UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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


For the
quarterly period ended March 31, 2010





or





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


For the
transition period from __________ to ____________





Commission
File No. 001-33407




ISORAY,
INC.


(Exact
name of registrant as specified in its charter)




Minnesota
                    41-1458152(State
      or other jurisdiction of incorporation or
                    (I.R.S.
      Employerorganization)
                    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: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes x No
 ̈


Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or such shorter period that the
registrant was required to submit and post such files).


Yes x     No
 ̈


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


Large
accelerated filer  ̈Accelerated
filer  ̈Non-accelerated
filer  ̈


Smaller
reporting company x





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





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





Class
                Outstanding as of May 6,
    2010Common
      stock, $0.001 par value
                23,048,754





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 Unaudited Financial Statements
                4Item
      2
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                9Item
      3
                Quantitative
      and Qualitative Disclosures About Market Risk
                16Item
      4
                Controls
      and Procedures
                16PART
      II
                OTHER
      INFORMATIONItem
      1A
                Risk
      Factors
                17Item
      2
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                17Item
      6
                Exhibits
                19Signatures
                20





PART
I – FINANCIAL INFORMATION




IsoRay,
Inc. and Subsidiaries


Consolidated
Balance Sheets





(Unaudited)March
      31,
                      
                      
                      June
      30,2010
                      
                      
                      2009ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      2,425,844
                      
                      
                      $
                      2,990,744Short-term
      investments
                      
                      
                      -
                      
                      
                      
                      1,679,820Accounts
      receivable, net of allowance for doubtful accounts of $69,057 and $86,931,
      respectively
                      
                      
                      872,561
                      
                      
                      
                      746,568Inventory
                      
                      
                      695,069
                      
                      
                      
                      789,246Prepaid
      expenses and other current assets
                      
                      
                      159,961
                      
                      
                      
                      151,077Total
      current assets
                      
                      
                      4,153,435
                      
                      
                      
                      6,357,455Fixed
      assets, net of accumulated depreciation and amortization
                      
                      
                      4,194,194
                      
                      
                      
                      4,891,484Deferred
      financing costs, net of accumulated amortization
                      
                      
                      13,830
                      
                      
                      
                      28,186Restricted
      cash
                      
                      
                      180,031
                      
                      
                      
                      178,615Other
      assets, net of accumulated amortization
                      
                      
                      266,788
                      
                      
                      
                      285,826Total
      assets
                      
                      $
                      8,808,278
                      
                      
                      $
                      11,741,566LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
                      
                      $
                      700,949
                      
                      
                      $
                      698,882Accrued
      payroll and related taxes
                      
                      
                      231,759
                      
                      
                      
                      188,703Notes
      payable, due within one year
                      
                      
                      48,340
                      
                      
                      
                      161,437Total
      current liabilities
                      
                      
                      981,048
                      
                      
                      
                      1,049,022Notes
      payable, due after one year
                      
                      
                      143,305
                      
                      
                      
                      176,023Asset
      retirement obligation
                      
                      
                      591,971
                      
                      
                      
                      553,471Total
      liabilities
                      
                      
                      1,716,324
                      
                      
                      
                      1,778,516Shareholders'
      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; 22,945,421 and
      22,942,088 shares issued and outstanding, respectively
                      
                      
                      22,945
                      
                      
                      
                      22,942Treasury
      stock, at cost, 13,200 shares
                      
                      
                      (8,390
                      )
                      
                      
                      (8,390
                      )Additional
      paid-in capital
                      
                      
                      47,898,972
                      
                      
                      
                      47,818,203Accumulated
      deficit
                      
                      
                      (40,821,632
                      )
                      
                      
                      (37,869,764
                      )Total
      shareholders' equity
                      
                      
                      7,091,954
                      
                      
                      
                      9,963,050Total
      liabilities and shareholders' equity
                      
                      $
                      8,808,278
                      
                      
                      $
                      11,741,566





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


1


IsoRay, Inc. and Subsidiaries


Consolidated
Statements of Operations


(Unaudited)





Three
      months ended March 31,
                            
                            
                            Nine
      months ended March 31,2010
                            
                            
                            2009
                            
                            
                            2010
                            
                            
                            2009Product
      sales
                            
                            $
                            1,203,216
                            
                            
                            $
                            1,366,289
                            
                            
                            $
                            3,950,650
                            
                            
                            $
                            4,212,574Cost
      of product sales
                            
                            
                            1,150,730
                            
                            
                            
                            1,351,044
                            
                            
                            
                            3,411,012
                            
                            
                            
                            4,523,705Gross
      income / (loss)
                            
                            
                            52,486
                            
                            
                            
                            15,245
                            
                            
                            
                            539,638
                            
                            
                            
                            (311,131
                            )Operating
      expenses:Research
      and development expenses
                            
                            
                            98,964
                            
                            
                            
                            301,907
                            
                            
                            
                            226,924
                            
                            
                            
                            826,513Sales
      and marketing expenses
                            
                            
                            447,693
                            
                            
                            
                            529,349
                            
                            
                            
                            1,494,572
                            
                            
                            
                            1,880,823General
      and administrative expenses
                            
                            
                            596,224
                            
                            
                            
                            666,637
                            
                            
                            
                            1,748,664
                            
                            
                            
