding period of 2006 due to additional payments to clinics
      for participation in the Company’s protocols.





***Sales
      and marketing expenses.*** **** Sales
      and
      marketing expenses were $2,412,691 for the nine months ended March 31, 2007.
      This represents an increase of $1,431,262 or 146% compared to the nine months
      ended March 31, 2006’s expenditures of $981,429 for sales and marketing. Wages,
      including payroll-related taxes, travel, office and other support expenses
      on
      behalf of our sales and marketing and customer service staff increased about
      $779,000 due to the hiring of additional sales and marketing personnel as the
      Company has more sales and marketing personnel than in the corresponding period
      of 2006. Conventions and tradeshows increased by about $196,000 due to the
      Company’s continued presence at these events in order to expand its market
      share. Marketing and advertising expenses increased about $111,000 as the
      Company has created and distributed brochures, videos, and other promotional
      literature designed to promote the benefits of our product. Consulting expenses
      increased due to consultants hired to increase brand and market awareness.
      Also
      included in sales and marketing expenses for the period ended March 31, 2007
      is
      share-based compensation expense of about $154,000 due to the implementation
      of
      SFAS No. 123R on July 1, 2006.


13








***General
      and administrative expenses.*** General
      and administrative expenses for the nine months ended March 31, 2007 were
      $3,492,565 compared to general and administrative expenses of $2,374,887 for
      the
      corresponding period of 2006. The increase of $1,117,678 or 47% is primarily
      due
      to approximately $748,000 of share-based compensation expense related to the
      implementation of SFAS No. 123R on July 1, 2006, a one-time severance accrual
      of
      $288,000, approximately $355,000 of increased payroll costs due to a higher
      headcount, and approximately $193,000 relating to investor relations and other
      public company expenses. These increased expenses were partially offset by
      a
      reduction in consulting fees of approximately $330,000 which represented merger
      consulting fees incurred in the three months ended September 30, 2005. Other
      consulting expenses also decreased approximately $144,000 as the Company hired
      more internal resources. In addition, audit related fees and legal expenses
      decreased approximately $65,000 as the Company had more regulatory and other
      filings in fiscal year 2006 due to the merger, private placements, and
      registration statement filings.





***Operating
      loss.*** Due to
      our rapid structural growth and related need to capture additional market share,
      product revenues not covering production costs, and significant research and
      development expenditures, we have not been profitable, and have generated
      operating losses since our inception. In the nine months ended March 31, 2007,
      the Company had an operating loss of $6,851,476 which is an increase of
      $2,034,837 or 42% over the operating loss of $4,816,639 for the nine months
      ended March 31, 2006. Included in the operating loss for the nine months ended
      March 31, 2007 is share-based compensation expense of $1,022,241 due to the
      implementation of SFAS No. 123R during the period and a one-time severance
      accrual of $288,000. Without these two expense items, our operating loss would
      have only increased by $724,596 or 15%.





***Interest
      income.*** Interest
      income increased by $123,323 or 346% to $158,947 for the nine months ended
      March
      31, 2007. Interest income is mainly derived from excess funds held in certain
      near-liquid accounts.





***Financing
      expense.*** Financing expense for the nine months ended March 31, 2007 was $177,443 or
      a
      decrease of $254,814 or 59% from financing expense of $432,257 for the
      corresponding period in 2006. Included in financing expense is interest expense
      of approximately $112,000 and $277,000 for the nine months ended March 31,
      2007
      and 2006, respectively. The decrease in interest expense is due to the
      conversion of debentures to common stock during the fiscal year ended June
      30,
      2006 partially offset by interest expense related to the Hanford Area Economic
      Investment Fund Committee (HAEIFC) loan that was entered into in June 2006.
      The
      remaining balance of financing expense represents the amortization of deferred
      financing costs which decreased due to the write-off in fiscal year 2006 of
      the
      deferred financing costs relating to the debentures that were converted to
      common stock, partially offset by the amortization of the HAEIFC deferred
      financing costs.


14








***Debt
      conversion expense.*** Debt
      conversion expense for the nine months ended March 31, 2006 relates to the
      one-time recognition of $385,511 expense in short-term inducement to convert
      debentures.





