UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
      D.C. 20549




FORM
      10-Q




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




For
      the
      quarterly period ended September 30, 2007





or





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




For
      the
      transition period from __________ to ____________




Commission
      File No. 001-33407




**ISORAY,
                INC.**(Exact
                name of registrant as specified in its
                charter)




Minnesota
            
            41-1458152(State
                or other jurisdiction of incorporation or
              organization)
            
            (I.R.S.
                Employer
              Identification
                No.)





350
                Hills St., Suite 106, Richland, Washington
            
            99354(Address
                of principal executive offices)
            
            (Zip
                Code)





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




Indicate
      by check mark whether the registrant has (1) filed all reports required to
      be
      filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months
      (or for such shorter period the registrant was required to file such reports),
      and (2) has been subject to such filing requirements for the past 90
      days.


Yes x No o





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


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





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





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





Class
            
            Outstanding
                as of November 3, 2007Common
                stock, $0.001 par value
            
            23,090,200







**ISORAY,
      INC.**




**Table
      of Contents**




PART
                I
            FINANCIAL
                INFORMATIONItem
                1
            Consolidated
                Unaudited Financial Statements
            1Consolidated
                Balance Sheets
            1Consolidated
                Statements of Operations
            2Consolidated
                Statements of Cash Flows
            3Notes
                to Consolidated Financial Statements
            4Item
                2
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            10Item
                3
            Quantitative
                and Qualitative Disclosures About Market Risk
            15Item
                4
            Controls
                and Procedures
            15PART
                II
            OTHER
                INFORMATIONItem
                1A
            Risk
                Factors
            16Item
                6
            Exhibits
            16Signatures
            17









**PART
      I – FINANCIAL INFORMATION**


**IsoRay,
      Inc. and Subsidiary******


**Consolidated
      Balance Sheets** ****





****
            
            **September 30,**
              **2007**
              **(Unaudited)**
            
            **June 30,**
              **2007********ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            6,448,058
            
            $
            9,355,730Short-term
                investments
            
            
            8,972,430
            
            
            9,942,840Accounts
                receivable, net of allowance for doubtful accounts of $69,936 and
                $99,789,
                respectively
            
            
            1,008,016
            
            
            1,092,925Inventory
            
            
            913,676
            
            
            880,834Prepaid
                expenses
            
            
            630,216
            
            
            458,123Total
                current assets
            
            
            17,972,396
            
            
            21,730,452Fixed
                assets, net of accumulated depreciation
            
            
            6,416,073
            
            
            3,665,551Deferred
                financing costs, net of accumulated amortization
            
            
            88,099
            
            
            95,725Licenses,
                net of accumulated amortization
            
            
            254,375
            
            
            262,074Other
                assets, net of accumulated amortization
            
            
            320,659
            
            
            322,360Total
                assets
            
            $
            25,051,602
            
            $
            26,076,162**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Current
                liabilities:Accounts
                payable and accrued expenses
            
            $
            1,352,991
            
            $
            1,946,042Accrued
                payroll and related taxes
            
            
            627,528
            
            
            459,068Accrued
                interest payable
            
            
            2,316
            
            
            1,938Deferred
                revenue
            
            
            -
            
            
            23,874Notes
                payable, due within one year
            
            
            46,130
            
            
            49,212Capital
                lease obligations, due within one year
            
            
            155,271
            
            
            194,855Asset
                retirement obligation, current portion
            
            
            134,115
            
            
            131,142Total
                current liabilities
            
            
            2,318,351
            
            
            2,806,131Notes
                payable, due after one year
            
            
            517,740
            
            
            528,246Capital
                lease obligations, due after one year
            
            
            14,984
            
            
            25,560Asset
                retirement obligation
            
            
            473,096
            
            
            -Total
                liabilities
            
            
            3,324,171
            
            
            3,359,937Commitments
                and contingencies (see Note 8)Shareholders'
                equity:Preferred
                stock, $.001 par value; 6,000,000 shares authorized:Series
                A: 1,000,000 shares allocated; no shares issued and outstanding
            
            
            -
            
            
            -Series
                B: 5,000,000 shares allocated; 59,065 shares issued and outstanding
            