                            2,205,616Total
      operating expenses
                            
                            
                            1,142,881
                            
                            
                            
                            1,497,893
                            
                            
                            
                            3,470,160
                            
                            
                            
                            4,912,952Operating
      loss
                            
                            
                            (1,090,395
                            )
                            
                            
                            (1,482,648
                            )
                            
                            
                            (2,930,522
                            )
                            
                            
                            (5,224,083
                            )Non-operating
      income (expense):Interest
      income
                            
                            
                            1,547
                            
                            
                            
                            18,722
                            
                            
                            
                            10,358
                            
                            
                            
                            101,070Gain
      on fair value of short-term investments
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            274,000Financing
      and interest expense
                            
                            
                            (6,445
                            )
                            
                            
                            (16,278
                            )
                            
                            
                            (31,704
                            )
                            
                            
                            (57,894
                            )Non-operating
      income (expense), net
                            
                            
                            (4,898
                            )
                            
                            
                            2,444
                            
                            
                            
                            (21,346
                            )
                            
                            
                            317,176Net
      loss
                            
                            
                            (1,095,293
                            )
                            
                            
                            (1,480,204
                            )
                            
                            
                            (2,951,868
                            )
                            
                            
                            (4,906,907
                            )Preferred
      stock dividends
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (36,679
                            )
                            
                            
                            -Net
      loss applicable to common shareholders
                            
                            $
                            (1,095,293
                            )
                            
                            $
                            (1,480,204
                            )
                            
                            $
                            (2,988,547
                            )
                            
                            $
                            (4,906,907
                            )Basic
      and diluted loss per share
                            
                            $
                            (0.05
                            )
                            
                            $
                            (0.06
                            )
                            
                            $
                            (0.13
                            )
                            
                            $
                            (0.21
                            )Weighted
      average shares used in computing net loss per share:Basic
      and diluted
                            
                            
                            22,942,458
                            
                            
                            
                            22,942,088
                            
                            
                            
                            22,942,458
                            
                            
                            
                            22,942,088





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


2


IsoRay,
Inc. and Subsidiaries


Consolidated
Statements of Cash Flows


(Unaudited)





Nine months ended March 31,2010
                
                
                2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                
                $
                (2,951,868
                )
                
                $
                (4,906,907
                )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization of fixed assets
                
                
                719,032
                
                
                
                905,678Impairment
      of IBt license (see Note 4)
                
                
                -
                
                
                
                425,434Write-off
      of certain foreign patents and trademarks
                
                
                
                
                
                
                84,671Amortization
      of deferred financing costs and other assets
                
                
                36,368
                
                
                
                60,448Gain
      on fair value of short-term investments
                
                
                
                
                
                
                (274,000
                )Realized
      (gains) / losses on short-term investments
                
                
                
                
                
                
                -Accretion
      of asset retirement obligation
                
                
                38,500
                
                
                
                35,198Share-based
      compensation
                
                
                115,285
                
                
                
                255,450Changes
      in operating assets and liabilities:Accounts
      receivable, net
                
                
                (125,993
                )
                
                
                152,399Inventory
                
                
                94,177
                
                
                
                78,162Prepaid
      expenses and other current assets
                
                
                (11,858
                )
                
                
                94,068Accounts
      payable and accrued expenses
                
                
                22,067
                
                
                
                132,403Accrued
      payroll and related taxes
                
                
                43,056
                
                
                
                (75,616
                )Net
      cash used by operating activities
                
                
                (2,021,234
                )
                
                
                (3,032,612
                )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of fixed assets
                
                
                (21,742
                )
                
                
                (41,961
                )Additions
      to licenses and other assets
                
                
                -
                
                
                
                (22,245
                )Change
      in restricted cash
                
                
                (1,416
                )
                
                
                (2,243
                )Purchases
      of short-term investments
                
                
                -
                
                
                
                (479,820
                )Proceeds
      from the sale or maturity of short-term investments
                
                
                1,679,820
                
                
                
                4,000,000Net
      cash  provided by investing activities
                
                
                1,656,662
                
                
                
                3,453,731CASH
      FLOWS FROM FINANCING ACTIVITIES:Principal
      payments on notes payable
                
                
                (145,815
                )
                
                
                (49,185
                )Principal
      payments on capital lease obligations
                
                
                -
                
                
                
                (23,312
                )Preferred
      dividends paid
                
                
                (36,679
                )
                
                
                -Proceeds
      from cash sales of common stock, pursuant to exercise of
      options
                
                
                2,166
                
                
                
                -Repurchase
      of Company common stock
                
                
                -
                
                
                
                (4,735
                )Net
      cash used by financing activities
                
                
                (180,328
                )
                
                
                (77,232
                )Net
      increase (decrease) in cash and cash equivalents
                
                
                (544,900
                )
                
                
                343,887Cash
      and cash equivalents, beginning of period
                
                
                2,990,744
                
                
                
                4,820,033CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                
                $
                2,445,844
                
                
                $
                5,163,920





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


3


IsoRay,
Inc. and Subsidiaries


Notes
to the Consolidated Unaudited Financial Statements


For
the three and nine-month periods ended March 31, 2010 and
2009





1.
            Basis
      of Presentation





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





The
accompanying interim consolidated financial statements have been prepared in
conformity with U.S. generally accepted accounting principles, consistent in all
material respects with those applied in the Company’s Annual Report on Form 10-K
for the fiscal year ended June 30, 2009.  The financial information is
unaudited but reflects all adjustments, consisting only of normal recurring
accruals, which are, in the opinion of the Company’s management, necessary for a
fair statement of the results for the interim periods
presented.  Interim results are not necessarily indicative of results
for a full year.  The information included in this Form 10-Q should be
read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal
year ended June 30, 2009.