**Liquidity
      and capital resources** .
      At
      March 31, 2007, cash and cash equivalents amounted to $22,214,256. During the
      nine months ended March 31, 2007, the Company closed an institutional round
      of
      financing (August 2006) and a public direct equity offering (March 2007).
      Pursuant to the round of institutional funding the Company issued 2,063,000
      shares of common stock at a price of $2.50 per share and 2,269,300 common stock
      warrants (including broker warrant commissions) with an exercise price of $3.00
      per share. Pursuant to the public equity offering the Company issued 4,130,500
      shares of common stock at a price of $4.00 per share, 826,100 common stock
      warrants with an exercise price of $5.00 per share, and 206,526 common stock
      warrants representing placement agent warrants with an exercise price of $4.40
      per share. The institutional funding provided approximately $4.7 million, net
      of
      offering costs and the public equity offering provided approximately $15.1
      million, net of offering costs. Additionally, the Company issued 3,031,327
      shares of common stock pursuant to the exercise of common stock options and
      warrants and preferred stock warrants, which were exchanged for common stock
      immediately upon exercise. The Company received approximately $7.5 million
      in
      cash pursuant to these exercises.


The
        Company had approximately $21.4 million cash on hand as of May 4,
        2007 **.** As of
        that date management believed that the Company’s monthly required cash operating
        expenditures were approximately $700,000. Management believes that approximately
        $5 million will be spent on improvements and equipment for the Company’s new
        production facility. Management presently anticipates to reach break even
        within
        the latter half of calendar 2008 and believes cash and cash equivalents
        currently on hand will be sufficient to meet our anticipated cash requirements
        for operations, debt service, and capital expenditure requirements. Management
        believes the Company will reach break even with revenues of approximately
        $2 million per month, subject to continuing to efficiently manufacture our
        product. If we should not experience an increase in sales or experience
        unforeseen manufacturing constraints, we may need to obtain additional
        funding.




Our
      growth plans for the remainder of fiscal 2007 include expanding sales to new
      customers, growing sales volume with existing customers, and developing
      additional therapies. Additional production capability, including new facilities
      and equipment and additional employees, will be needed to meet our anticipated
      growth. The Company completed a review of its current facilities, lease
      agreements and future needs based on current forecasts. The current production
      facility lease ends in October 2007 and the landlord has indicated it will
      not
      renew the lease. Management has also determined that a larger facility is
      necessary to handle the anticipated sales growth as the current production
      facility has limited space.




On
      May 2,
      2007, the Company entered into a lease for a new production facility with 19,328
      square feet of manufacturing and office space. The Company has already obtained
      the necessary permits and has begun to make the necessary leasehold
      improvements. The Company has applied for a radioactive material license
      amendment for this new facility and management believes the Company will be
      able
      to obtain the license in a timely manner. This new facility is expected to
      be
      operational before the end of calendar year 2007. It is possible that the
      Company will not be able to vacate its existing production facility by the
      end
      of its lease due to its new facility not being completed in time. In addition,
      there will likely be residual radioactive materials in the Company’s equipment
      that will need to be remediated prior to removing the equipment from the
      facility. The Company is in negotiations with the landlord to extend the current
      lease for several months to enable a smooth transition to the new facility
      and
      allow for removal of the residual radioactive materials.





Management
      believes that the new production facility will be able to accommodate the
      Company’s anticipated future growth during the lease term. The Company continues
      to use the Pacific Northwest National Laboratory ("PNNL") to provide third-party
      assay of its products, but has otherwise vacated PNNL facilities. Management
      is
      also currently setting up facilities to move the third party assay of its
      products in house which will reduce isotope depletion and also minimize assay
      expenditures. Management believes that if the Company is unable to complete
      the
      leasehold improvements or obtain the radioactive material license amendment
      before having to vacate the present manufacturing facility that a temporary
      manufacturing facility is available and could be used, although production
      capacity and scheduling flexibility would be limited.


15








IsoRay
      has two loan facilities in place as of March 31, 2007. The first loan is from
      the Benton-Franklin Economic Development District (“BFEDD”) in an original
      principal amount of $230,000 and was funded in December 2004. It bears interest
      at eight percent and has a sixty month term with a final balloon payment. As
      of
      March 31, 2007, the principal balance owed was $189,004. This loan is secured
      by
      certain equipment, materials and inventory of IsoRay, and also required personal
      guarantees, for which the guarantors were issued approximately 70,455 shares
      of
      common stock. The second loan is from the Hanford Area Economic Investment
      Fund
      Committee and was originated in June 2006. The loan has a total facility of
      $1,400,000 and bears interest at nine percent. As of March 31, 2007, the Company
      has taken only a partial draw of $418,670 on the facility and the remaining
      facility of $981,330 is available to use to purchase equipment. The principal
      balance owed on the loan as of March 31, 2007 was $398,604. This loan is secured
      by receivables, equipment, materials and inventory, and certain life insurance
      policies.