            
            59
            
            
            59Common
                stock, $.001 par value; 194,000,000 shares authorized; 23,033,324
                and
                22,789,324 shares issued and outstanding
            
            
            23,033
            
            
            22,789Additional
                paid-in capital
            
            
            47,015,156
            
            
            45,844,793Accumulated
                deficit
            
            
            (25,310,817
            )
            
            (23,151,416
            )Total
                shareholders' equity
            
            
            21,727,431
            
            
            22,716,225Total
                liabilities and shareholders' equity
            
            $
            25,051,602
            
            $
            26,076,162





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


1





**IsoRay,
      Inc. and Subsidiary** ****


**Consolidated
      Statements of Operations** ****


**(Unaudited)**


****


**Three months ended September 30,****2007**
            
            **2006**Product
                sales
            
            $
            1,855,719
            
            $
            1,025,444Cost
                of product sales
            
            
            2,005,502
            
            
            1,288,145Gross
                loss
            
            
            (149,783
            )
            
            (262,701
            )Operating
                expenses:Research
                and development
            
            
            256,370
            
            
            245,598Sales
                and marketing expenses
            
            
            1,059,816
            
            
            672,930General
                and administrative expenses
            
            
            902,025
            
            
            1,733,132Total
                operating expenses
            
            
            2,218,211
            
            
            2,651,660Operating
                loss
            
            
            (2,367,994
            )
            
            (2,914,361
            )Non-operating
                income (expense):Interest
                income
            
            
            238,696
            
            
            40,183Financing
                expense
            
            
            (30,103
            )
            
            (53,257
            )Non-operating
                income (expense), net
            
            
            208,593
            
            
            (13,074
            )Net
                loss
            
            $
            (2,159,401
            )
            $
            (2,927,435
            )Basic
                and diluted loss per share
            
            $
            (0.09
            )
            $
            (0.19
            )Weighted
                average shares used in computing net loss per share:Basic
                and diluted
            
            
            23,001,041
            
            
            15,300,747





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




2





**IsoRay,
      Inc. and Subsidiary** ****


**Consolidated
      Statements of Cash Flows** ****


**(Unaudited)**  ****




**Three months ended September 30,****2007**
            
            **2006********CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                loss
            
            $
            (2,159,401
            )
            $
            (2,927,435
            )Adjustments
                to reconcile net loss to net cash used by operating activities:Depreciation
                and amortization of fixed assets
            
            
            206,937
            
            
            89,426Amortization
                of deferred financing costs and other assets
            
            
            68,733
            
            
            39,773Amortization
                of discount on short-term investments
            
            
            (67,593
            )
            
            -Accretion
                of asset retirement obligation
            
            
            2,973
            
            
            1,528Noncash
                share-based compensation
            
            
            187,607
            
            
            781,443Changes
                in operating assets and liabilities:Accounts
                receivable, net
            
            
            84,909
            
            
            (55,808
            )Inventory
            
            
            (32,842
            )
            
            (56,407
            )Prepaid
                expenses
            
            
            (172,093
            )
            
            (32,225
            )Accounts
                payable and accrued expenses
            
            
            (593,051
            )
            
            69,766Accrued
                payroll and related taxes
            
            
            168,460
            
            
            92,182Accrued
                interest payable
            
            
            378
            
            
            1,713Deferred
                revenue
            
            
            (23,874
            )
            
            -Net
                cash used by operating activities
            
            
            (2,328,857
            )
            
            (1,996,044
            )**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Purchases
                of fixed assets
            
            
            (2,484,363
            )
            
            (55,390
            )Additions
                to licenses and other assets
            
            
            (51,707
            )
            
            (21,256
            )Purchases
                of short-term investments
            
            
            (5,947,407
            )
            
            -Proceeds
                from the sale or maturity of short-term investments
            
            
            6,985,410
            
            
            -Net
                cash used by investing activities
            
            
            (1,498,067
            )
            
            (76,646
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Principal
                payments on notes payable
            
            
            (13,588
            )
            
            (17,269
            )Principal
                payments on capital lease obligations
            
            
            (50,160
            )
            
            (51,061
            )Proceeds
                from cash sales of common shares pursuant to private placement, net
                of
                offering costs
            
            
            -
            
            
            4,702,931Proceeds
                from cash sales of preferred stock, pursuant to exercise of warrants
            