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





2.
            New
      Accounting Pronouncements





On July
1, 2009, the Company adopted new accounting provisions which establishes the
FASB Accounting Standards CodificationTM (the Codification) as the single
official source of authoritative accounting principles recognized by the FASB to
be applied by nongovernmental entities in the preparation of financial
statements in conformity with generally accepted accounting principles (GAAP)
other than rules and interpretive releases issued by the Securities and Exchange
Commission. The Codification reorganized the literature and changed the naming
mechanism by which topics are referenced.  The Codification became
effective for interim and annual periods ending after September 15,
2009.  The Company’s accounting policies and amounts presented in the
financial statements were not impacted by this change.





On July
1, 2009, the Company adopted new accounting provisions which were delayed from
the effective date of fair value accounting for one year for certain
nonfinancial assets and nonfinancial liabilities, excluding those that are
recognized or disclosed in financial statements at fair value on a recurring
basis (that is, at least annually). For purposes of applying the new provisions,
nonfinancial assets and nonfinancial liabilities include all assets and
liabilities other than those meeting the definition of a financial asset or a
financial liability. The Company had previously adopted new standards for fair
value accounting on July 1, 2008.  The adoption of these new
provisions did not have a material effect on the Company but will affect future
calculations of asset retirement obligations and long-lived asset
impairment.





On July
1, 2009, the Company adopted new accounting provisions for business combinations
and for non-controlling interests.   The new business combination
provisions require an acquirer to measure the identifiable assets acquired,
the liabilities assumed and any non-controlling interest in the acquiree at
their fair values on the acquisition date, with goodwill being the excess value
over the net identifiable assets acquired. In addition, the new provisions
require that a non-controlling interest in a subsidiary be reported as equity in
the consolidated financial statements. The calculation of earnings per share
will continue to be based on income amounts attributable to the
parent.  The adoption of these statements did not have a material
effect on the Company’s financial statements.


4


3.
            Loss
      per Share





Basic
earnings per share is calculated by dividing net income (loss) available to
common shareholders by the weighted average number of common shares outstanding,
and does not include the impact of any potentially dilutive common stock
equivalents.  Common stock equivalents, including warrants and options
to purchase the Company's common stock, are excluded from the calculations when
their effect is anti-dilutive.  At March 31, 2010 and 2009, the
calculation of diluted weighted average shares does not include preferred stock,
common stock warrants, or options that are potentially convertible into common
stock as those would be anti-dilutive due to the Company’s net loss
position.





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





March
      31,2010
                    
                    
                    2009Preferred
      stock
                    
                    
                    59,065
                    
                    
                    
                    59,065Common
      stock warrants
                    
                    
                    3,216,644
                    
                    
                    
                    3,216,644Common
      stock options
                    
                    
                    2,317,237
                    
                    
                    
                    2,430,839Total
      potentially dilutive securities
                    
                    
                    5,592,946
                    
                    
                    
                    5,706,548





4.
            Impairment
      of IBt License





In
December 2008, the Company reevaluated its license agreement with International
Brachytherapy SA (IBt) in connection with an overall review of its present cost
structure and projected market and manufacturing
strategies.  Management determined through this review that it does
not currently intend to utilize the IBt license as part of its market strategy
due to the cost of revamping its manufacturing process to incorporate the
technology and as there can be no assurance that physicians would accept this
new technology without extensive education and marketing
costs.  However, the Company does not intend to cancel the license
agreement at this time; therefore, the license was reviewed in terms of an
“abandoned asset” for purposes of ASC 360.As there are no
anticipated future revenues from the license and the Company cannot sell or
transfer the license, it was determined that the entire value was
impaired.  Therefore, the Company recorded an impairment charge of
$425,434 that is included in cost of product sales for the nine months ended
March 31, 2009.





5.
            Short-Term
      Investments





The
Company’s short-term investments are classified as available-for-sale and
recorded at fair market value.  The Company’s short-term investments
consisted entirely of certificates of deposit at various banks.  As of
March 31, 2010 the Company had no short-term investments and as of June 30,
2009, the Company had $1,679,820 in short-term investments.  The
Company’s short-term investments are accounted for and reported at fair value
using level 1 inputs.