The
      Company had a line of credit from Columbia River Bank, which provided credit
      in
      the amount of $375,000. This line expired on March 1, 2007 and the Company
      is
      currently working to renew this line.





The
      Company has certain capital leases for production and office equipment that
      expire at various times from March 2008 to April 2009. These leases currently
      call for total monthly payments of $19,361. The total of all capital lease
      obligations at March 31, 2007 was $268,804.





At
      March
      31, 2007, the Company had outstanding $355,000 of convertible debentures. These
      debentures could be converted into 85,542 shares of common stock at a conversion
      rate of $4.15 per share. Each debenture bears interest at an annual rate of
      eight percent (not compounded) with accrued interest paid quarterly. The
      debentures mature at various times from April 2007 to June 2007.





In
      February 2006, the Company signed a license agreement with International
      Brachytherapy s.a. (“IBt”) covering North America and providing the Company with
      access to IBt’s Ink Jet production process and its proprietary polymer seed
      technology for use in brachytherapy procedures using Cesium-131. The Company
      paid license fees of $275,000 during 2006 but did not make another payment
      of
      $225,000 that was due in August 2006 or the minimum royalty payments in 2007
      of
      $100,000 per quarter as stated in the agreement. The Company has been in
      negotiations with IBt to modify this agreement to allow further evaluation
      of
      the polymer seed technology before deciding to implement it with
      Cesium-131.





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





The
      Company has no off-balance sheet arrangements.





**Going
      Concern Issues**




Our
      independent auditors have noted in their reports on our financial statements
      as
      of June 30, 2006 and 2005 and for the years then ended, that there is
      substantial doubt regarding our ability to continue as a going concern. We
      had
      net losses of $8,218,130 and $4,269,188 for the years ended June 30, 2006 and
      2005 and an accumulated deficit of $13,546,261 at June 30, 2006. Our accumulated
      deficit at March 31, 2007 was $20,416,233.


16




In
      March
      2007, we completed a public equity offering (see Note 7) and a warrant call
      (see
      Note 8) that raised gross proceeds of approximately $20 million.  Due to
      raising this additional capital, management believes cash and cash equivalents
      on hand at March 31, 2007 will be sufficient to meet our anticipated cash
      requirements for operations, debt service, and capital expenditure requirements
      assuming our revenues increase to permit us to break even in the latter half
      of
      2008 and we continue to efficiently manufacture our product..





**Recent
      Accounting Pronouncements**




In
      July
      2006, the FASB issued Financial Accounting Standard Interpretation No. 48,
      Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 is an
      interpretation of SFAS 109 and it seeks to reduce the diversity in practice
      associated with certain aspects of measurement and recognition in accounting
      for
      income taxes. In addition, FIN 48 requires expanded disclosure with respect
      to uncertainties in income taxes. The Company does not believe the adoption
      of
      FIN 48 on July 1, 2007 will have a material effect on its consolidated
      financial statements.





In
      September 2006, the FASB issued statement No. 157, Fair Value Measurements,
      (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for
      measuring fair value in accordance with accounting principles generally accepted
      in the United States, and expands disclosures about fair value measurements.
      SFAS 157 is effective for fiscal years beginning after November 15,
      2007, with earlier application encouraged. Any amounts recognized upon adoption
      as a cumulative effect adjustment will be recorded to the opening balance of
      retained earnings in the year of adoption. The Company has not yet determined
      the impact of this Statement on its financial condition and results of
      operations.





In
      February 2007, the FASB issued statement No. 159, The Fair Value Option for
      Financial Assets and Financial Liabilities Including an Amendment of FASB
      Statement No. 115 (“SFAS 159”). The statement allows entities to value financial
      instruments and certain other items at fair value. The statement provides
      guidance over the election of the fair value option, including the timing of
      the
      election and specific items eligible for the fair value accounting. Changes
      in
      fair values would be recorded in earnings. The statement is effective for fiscal
      years beginning after November 15, 2007. The Company has not yet determined
      the impact of this Statement on its financial condition and results of
      operations.