            
            -
            
            
            8,709Proceeds
                from cash sales of common stock, pursuant to exercise of warrants
            
            
            971,100
            
            
            -Proceeds
                from cash sales of common stock, pursuant to exercise of options
            
            
            11,900
            
            
            382,485Net
                cash provided by financing activities
            
            
            919,252
            
            
            5,025,795Net
                (decrease) increase in cash and cash equivalents
            
            
            (2,907,672
            )
            
            2,953,105Cash
                and cash equivalents, beginning of period
            
            
            9,355,730
            
            
            2,207,452**CASH
                AND CASH EQUIVALENTS, END OF PERIOD**
            
            $
            6,448,058
            
            $
            5,160,557Non-cash
                investing and financing activities:Increase
                in fixed assets related to asset retirement obligation
            
            $
            473,096
            
            $
            -





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


3





**IsoRay,
      Inc.**


**Notes
      to the Unaudited Consolidated Financial Statements**


**For
      the three-month periods ended September 30, 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, 2007. The financial information is
      unaudited but reflects all adjustments, consisting only of normal recurring
      accruals, which are, in the opinion of the Company’s management, necessary for a
      fair statement of the results for the interim periods presented. Interim results
      are not necessarily indicative of results for a full year. The information
      included in this Form 10-Q should be read in conjunction with the Company’s
      Annual Report on Form 10-KSB for the fiscal year ended June 30,
      2007.





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





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





The
      Company adopted FIN No. 48 using the modified prospective transition method,
      which requires the application of the accounting standard as of July 1, 2007.
      There was no impact on the financial statements as of and for the three months
      ended September 30, 2007 as a result of the adoption of FIN No. 48. In
      accordance with the modified prospective transition method, the financial
      statements for prior periods have not been restated to reflect, and do not
      include, the impact of FIN No. 48.





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





The
      Company accounts for its income (loss) per common share according to Statement
      of Financial Accounting Standard (SFAS) No. 128, *Earnings
      Per Share* .
      Under
      the provisions of SFAS No. 128, primary and fully diluted earnings per share
      are
      replaced with basic and diluted earnings per share. Basic earnings per share
      is
      calculated by dividing net income (loss) available to common shareholders by
      the
      weighted average number of common shares outstanding, and does not include
      the
      impact of any potentially dilutive common stock equivalents. Common stock
      equivalents, including warrants to purchase the Company's common stock and
      common stock issuable upon the conversion of notes payable, are excluded from
      the calculations when their effect is antidilutive. At September 30, 2007 and
      2006, the calculation of diluted weighted average shares does not include
      preferred stock, options, or warrants that are potentially convertible into
      common stock as those would be antidilutive due to the Company’s net loss
      position.





4




Securities
      that could be dilutive in the future as of September 30, 2007 and 2006 are
      as
      follows:





September
                30,2007
            
            2006Preferred
                stock
            
            
            59,065
            
            
            91,928Preferred
                stock warrants
            
            
            **–**
            
            
            173,292Common
                stock warrants
            
            
            3,350,150
            
            
            4,768,563Common
                stock options
            
            
            3,320,906
            
            
            3,436,176Convertible
                debentures
            
            
            **–**
            
            
            109,639Total
                potential dilutive securities
            
            
            6,730,121
            
            
            8,579,598





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





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





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





September
                30,
            
            June
                30,2007
            
            2007Municipal
                debt securities
            
            $
            4,000,000
            
            $
            3,000,000Corporate
                debt securities
            
            
            4,972,430
            
            
            6,942,840$
            8,972,430
            
            $
            9,942,840





**5.** **Inventory**





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





September
                30,
            
            June
                30,2007
            
            2007Raw
                materials
            
            $
            734,249
            
            $
            682,327Work
                in process
            
            
            147,637
            
            
            120,242Finished
                goods
            
            
            31,790
            
            
            78,265$
            913,676
            
            $
            880,834





**6.** **Asset
        Retirement Obligations**





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




5


In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represented the discounted cost of cleanup that the Company
      anticipated it would have to incur at the end of its equipment and property
      leases in its old production facility. This amount was determined based on
      discussions with qualified production personnel and on historical evidence.
      During fiscal year 2007, the Company reevaluated its obligations based on
      discussions with the Washington Department of Health and determined that the
      initial asset retirement obligation should be increased by an additional
      $56,120. The Company anticipates spending most of the amounts represented by
      this accrual in fiscal year 2008.