5


6.
            Inventory





Inventory
consisted of the following at March 31, 2010 and June 30, 2009:





March 31,
                  
                  
                  June 30,2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  559,946
                  
                  
                  $
                  609,932Work
      in process
                  
                  
                  135,123
                  
                  
                  
                  155,827Finished
      goods
                  
                  
                  –
                  
                  
                  
                  23,487$
                  695,069
                  
                  
                  $
                  789,246





7.
            Share-Based
      Compensation





The
following table presents the share-based compensation expense recognized in the
statement of operations during the three and nine months ended March 31, 2010
and 2009:





Three months
                  
                  
                  Nine monthsended March 31,
                  
                  
                  ended March 31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Cost
      of product sales
                  
                  $
                  5,506
                  
                  
                  $
                  3,100
                  
                  
                  $
                  16,778
                  
                  
                  $
                  17,010Research
      and development expenses
                  
                  
                  1,840
                  
                  
                  
                  4,001
                  
                  
                  
                  2,176
                  
                  
                  
                  23,490Sales
      and marketing expenses
                  
                  
                  19,599
                  
                  
                  
                  18,869
                  
                  
                  
                  70,684
                  
                  
                  
                  123,852General
      and administrative expenses
                  
                  
                  7,863
                  
                  
                  
                  29,698
                  
                  
                  
                  25,647
                  
                  
                  
                  91,098Total
      share-based compensation
                  
                  $
                  34,808
                  
                  
                  $
                  55,668
                  
                  
                  $
                  115,285
                  
                  
                  $
                  255,450





As of
March 31, 2010, total unrecognized compensation expense related to share-based
options was $92,251 and the related weighted-average period over which it is
expected to be recognized is approximately 1.09 years.





The
Company currently provides share-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.





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





WeightedWeighted
                              
                              
                              AverageAverage
                              
                              
                              Remaining
                              
                              
                              AggregateNumber of
                              
                              
                              Exercise
                              
                              
                              Contractual
                              
                              
                              IntrinsicOptions
                              
                              
                              Price
                              
                              
                              Term
                              
                              
                              ValueOutstanding
      at March 31, 2010
                              
                              
                              2,317,237
                              
                              
                              $
                              1.91
                              
                              
                              
                              7.08
                              
                              
                              $
                              976,633Vested
      and expected to vest at March 31, 2010
                              
                              
                              2,235,647
                              
                              
                              $
                              1.97
                              
                              
                              
                              7.02
                              
                              
                              $
                              893,448Vested
      and exercisable atMarch 31, 2010
                              
                              
                              1,854,603
                              
                              
                              $
                              2.29
                              
                              
                              
                              6.72
                              
                              
                              $
                              536,375




6





The
aggregate intrinsic value of options exercised during the nine months ended
March 31, 2010 and 2009 was $2,233 and $0, respectively.  The
Company’s current policy is to issue new shares to satisfy option
exercises.





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





Three months
                    
                    
                    Nine monthsended March 31,
                    
                    
                    ended March 31,2010(a)
                    
                    
                    2009(b)
                    
                    
                    2010(c)
                    
                    
                    2009(d)Weighted
      average fair value of options granted
                    
                    $
                    0.56
                    
                    
                    $
                    –
                    
                    
                    $
                    0.68
                    
                    
                    $
                    0.37Key
      assumptions used in determining fair value:Weighted
      average risk-free interest rate
                    
                    
                    1.93
                    %
                    
                    
                    –
                    %
                    
                    
                    2.55
                    %
                    
                    
                    2.63
                    %Weighted
      average life of the option (in years)
                    
                    
                    3.75
                    
                    
                    
                    –
                    
                    
                    
                    4.75
                    
                    
                    
                    5.68Weighted
      average historical stock price volatility
                    
                    
                    101.84
                    %
                    
                    
                    –
                    %
                    
                    
                    134.89
                    %
                    
                    
                    191.04
                    %Expected
      dividend yield
                    
                    
                    0.00
                    %
                    
                    
                    –
                    %
                    
                    
                    0.00
                    %
                    
                    
                    0.00
                    %





(a)
            During
      the three months ended March 31, 2010, the Company granted 30,000 stock
      options.


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


(c)
            During
      the nine months ended March 31, 2010, the Company granted 40,000 stock
      options.


(d)
            During
      the nine months ended March 31, 2009, the Company granted 95,000 stock
      options.





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.  Although the Company is using the Black-Scholes option
valuation model, management believes that because changes in the subjective
input assumptions can materially affect the fair value estimate, this valuation
model does not necessarily provide a reliable single measure of the fair value
of its stock options.  The risk-free interest rate is based on the
U.S. treasury security rate with an equivalent term in effect as of the date of
grant.  The expected option lives, volatility, and forfeiture
assumptions 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
therefore no royalty is due pursuant to the terms of the
agreement.  Management believes that ultimately no royalties should be
paid under this agreement as there is no intent to use this “know-how” in the
future.





The
licensor of the “know-how” has disputed management’s contention that it is not
using this “know-how”.  On September 25, 2007 and again on October 31,
2007, the Company participated in nonbinding mediation regarding this matter;
however, no settlement was reached with the Lawrence Family
Trust.  After additional settlement discussions, which ended in April
2008, the parties failed to reach a settlement.  The parties may
demand binding arbitration at any time.


7





9.
            Preferred
      Dividends




On
December 11, 2009, the Board of Directors declared a dividend on the Series B
Preferred Stock of all currently payable and accrued outstanding and cumulative
dividends through December 31, 2009.  Dividends on the Series B
Preferred Stock were last paid on February 15, 2007 for dividends outstanding
and cumulative through December 31, 2006.  The dividends outstanding
and cumulative through December 31, 2009 of $36,679 were paid as of that
date.