**Risk
      Factors**





**You
      should consider the following discussion of risks as well as other information
      regarding our operations. The risks and uncertainties described below are not
      the only ones. Additional risks and uncertainties not presently known to us
      or
      that we currently deem immaterial also may impair our business operations.
      For a
      more detailed discussion of the risks facing us, you should review the "Risk
      Factors" sections contained in our Form 10-KSB for the fiscal year ended June
      30, 2006, and our Prospectus Supplement filed with the SEC on March 23,
      2007.**





·
            Our
                  independent accountants have expressed uncertainty about our ability
                  to
                  continue as a going concern. However, in March 2007, we completed
                  a public
                  equity offering (see Note 7) and a warrant call (see Note 8) that
                  raised
                  gross proceeds of approximately $20 million.  Due to raising this
                  additional capital, management believes cash and cash equivalents
                  on hand
                  at March 31, 2007 will be sufficient to meet our anticipated cash
                  requirements for operations, debt service, and capital expenditure
                  requirements assuming our revenues increase to permit us to break-even
                  in
                  the latter half of 2008 and we continue to efficiently manufacture
                  our
                  product.




17







·
            Our
                revenues depend upon one product, our131Cs
                brachytherapy seed, which is used to treat only one type of cancer
                as of
                the date of this report, although it is approved to treat any malignant
                disease.




·
            The
                lease on our production facility ends in October 2007 and although
                we have
                obtained a lease for a new production facility, there can be no assurance
                that this new facility will be licensed and the necessary leasehold
                improvements completed by the time our current lease
                expires.




·
            We
                have limited data on the clinical performance of the131Cs
                seed.




·
            The
                passage of Initiative 297, which may in the future impose restrictions
                on
                sites generating certain types of radioactive wastes in Washington,
                may
                result in the relocation of our manufacturing
                operations.




·
            We
                may not be able to meet future demand without increasing our supply
                of the
                isotopes used to manufacture our product and also increasing our
                level of
                staffing.




·
            We
                are subject to the risk that certain third parties may mishandle
                our
                product.




·
            Our
                quarterly operating results will be subject to significant
                fluctuations.




·
            We
                rely heavily on a limited number of suppliers, particularly on our
                Russian
                suppliers of131Cs
                which amount to well over 60% of the raw materials needed for our
                production.




·
            Future
                production increases will depend on our ability to acquire larger
                quantities of131Cs
                and hire more employees.




·
            We
                are subject to uncertainties regarding reimbursement for use of our
                product.




·
            It
                is possible that other treatments may be deemed superior to brachytherapy
                for the treatment of cancer and if this were to occur, demand for
                our
                product could decline.




·
            Our
                industry is intensely competitive, and many of our competitors are
                larger
                than we are and possess greater
                resources.




·
            We
                may be unable to adequately protect or enforce our intellectual property
                rights or secure rights to third-party patents, the value of our
                granted
                patent and our patents pending is uncertain, and one of our licensed
                patents may be terminated under certain
                conditions.




·
            Failure
                to comply with government regulations, which are quite complex, could
                harm
                our business.




·
            Our
                business exposes us to product liability claims and also involves
                environmental risks.




·
            We
                rely heavily upon the expertise of our executive officers and key
                scientific personnel.




·
            Our
                ability to expand into foreign markets is
                uncertain.




·
            Our
                ability to expand operations and manage growth is
                uncertain.




·
            Our
                reporting obligations as a public company are
                costly.




·
            Historically,
                there has been a limited market for our common stock, and while our
                volume
                is still limited, the Company was recently listed on the American
                Stock
                Exchange. Our stock price is subject to volatility.




·
            Our
                common stock may be subject to penny stock regulation.




·
            Future
                sales by shareholders of the shares available for sale in the public
                market, or the perception that such sales may occur, may depress
                the price
                of our common stock.




·
            We
                do not expect to pay dividends for the foreseeable
                future.




·
            Certain
                provisions of Minnesota law and our charter documents have an
                anti-takeover effect.




18





**ITEM
      3.**  **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 the end of the period covered by this report. Based on that
      evaluation, our principal executive officer and our principal financial officer
      concluded that the design and operation of our disclosure controls and
      procedures were effective in timely alerting them to material information
      required to be included in the Company's periodic reports filed with the SEC
      under the Exchange Act. The design of any system of controls is based in part
      upon certain assumptions about the likelihood of future events, and there can
      be
      no assurance that any design will succeed in achieving its stated goals under
      all potential future conditions, regardless of how remote. However, management
      believes that our system of disclosure controls and procedures is designed
      to
      provide a reasonable level of assurance that the objectives of the system will
      be met.