In
      September 2007, a new asset retirement obligation of $473,096 was established
      representing the discounted cost of the Company’s obligations to remove any
      residual radioactive materials and any unwanted leasehold improvements at the
      end of the lease term at its new production facility. The estimate was developed
      by qualified production personnel and the general contractor of the new
      facility.





**7.** **Share-Based
        Compensation**





Effective
      July 1, 2006, the Company adopted SFAS No. 123R, *Share-Based
      Payment* ,
      using
      the modified prospective method. The following table presents the share-based
      compensation expense recognized in accordance with SFAS No. 123R during the
      three months ended September 30, 2007 and 2006:





Three months ended September 30,2007
            
            2006Cost
                of product sales
            
            $
            37,003
            
            $
            50,833Research
                and development
            
            
            11,550
            
            
            11,835Sales
                and marketing expenses
            
            
            59,557
            
            
            46,781General
                and administrative expenses
            
            
            79,497
            
            
            671,994Total
                share-based compensation
            
            $
            187,607
            
            $
            781,443





As
      of
      September 30, 2007, total unrecognized compensation expense related to
      stock-based options was $1,470,023 and the related weighted-average period
      over
      which it is expected to be recognized is approximately 1.13 years.





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




6




A
      summary
      of stock option activity within the Company’s share-based compensation plans for
      the three months ended September 30, 2007 is as follows:





WeightedWeighted
            
            AverageAverage
            
            Remaining
            
            AggregateNumber
                of
            
            Exercise
            
            Contractual
            
            IntrinsicOptions
            
            Price
            
            Term
            
            ValueOutstanding
                at September 30, 2007
            
            
            3,320,906
            
            $
            2.73
            
            
            8.29
            
            $
            3,600,466Vested
                and expected to vest at September 30, 2007
            
            
            3,274,567
            
            $
            2.45
            
            
            8.29
            
            $
            3,596,459Vested
                and exercisable at September 30, 2007
            
            
            2,438,817
            
            $
            2.18
            
            
            8.01
            
            $
            3,502,713





The
      aggregate intrinsic value of options exercised during the three months ended
      September 30, 2007 and 2006 was $25,300 and $702,763, respectively. The
      Company’s current policy is to issue new shares to satisfy option
      exercises.





During
      the quarter ended September 30, 2007, the Company did not grant any stock
      options. The weighted average fair value of stock option awards granted and
      the
      key assumptions used in the Black-Scholes valuation model to calculate the
      fair
      value are as follows:





Three months ended September 30,2007
            
            2006Weighted average fair
                value of options granted
            
            $
            –
            
            $
            2.10Key
                assumptions used in determining fair value:Weighted
                average risk-free interest rate
            
            
            –
            %
            
            4.90
            %Weighted
                average life of the option (in years)
            
            
            –
            
            
            5.51Weighted
                average historical stock price volatility
            
            
            –
            %
            
            75.00
            %Expected
                dividend yield
            
            
            –
            %
            
            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 stock
      price volatility are based on historical data of the Company.





**8.**  **Commitments
      and Contingencies**





Patent
      and Know-How Royalty License Agreement





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


7


The
      licensor of the “know-how” has disputed management’s contention that it is not
      using this “know-how”. On September 25, 2007 and again on October 31, 2007, the
      Company participated in nonbinding mediation and no settlement was reached
      with
      the Lawrence Family Trust. The parties have agreed to extend negotiations of
      a
      mutually agreeable settlement through December 1, 2007. If no settlement is
      reached, the parties may demand binding arbitration.





License
      Agreement with IBt





In
      February 2006, the Company signed a license agreement with International
      Brachytherapy SA (IBt), a Belgian company, covering North America and providing
      the Company with access to IBt’s Ink Jet production process and its proprietary
      polymer seed technology for use in brachytherapy procedures using Cs-131. The
      Company paid license fees of $275,000 during 2006 and another payment of
      $225,000 was to be made in August 2006 pursuant to the license agreement.
      Royalty payments based on net sales revenue incorporating the technology are
      also required, with minimum quarterly royalties ranging from $100,000 to
      $200,000 and minimum annual royalties ranging from $400,000 to $800,000 over
      the
      term of the agreement.