10.
            Subsequent
      Event





Management
executed a sales agreement with C.K.Cooper & Company, Inc on April 22, 2010
to sell shares as the Company’s sales agent at market prices.  The
sales agreement expires on June 30, 2010.  If the shares are sold, the
shares will be issued pursuant to the Form S-3 (File No. 333-162694) which
became effective on November 13, 2009 and the prospectus supplement dated April
23, 2010.  Sales cannot exceed $4 million under the prospectus
supplement and must be sold “at the market” price of the common stock as of the
day the sales are made.


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-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 17 below and in the “Risk
Factors” section of our Form 10-K for the fiscal year ended June 30, 2009 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-K as filed with the Securities and Exchange Commission on September
23, 2009 are those that depend most heavily on these judgments and
estimates.  As of March 31, 2010, there have been no material
changes to any of the critical accounting policies contained
therein.


9





Results of
Operations





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





Product sales.  The
Company generated revenue of $1,203,216 during the three months ended March 31,
2010 compared to revenue of $1,366,289 during the three months ended March 31,
2009.  The decrease of $163,073 or 12% in revenue directly correlates
with a reduction in the quantity of seeds sold. While no marketing program has
been implemented for the treatment of sites other than
prostate,  these new treatment sites  including lung, head
and neck, colorectal and others contributed 5 new cases in the three months
ended March 31, 2010 and approximately $31,000 in additional revenue to the
revenue generated by prostate related treatments.  Management believes
that the overall market for prostate brachytherapy has received increased
pressure from other treatment modalities with higher reimbursement rates such as
Intensity-Modulated Radiation Therapy (IMRT) and Robotics. While these new
treatment sites for the quarter ended March 31. 2010  comprised 3% of
Company revenue, management believes these sites present opportunities for
growth with market acceptance that is not available at this time in the highly
competitive prostate market.





Cost of product
sales.  Cost of product sales was $1,150,730 for the three
months ended March 31, 2010 compared to cost of product sales of $1,351,044
during the three months ended March 31, 2009.  The decrease in cost of
$200,314 or 15% correlates with the reduced sales.  The major
components of the decrease were personnel costs, materials, preload expenses,
occupancy costs and depreciation and amortization expense.  Personnel
costs, including payroll, benefits, and related taxes, decreased approximately
$31,000 as the number of production personnel decreased for the three months
ended March 31, 2010 compared to March 31, 2009.  Materials decreased
approximately $66,000 mainly due to decreased rate of consumption of inventory
materials as a result of changes in sales in the three months ended March 31,
2010 compared to March 31, 2009.  Preload expenses decreased by
approximately $14,000 mainly due to the lower volume of sales and increased
in-house loading for the three months ended March 31, 2010 compared to March 31,
2009.  Occupancy costs were reduced by approximate $17,000 for the
three months ended March 31, 2010 compared to March 31, 2009 as a result of
reduced rent and related utility consumption.  Depreciation and
amortization was reduced by approximately $53,000 for the three months ended
March 31, 2010 compared to March 31, 2009.





Gross margin.  Gross
margin was $52,486 for the three month period ended March 31, 2010 as compared
to $15,245 for the three months ended March 31, 2009.  This represents
an increase in the Company’s gross margin of $37,241 or 244%.  The
increase in the gross margin is due to the Company’s continuing efforts in
managing production during decreased periods of sales.





Research and development
expenses.  Research and development expenses for the three
month period ended March 31, 2010 were $98,964 which represents a decrease of
$202,943 or 67% less than the research and development expenses of $301,907 for
the three month period ended March 31, 2009.  The decrease in cost is
primarily due to lower consulting, personnel expenses and protocol
expense.  Consulting expenses decreased approximately $49,000 as the
Company completed several projects related to production automation and bringing
delivery methods to treat head and neck, lung and colorectal cancer to
market.  Protocol expenses decreased approximately $61,000 as the
major cost for the monotherapy protocol has been completed.  Legal
costs were reduced by approximately $90,000 because in the three months ended
March 31, 2009, the Company finalized its on-going strategy regarding foreign
patents and trademarks and wrote-off $84,671 of previously capitalized
costs.  The Company had pursued patents and trademarks in various
foreign countries including Australia, Japan, and China; however, the Company no
longer believes that pursuing patents and trademarks in these foreign countries
is fundamental to its current business strategy.


10





Sales and marketing
expenses.  Sales and marketing expenses were $447,693 for the
three months ended March 31, 2010.  This represents a decrease of
$81,656 or 15% compared to expenditures in the three months ended March 31, 2009
of $529,349 for sales and marketing.  Personnel expenses, including
payroll, benefits, and related taxes, decreased approximately $46,000 due to a
lower sales headcount.  Training for physicians was reduced by
approximately $18,000 for the three months ended March 31, 2010 as the training
that occurred in the three months ended March 31, 2009 did not occur in the
three months ended March 31, 2010.