***Management’s
      Remediation Initiatives***





As
      previously reported, our independent registered public accounting firm, in
      connection with the review of our consolidated financial statements for the
      period ended September 30, 2005, advised the Board of Directors and management
      of certain significant internal control deficiencies that they considered to
      be,
      in the aggregate, a material weakness. In particular, our independent registered
      public accounting firm identified the following weaknesses in our internal
      control system: (1) a lack of segregation of duties and (2) a lack of formal
      procedures relating to all areas of financial reporting. The independent
      registered public accounting firm indicated that they considered these
      weaknesses to be significant deficiencies as that term is defined under
      standards established by the American Institute of Certified Public Accountants.
      A material weakness is a significant deficiency in one or more of the internal
      control components that alone or in the aggregate precludes our internal
      controls from reducing to an appropriately low level of risk that material
      misstatements in our financial statements will not be prevented or detected
      on a
      timely basis. The Company considered these matters in connection with the period
      end closing of accounts and preparation of the related consolidated financial
      statements and determined that no prior period financial statements were
      materially affected by such matters.





During
      the second quarter of fiscal year 2007, the Company completed the implementation
      of the following control improvements to remediate the two material
      weaknesses:





***Lack
      of segregation of duties***


§
            Reviewed
                the duties of all accounting personnel and reassigned any conflicting
                duties to other personnel;


§
            Established
                daily management reviews of cash and accounts receivable activities
                and
                positions;


§
            Distributed
                monthly operating results for review by management in an appropriate
                time
                frame; and


§
            Established
                monthly reconciliation procedures including review by the appropriate
                supervisor.





***Financial
      reporting procedures***


§
            Established
                monthly reconciliation procedures including review by the appropriate
                supervisor;


§
            Established
                and implemented various accounting policies and procedures;
                and


§
            Distributed
                monthly operating results for review by management in an appropriate
                time
                frame.


19





Based
      on
      the evaluation completed in the third quarter of fiscal year 2007, the
      Company has concluded that these control improvements are properly designed
      and
      operating effectively as of March 31, 2007, and the two significant
      deficiencies that previously existed have been substantially
      remediated.





**PART
      II - OTHER INFORMATION**





**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES**





On
      March
      22, 2007, the Company issued 206,526 warrants with an exercise price of $4.40
      per share to Punk, Ziegel & Company, L.P. and Maxim Group LLC as part of
      their placement agent fee for the Company’s March 2007 public offering, in
      reliance on the exemption from registration provided by § 4(2) of the Securities
      Act of 1933, as amended.





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





(a)
            On
                February 20, 2007, the Company held its Annual Meeting of Stockholders
                at
                which our stockholders elected seven Directors and ratified the
                appointment of our independent registered public accounting firm
                for the
                fiscal year ending June 30, 2007.





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





**Director**
            
            **For**
            
            **Withhold**Dwight
                Babcock
            
            
            8,762,544
            
            
            1,664,681Stephen
                R. Boatwright
            
            
            8,697,853
            
            
            1,729,372Roger
                E. Girard
            
            
            10,381,744
            
            
            45,481Robert
                R. Kauffman
            
            
            8,762,544
            
            
            1,664,681Thomas
                C. LaVoy
            
            
            8,707,853
            
            
            1,719,372Albert
                Smith
            
            
            8,710,353
            
            
            1,716,872David
                J. Swanberg
            
            
            10,214,569
            
            
            212,656





(c)
            *Appointment
                of our independent registered public accounting firm.*Proposal to ratify the appointment of DeCoria, Maichel & Teague, P.S.
                as independent registered public accounting firm of the Company for
                the
                fiscal year ending June 30, 2007 was approved as
                follows:





**For**
            
            **Against**
            
            **Abstain**10,363,680
            
            24,224
            
            79,321





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




(a)
            Exhibits:




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




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




32
            Section
                1350 Certifications




20





(b)  Reports
      on Form 8-K:




On
      February 7, 2007, the Company filed a Current Report on Form 8-K announcing
      the
      approval of a share rights plan and the adoption of certain bylaw
      amendments.





On
      March
      23, 2007, the Company filed a Current Report on Form 8-K announcing the sale
      of
      common stock and warrants to certain institutional investors pursuant to a
      securities purchase agreement.





On
      April
      4, 2007, the Company filed a Current Report on Form 8-K announcing that as
      a
      result of its warrant call on March 26, 2007, the Company received $4,989,000
      of
      capital from warrant exercises.





On
      May 8,
      2007, the Company filed a Current Report on Form 8-K announcing its subsidiary,
      IsoRay Medical, Inc., entered into a new lease for 19,328 square feet to be
      used
      for its new production facility.


21


SIGNATURES





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




Dated:
                May 15, 2007ISORAY,
                INC., a Minnesota corporationBy
            /s/ Roger
                E. GirardRoger
                E. Girard, Chief Executive Officer





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








22