On
      October 12, 2007, the Company entered into an amendment to the original license
      agreement as part of the global strategic alliance with IBt and paid the
      remaining $225,000 license fee to IBt (see Note 9).





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





*Perma-Fix
      Lease*





On
      October 10, 2007, the Company executed a Lease Agreement with Perma-Fix
      Northwest Richland, Inc. (Perma-Fix).  The Lease Agreement has an effective
      date of September 1, 2007, and provides for the continuation of the Company's
      lease of its PIRL facility located at 2025 Battelle Boulevard, Richland,
      Washington.  The Company previously leased this facility from Nuvotec USA,
      Inc. under a Lease Agreement dated February 9, 2005, but Nuvotec USA, Inc.
      subsequently sold the facility to Perma-Fix.  The new lease term is through
      January 31, 2008, with early termination permitted upon 45 days prior written
      notice.  Monthly rent payments are $5,000 and increase to $50,000 per month
      if the Company has not vacated the premises by January 31, 2008, with an
      additional one-time payment due of $100,000 if the Company continues to occupy
      the premises beyond February 1, 2008.  The Company has already moved its
      production operations to its new facility at the Applied Process Engineering
      Laboratory, and is in the process of completing decommissioning work to vacate
      the PIRL facility, which management anticipates will occur by the end of
      December 2007.




*Amended
      License Agreement with IBt*





On
      October 12, 2007, the Company entered into Amendment No. 1 (the Amendment)
      to
      its License Agreement dated February 2, 2006 with IBt. The original License
      Agreement provided the Company with access to IBt’s proprietary ink jet
      technology and polymer based seed encapsulation technology for use in
      brachytherapy procedures using Cesium-131 in the United States for a fifteen
      year term.





The
      Company already paid a total of $275,000 in license fees during fiscal year
      2006. Another payment of $225,000 was made on October 12, 2007 pursuant to
      the
      Amendment. The Amendment eliminates the previously required royalty payments
      based on net sales revenue, and the parties intend to negotiate terms for future
      payments by the Company for polymer seed components to be purchased from IBt
      in
      the future at IBt's cost plus a to-be-determined profit percentage, although
      no
      agreement has been reached on these terms and there is no assurance that the
      parties will consummate an agreement pursuant to such terms.


8


*HAEIFC
      Loan Amendment*





On
      October 30, 2007 the Company was notified by the Hanford Area Economic
      Investment Fund Committee (HAEIFC) that it had withdrawn the commitment of
      the
      Company’s remaining undisbursed loan funds as of September 24, 2007. With the
      success of its capital raise completed in March 2007, management had no plans
      to
      use the undisbursed funds at an interest rate of 9% per annum.


9


**ITEM
      2 – MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION**





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





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





*All
      statements contained in this Form 10-Q, other than statements of historical
      facts, that address future activities, events or developments are
      forward-looking statements, including, but not limited to, statements containing
      the words "believe," "expect," "anticipate," "intends," "estimate," "forecast,"
      "project," and similar expressions . All statements other than statements of
      historical fact are statements that could be deemed forward-looking statements,
      including any statements of the plans, strategies and objectives of management
      for future operations; any statements concerning proposed new products,
      services, developments or industry rankings; any statements regarding future
      economic conditions or performance; any statements of belief; and any statements
      of assumptions underlying any of the foregoing. These statements are based
      on
      certain assumptions and analyses made by us in light of our experience and
      our
      assessment of historical trends, current conditions and expected future
      developments as well as other factors we believe are appropriate under the
      circumstances. However, whether actual results will conform to the expectations
      and predictions of management is subject to a number of risks and uncertainties
      described under “Risk Factors” beginning on page 16 below and in the “Risk
      Factors” section of our Form 10-KSB for the fiscal year ended June 30, 2007 that
      may cause actual results to differ materially.*





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





**Critical
      Accounting Policies and Estimates**





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


10


**Results
      of Operations**




**Three
      months ended September 30, 2007 compared to three months ended September 30,
      2006**





**Revenues.** The
      Company generated revenue of $1,855,719 during the three months ended September
      30, 2007 compared to sales of $1,025,444 during the three months ended September
      30, 2006. The increase of $830,275 or 81% is due to increased sales of the
      Company’s Proxcelan Cs-131 brachytherapy seed. During the three months ended
      September 30, 2007, the Company sold its Proxcelan seeds to 49 different medical
      centers as compared to 23 medical centers during the corresponding period of
      2006.