General and administrative
expenses.  General and administrative expenses for the three
months ended March 31, 2010 were $596,224 compared to general and administrative
expenses of $666,637 for the three months ended March 31, 2009.  The
decrease of $70,413 or 11% is mainly due to decreased personnel, and consulting
expenses that were partially offset by an increase in other
costs.  Personnel expenses, including payroll, benefits, related
taxes, and share-based compensation decreased approximately $77,000 due
primarily to the resignation of the Company’s CFO in October
2009.  Public company and consulting expenses were reduced by
approximately $40,000 due primarily to the conversion of the interim CEO to a
full-time employee.   These reductions were partially offset by
an increase in other costs of approximately $46,000 that include franchise
taxes, licenses and permits, credit card discount expense and allowance for bad
debt.





Operating loss.  The
Company continues to focus its resources on improving sales while retaining the
necessary administrative infrastructure to increase the level of demand for the
Company’s product.  These objectives and resulting costs have resulted
in the Company not being profitable and generating operating losses since its
inception.  In the three months ended March 31, 2010, the Company had
an operating loss of $1,090,395 which is a decrease of $392,253 or 26% less than
the operating loss of $1,482,648 for the three months ended March 31,
2009.





Interest
income.  Interest income was $1,547 for the three months ended
March 31, 2010.  This represents a decrease of $17,175 or 92% compared
to interest income of $18,722 for the three months ended March 31,
2009.  Interest income is mainly derived from excess funds held in
money market accounts and invested in short-term investments.  The
decrease is due to lower interest rates and lower balances in the Company’s
money market and short-term investment accounts.





Financing and interest
expense.  Financing and interest expense for the three months
ended March 31, 2010 was $6,445 or a decrease of $9,833 or 60% from financing
and interest expense of $16,278 for the three months ended March 31,
2009.  Included in financing expense is interest expense of
approximately $6,000 for each of the three months ended March 31, 2010 and 2009,
respectively.  The remaining balance of financing expense represents
the amortization of deferred financing costs.





Nine
months ended March 31, 2010 compared to nine months ended March 31,
2009





Product
sales.  Sales for the nine months ended March 31, 2010 were
$3,950,650 compared to sales of $4,212,574 for the nine months ended March 31,
2009.  The decrease of $261,924 or 6% directly correlates with a
reduction in the quantity of seeds sold.   New treatment sites
including lung, head and neck, colorectal and other applications contributed 19
new cases in the nine months ended March 31, 2010 and approximately $108,000 in
additional revenue to the revenue generated by prostate related
treatments.  Management believes that the overall market for prostate
brachytherapy has received increased pressure from other treatment modalities
with higher reimbursement rates such as Intensity-Modulated Radiation Therapy
(IMRT) and Robotics.  While these new treatment sites year to date
only comprise 3% of Company revenue, management believes these sites present
opportunities for growth with market acceptance that is not available at this
time in the highly competitive prostate market.


11





Cost of product
sales.  Cost of product sales was $3,411,012 for the nine
months ended March 31, 2010 compared to cost of product sales of $4,523,705
during the nine months ended March 31, 2009.  The cost reduction of
$1,112,693 or 25% for the nine months ended March 31, 2010 were the result of
both the reduction in sales and continued production efficiency
improvements.  Depreciation and amortization cost was reduced by
approximately $164,000.  Personnel expenses, including payroll,
benefits, and related taxes, decreased approximately $170,000 due to a reduction
in the average production headcount levels.  Preload expenses
decreased approximately $183,000 due to lower sales volumes and increased
in-house loading.  Occupancy costs were reduced by approximately
$64,000 as the Company continues to evaluate and reconfigure leased space that
has resulted in a reduced facility rent.  In addition, the Company
continues to monitor its utility consumption and more efficient consumption of
utilities in combination with a very mild winter has created a significant
savings of approximately $43,000 in utility costs that is included in occupancy
cost for the nine months ended March 31, 2010 as compared to the nine months
ended March 31, 2009.  Other expenses were reduced by approximately
$435,000, primarily resulting from the impairment charge for the IBt license of
approximately $425,000 that was recorded in the nine months ended March 31,
2009.





Gross margin /
(loss).  Gross margin was $539,638 for the nine month period
ended March 31, 2010.  This represents an improvement of $850,769
compared to a gross loss of $311,131 during the nine month period ended March
31, 2009.  Included in the gross loss of $311,131 for the nine months
ended March 31, 2009 is the one-time IBt license impairment charge of
$425,434.  Without this one-time expense, the Company would have
recognized a gross margin of $114,303 for the nine months ended March 31,
2009.





Research and development
expenses.  Research and development expenses for the nine
months ended March 31, 2010 were $226,924 which represents a decrease of
$599,589 or 73% less than the research and development expenses of $826,513 for
the nine months ended March 31, 2009.  Consulting expenses decreased
approximately $88,000 as several production projects were completed related to
both production automation and delivery methods to treat head and neck, lung,
and colorectal cancers.  These decreases were partially offset by the
transition of a former R&D employee to a consulting role.  Legal
expenses were reduced by approximately $125,000 in the nine months ended March
31, 2010 due to the Company finalizing its on-going strategy regarding foreign
patents and trademarks and wrote-off $84,671 of previously capitalized costs and
the resulting reduction in continuing activities as a result during the nine
months ended March 31, 2009.  Personnel expenses, including payroll,
benefits, and related taxes, decreased approximately $72,000 due to lower
headcount.  Protocol expense was reduced by approximately $255,000 for
the nine month period ended March 31, 2010 as the major cost for the monotherapy
protocol has been completed.