**Cost
      of product sales.** Cost of
      product sales was $2,005,502 for the three months ended September 30, 2007
      compared to cost of product sales of $1,288,145 during the three months ended
      September 30, 2006. The increase of $717,357 or 56% was mainly due to higher
      production levels during the three months ended September 30, 2007 which were
      related to the increase in sales volume over the corresponding period from
      2006
      and increased isotope expenditures and small tools expense related to the
      start-up of the new facility. The major components of the increase attributable
      to higher production levels were wages, benefits, and related taxes, materials,
      depreciation, preload expenses, and occupancy costs. Wages, benefits, and
      related taxes increased approximately $131,000 due to the hiring of additional
      production employees to support the higher production levels. Material costs
      increased approximately $281,000 due to increased sales volume. Depreciation
      and
      amortization expense increased approximately $118,000 due to the additional
      equipment placed in service in fiscal year 2007 and 2008. Preload expenses
      increased approximately $88,000 due to higher sales volumes. Occupancy costs
      increased approximately $42,000 due to higher rent expense on the Company’s new,
      larger production facility and the continued rental payments on our old
      production facility. These increases were partially offset by a decrease in
      consulting expenses of approximately $64,000 as the quarter ended September
      30,
      2006 contained consulting projects that were completed during fiscal year 2007
      and less consulting projects were undertaken in the quarter ended September
      30,
      2007 due to the Company’s focus on opening the new facility.





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





**Gross
      loss.** Gross
      loss was $149,783 for the three month period ended September 30, 2007 compared
      to a gross loss of $262,701 for the three month period ended September 30,
      2006.
      The decrease of $112,918 or 43% was due to higher revenues offsetting fixed
      production costs partially offset by start-up costs of the new production
      facility.





**Research
      and development.** Research
      and development expenses for the three month period ended September 30, 2007
      were $256,370 which represents an increase of $10,772 or 4% over the research
      and development expenses of $245,598 for the corresponding period of 2006.
      The
      slight increase is due to wages, benefits, and related taxes increasing
      approximately $13,000 due to higher salaries, consulting expenses increasing
      approximately $9,000 as the Company continues its project to increase the
      efficiency of isotope production, legal fees increasing approximately $17,000
      relating to patents and trademarks, and other miscellaneous expenses increasing
      approximately $15,000. These increases were partially offset by a decrease
      of
      approximately $43,000 in clinical study protocol expenses as our mono therapy
      protocol is fully enrolled and our dual therapy protocol is just beginning
      to
      enroll patients.


11


**Sales
      and marketing expenses.** Sales
      and
      marketing expenses were $1,059,816 for the three months ended September 30,
      2007. This represents an increase of $386,886 or 57% compared to expenditures
      in
      the three months ended September 30, 2006 of $672,930 for sales and marketing.
      Wages, benefits, payroll taxes, travel and office and other support expenses
      relating to the Company’s sales, marketing, and customer service personnel
      increased approximately $304,000 due to the hiring of additional sales and
      marketing personnel. From September 30, 2006 to September 30, 2007, the Company
      increased its sales staff by eight persons. Marketing and advertising increased
      approximately $40,000 as the Company’s brochures, literature, and other
      marketing materials have been updated to reflect new clinical study protocol
      results and conclusions and the new Proxcelan brand name. Consulting expenses
      also increased about $48,000 relating to consultants hired to assist with
      protocols, healthcare reimbursement, and business development.




**General
      and administrative expenses.** General
      and administrative expenses for the three months ended September 30, 2007 were
      $902,025 compared to general and administrative expenses of $1,733,132 for
      the
      corresponding period of 2006. The decrease of $831,107 or 48% is primarily
      due
      to a decrease in share-based compensation expense of approximately $592,000
      and
      a one-time severance accrual of $288,000 in the corresponding period of 2006.
      These were partially offset by an increase in investor relations and other
      public company expenses of approximately $77,000 due to higher cash payments
      to
      directors and increased investor relations activities.





**Operating
      loss.** Due to
      the Company’s rapid structural growth and related need to capture additional
      market share, through the hiring of additional sales and marketing personnel,
      product revenues not covering production costs, and significant research and
      development expenditures, the Company has not been profitable, and has generated
      operating losses since its inception. In the three months ended September 30,
      2007, the Company had an operating loss of $2,367,994 which is a decrease of
      $546,367 or 19% over the operating loss of $2,914,361 for the three months
      ended
      September 30, 2006.





**Interest
      income.** Interest
      income was $238,696 for the three months ended September 30, 2007. This
      represents an increase of $198,513 or 494% compared to interest income of
      $40,183 for the three months ended September 30, 2006. Interest income is mainly
      derived from excess funds held in money market accounts and invested in
      short-term investments.





**Financing
      expense.** Financing expense for the three months ended September 30, 2007 was $30,103
      or a
      decrease of $23,154 or 43% from financing expense of $53,257 for the
      corresponding period in 2006. Included in financing expense is interest expense
      of approximately $22,000 and $31,000 for the three months ended September 30,
      2007 and 2006, respectively. The decrease in interest expense is due to the
      maturity and payment of the convertible debentures during the fiscal year ended
      June 30, 2007. The remaining balance of financing expense represents the
      amortization of deferred financing costs which decreased due to the final
      amortization of the deferred financing costs relating to the convertible
      debentures and the write-off in fiscal year 2007 of the deferred financing
      costs
      relating to the Columbia River line of credit.





**Liquidity
      and capital resources** .
      The
      Company has historically financed its operations through cash investments from
      shareholders. During the quarter ended September 30, 2007, the Company’s primary
      source of cash was the exercise of common stock warrants and options for
      $983,000 and the Company primarily used existing cash reserves to fund its
      operations and capital expenditures.


12


*Cash
      flows from operating activities*





Cash
      used
      in operating activities was $2.3 million for the three months ended September
      30, 2007 compared to $2.0 million for the three months ended September 30,
      2006.
      Cash used by operating activities is net loss adjusted for non-cash items and
      changes in operating assets and liabilities. The increase in cash usage is
      mainly due to an increase in operating assets and liabilities related to a
      large
      decrease in accounts payable and accrued expenses. This is due to a payment
      in
      July 2007 for enriched barium that was included in the Company’s June 2007
      accounts payable balance.





*Cash
      flows from investing activities*





Cash
      used
      in investing activities was approximately $1.5 million and $77,000 for the
      three
      months ended September 30, 2007 and 2006, respectively. Cash expenditures for
      fixed assets were approximately $2.5 million and $55,000 during the three months
      ended September 30, 2007 and 2006, respectively. The large increase is mainly
      due to construction of our new facility and equipment purchases for the new
      facility. This was partially offset by net proceeds of approximately $1.0
      million from the sale of short-term securities.





*Cash
      flows from financing activities*





During
      the three months ended September 30, 2007, the Company issued 244,000 shares
      of
      common stock pursuant to the exercise of common stock options and warrants.
      The
      Company received $983,000 in cash pursuant to these exercises.





*Projected
      2008 Liquidity and Capital Resources*





At
      September 30, 2007, cash and cash equivalents amounted to $6,448,058 and
      short-term investments amounted to $8,972,430 compared to $9,355,730 of cash
      and
      cash equivalents and $9,942,840 of short-term investments at June 30,
      2007.





The
      Company had approximately $4.8 million of cash and $9.0 million of short-term
      investments as of November 2, 2007. As of that date management believed that
      the
      Company’s monthly required cash operating expenditures were approximately
      $600,000 excluding capital expenditure requirements. The Company’s cash
      operating expenditures were higher than this level during the quarter ended
      September 30, 2007 but this was mainly due to the additional expenditures
      necessary to make the new facility operational while maintaining operations
      at
      the previous facility.