Sales and marketing
expenses.  Sales and marketing expenses were $1,494,572 for the
nine months ended March 31, 2010.  This represents a decrease of
$386,251 or 21% compared to expenditures in the nine months ended March 31, 2009
of $1,880,823 for sales and marketing.  Personnel expenses, including
payroll, benefits, related taxes, and share-based compensation decreased
approximately $209,000 due to a lower sales headcount.  Travel
expenses also decreased approximately $85,000 due to the decrease in average
headcount


12


General and administrative
expenses.  General and administrative expenses for the nine
months ended March 31, 2010 were $1,748,664 compared to general and
administrative expenses of $2,205,616 for the nine months ended March 31,
2009.  This represents a decrease of $456,952 or
21%.  Personnel costs including payroll, benefits, related taxes, and
share-based compensation decreased approximately $222,000 as a result of the CEO
becoming an employee, the resignation of the CFO, an overall reduction in
headcount and the related forfeiture of option grants and option grants that
have been fully amortized.  Public company expenses decreased
approximately $59,000 due to the CEO no longer being paid fees for service on
the Board of Directors upon becoming an employee.  Legal expenses
decreased by approximately $126,000 in the nine months ended March 31, 2010 as
the Company incurred legal fees related to settling a lawsuit with a former
employee during the nine months ended March 31, 2009.





Operating loss.  The
Company continues to focus its resources on improving sales while retaining the
necessary administrative infrastructure to increase the level of demand for the
Company’s product.  These objectives and resulting costs have resulted
in the Company not being profitable and generating operating losses since its
inception.  In the nine months ended March 31, 2010, the Company had
an operating loss of $2,930,522 which is an improvement of $2,293,561 or 44%
better than the operating loss of $5,224,083 for the nine months ended March 31,
2009.  Included in the operating loss for the nine months ended March
31, 2009 is the one-time IBt license impairment loss of
$425,434.  Without this impairment loss, the Company’s operating loss
would have been $4,798,649 for the nine months ended March 31,
2009.





Interest
income.  Interest income was $10,358 for the nine months ended
March 31, 2010.  This represents a decrease of $90,712 or 90% compared
to interest income of $101,070 for the nine months ended March 31,
2009.  Interest income is mainly derived from excess funds held in
money market accounts and invested in short-term investments.  The
decrease is due to lower interest rates and lower balances in the Company’s
money market and short-term investment accounts.





Gain on fair value of short-term
investments.  There was no gain on short-term investments for
the nine months ended March 31, 2010 as compared to a gain of $274,000 for the
nine months ended March 31, 2009.  The gain of $274,000 for the nine
months ended March 31, 2009 was due to the receipt of rights issued by the
Company’s broker in October 2008.  The gain was calculated as the fair
value amount of the rights estimated on the date of receipt plus the changes in
their fair value offset by additional realized losses on the Company’s auction
rate securities.





Financing and interest
expense.  Financing and interest expense for the nine months
ended March 31, 2010 was $31,704 or a decrease of $26,190 or 45% from financing
and interest expense of $57,894 for the nine months ended March 31,
2009.  Included in financing expense is interest expense of
approximately $17,000 and $31,000 for the nine months ended March 31, 2010 and
2009, respectively.  The decrease in interest expense is due to the
reduction of the principal balances of the Company’s overall debt and capital
lease balances.  The remaining balance of financing expense represents
the amortization of deferred financing costs.





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





Cash
flows from operating activities





Cash used
in operating activities was $2.0 million for the nine months ended March 31,
2010 compared to $3.0 million for the nine months ended March 31,
2009.  Cash used by operating activities is net loss adjusted for
non-cash items and changes in operating assets and liabilities.


13





Cash
flows from investing activities





Cash
provided by investing activities was approximately $1.7 million for the nine
months March 31, 2010 as compared to cash provided by investing activities of
$3.5 million for the nine months ended March 31, 2009.  Cash
expenditures for fixed assets were approximately $22,000 and $42,000 during the
nine months ended March 31, 2010 and 2009, respectively.  The Company
sold its remaining auction rate securities in January 2009 which generated $4.0
million of cash proceeds in the nine months ended March 31, 2009.  The
Company reinvested most of these proceeds in money market funds and certificates
of deposit with maturities of less that 3 months which are classified as cash
equivalents on the balance sheet.





Cash
flows from financing activities





Cash used
in financing activities was approximately $180,000 and $77,000 for the nine
months ended March 31, 2010 and 2009, respectively.  $146,000 and
$72,000 was used mainly for payments of debt and capital leases in the nine
months ended March 31, 2010 and 2009 respectively.  Approximately
$108,000 of the $146,000 in cash that was used for payments of debt and capital
leases in the nine months ended March 31, 2010 was to retire the loan facility
with Benton-Franklin Council of Governments (BFEDD).  Approximately
$37,000 of the remaining cash consumed in financing activities was related to
the payment of preferred dividends which was partially offset by the exercise of
stock options.





Projected
2010 Liquidity and Capital Resources





At March
31, 2010, cash and cash equivalents amounted to $2,425,844 and the Company had
no short-term investments, compared to $2,990,744 of cash and cash equivalents
and $1,679,820 of short-term investments at June 30, 2009.