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





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


13


*Long-Term
      Debt and Capital Lease Agreements*





IsoRay
      has two loan facilities in place as of September 30, 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
      September 30, 2007, the principal balance owed was $179,412. This loan is
      secured by certain equipment, materials and inventory of the Company, and also
      required personal guarantees, for which the guarantors were issued approximately
      70,455 shares of common stock. The second loan is from the Hanford Area Economic
      Investment Fund Committee (HAEIFC) and was originated in June 2006. The loan
      originally had a total facility of $1,400,000 which was reduced in September
      2007 to the amount of the Company’s initial draw of $418,670 (see Note 9). The
      loan bears interest at nine percent and the principal balance owed as of
      September 30, 2007 was $384,458. This loan is secured by receivables, equipment,
      materials and inventory, and certain life insurance policies and also required
      personal guarantees.





The
      Company has certain capital leases for production and office equipment that
      expire at various times from March 2008 to April 2009. These leases currently
      call for total monthly payments of $19,361. The total of all capital lease
      obligations at September 30, 2007 was $170,255.





*Other
      Commitments and Contingencies*





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 (Cs-131). The
      Company paid license fees of $275,000 during 2006 and another payment of
      $225,000 was to be made in August 2006 pursuant to the License Agreement.
      Royalty payments based on net sales revenue are also required, with minimum
      quarterly royalties ranging from $100,000 to $200,000 and minimum annual
      royalties ranging from $400,000 to $800,000 over the term of the License
      Agreement.





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





The
      Company is subject to various local, state, and federal environmental
      regulations and laws due to the isotopes used to produce the Company’s product.
      As part of normal operations, amounts are expended to ensure that the Company
      is
      in compliance with these laws and regulations. While there have been no
      reportable incidents or compliance issues, the Company will incur certain
      decommissioning expenses as part of vacating its old production facility.
      Therefore, the Company established in fiscal year 2006 an initial asset
      retirement obligation of $63,040 which represented the discounted cost of
      cleanup that the Company anticipated it will have to incur at the end of its
      equipment and property leases. This amount was determined based on discussions
      with qualified production personnel and on historical evidence. During fiscal
      year 2007, the Company reevaluated its obligations based on discussions with
      the
      Washington Department of Health and determined that the initial asset retirement
      obligation should be increased by an additional $56,120. The Company anticipates
      spending most of the amounts represented by this accrual in fiscal year 2008.
      In
      addition, another asset retirement obligation of $473,096 was established in
      the
      first quarter of fiscal year 2008 representing obligations at its new production
      facility. This new asset retirement obligation is for obligations to remove
      any
      residual radioactive materials and to remove any unwanted leasehold improvements
      at the end of the lease term.


14


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





The
      Company has no off-balance sheet arrangements.





**New
      Accounting Standards**





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





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





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





As
      the
      Company has not yet filed an annual report including Regulation S-K Item 305
      information, it is not required to provide Part I, Item 3 disclosure in this
      Quarterly Report.





**ITEM
      4 – CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**





Under
      the
      supervision and with the participation of our management, including our
      principal executive officer and principal financial officer, we conducted an
      evaluation of the design and operation of our disclosure controls and
      procedures, as such term is defined under Rules 13a-14(c) and 15d-14(c)
      promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
      Act"), as of September 30, 2007. Based on that evaluation, our principal
      executive officer and our principal financial officer concluded that the design
      and operation of our disclosure controls and procedures were effective in timely
      alerting them to material information required to be included in the Company's
      periodic reports filed with the SEC under the Exchange Act. The design of any
      system of controls is based in part upon certain assumptions about the
      likelihood of future events, and there can be no assurance that any design
      will
      succeed in achieving its stated goals under all potential future conditions,
      regardless of how remote. However, management believes that our system of
      disclosure controls and procedures is designed to provide a reasonable level
      of
      assurance that the objectives of the system will be met.


15


**Changes
      in Internal Control over Financial Reporting**





There
      have not been any changes in our internal control over financial reporting
      (as
      such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
      during the most recent fiscal quarter that have materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.





**PART
      II - OTHER INFORMATION**





**ITEM
      1A – RISK FACTORS**





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




**ITEM
      6. EXHIBITS**




Exhibits:




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


16


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:
      November 9, 2007





ISORAY,
                INC., a Minnesota corporationBy
            /s/ Roger
                E. GirardRoger
                E. Girard, Chief Executive OfficerBy
            /s/ Jonathan
                R. HuntJonathan
                R. Hunt, Chief Financial
                Officer


17