The
Company had approximately $2.1 million of cash and no short-term investments as
of April 30, 2010.  The Company’s monthly required cash operating
expenditures were approximately $225,000 in the nine months ended March 31,
2010, which represents a 40% decrease of approximately $150,000 from average
monthly cash operating expenditures in fiscal year 2009 of approximately
$375,000. This reduction is primarily the result of improved operating
performance in fiscal year 2010.  Management believes that less than
$100,000 will be spent on capital expenditures for fiscal year 2010, but there
is no assurance that unanticipated needs for capital equipment may not
arise.





The
Company’s loan facility with BFEDD matured during the nine months ended March
31, 2010 and the full amount due of approximately $108,000 was paid on November
13, 2009 to settle the loan facility.  The Company has only one
remaining loan facility outstanding with the Hanford Area Economic Investment
Fund Committee (HAEIFC), with a principal balance of approximately $192,000 of
which approximately $48,000 will be due in the next 12 months.





The
Company has significantly decreased its protocol studies in the prostate market
as management believes the studies conducted to date are
adequate.  Management is in the process of determining whether the
approximately $225,000 originally budgeted for protocol expenses relating to
lung cancer and the ongoing protocols still needed for dual therapy and mono
therapy prostate protocols is adequate.  For the nine months ended
March 31, 2010, approximately $54,000 has been spent.


14


Based on
the foregoing assumptions, management believes cash, cash equivalents, and
short-term investments on hand at March 31, 2010 will not be sufficient to
meet our anticipated cash requirements for operations, debt service, and capital
expenditure requirements through the next twelve months but will fund operations
for approximately 11 months.  Management plans to attain breakeven and
generate additional cash flows by increasing  revenues from both new
and existing customers (through our direct sales channels and through our
distributors), expanding into other market applications which initially will
include head and neck implants, colorectal and lung implants while maintaining
the Company's focus on cost control.  However, there can be no
assurance that the Company will attain profitability or that the Company will be
able to attain its revenue targets.  Sales in the prostate market have
not shown the increases necessary to breakeven during the past two fiscal years
and did not improve during the nine months ended March 31, 2010.





Management
is now focused on expanding into head and neck, colorectal and lung application
segments and our cash and cash equivalents are only sufficient to meet cash
requirements for operations, debt service and capital expenditures at our
current monthly average expenses for the next eleven months assuming no
expansion of our operations.  As a result, management believes the
Company will need to raise additional capital for protocols, marketing staff,
production staff and production equipment as it plans to enter new market
applications for the Company’s technologies.





Management
executed a sales agreement with C.K.Cooper & Company, Inc (CKCC) on April
22, 2010 to sell shares as the Company’s sales agent at market
prices.  The sales agreement expires on June 30, 2010.  If
the shares are sold, the shares will be issued pursuant to the Form S-3 (File
No. 333-162694) which became effective on November 13, 2009 and the prospectus
supplement dated April 23, 2010.  Sales cannot exceed $4 million under
the prospectus supplement and must be sold “at the market” price of the common
stock as of the day the sales are made.





The
Company expects to finance its cash needs through the sale of equity securities
and possibly strategic collaborations or debt financing or through other sources
that may be dilutive to existing shareholders.  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.





Long-Term
Debt and Capital Lease Agreements





IsoRay
has a single loan facility in place as of March 31, 2010.  This loan
facility is from the HAEIFC and was originated in June 2006.  The loan
originally had a total facility of $1,400,000 which was reduced in September
2007 to the amount of the Company’s initial draw of $418,670.  The
loan bears interest at nine percent and the principal balance owed as of March
31, 2010 was $191,645.  This loan is secured by receivables,
equipment, materials and inventory, and certain life insurance policies and also
required personal guarantees.





Other
Commitments and Contingencies





The
Company is subject to various local, state, and federal environmental
regulations and laws due to the isotopes used to produce the Company’s
product.  As part of normal operations, amounts are expended to ensure
that the Company is in compliance with these laws and
regulations.  While there have been no reportable incidents or
compliance issues, the Company believes that if it relocates its current
production facilities then certain decommissioning expenses will be
incurred.  An asset retirement obligation was established in the first
quarter of fiscal year 2008 for the Company’s obligations at its current
production facility.  This asset retirement obligation will be for
obligations to remove any residual radioactive materials and to remove all
leasehold improvements.


15





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.





ITEM
3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





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





ITEM
4 – CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures





Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the design and operation of our disclosure controls and
procedures, as such term is defined under Rules 13a-14(c) and 15d-14(c)
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), as of March 31, 2010.  Based on that evaluation, our principal
executive officer and our principal financial officer concluded that the design
and operation of our disclosure controls and procedures were
effective.  The design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote.  However,
management believes that our system of disclosure controls and procedures is
designed to provide a reasonable level of assurance that the objectives of the
system will be met.





Changes
in Internal Control over Financial Reporting





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


16





PART
II - OTHER INFORMATION





ITEM
1A – RISK FACTORS





There
have been no material changes for the risk factors disclosed in the “Risk
Factors” section of our Annual Report on Form 10-K for the year ended June 30,
2009, except for the addition of the following risk factors:





The Price Of Our Common Stock May Be
Adversely Affected By The Future Issuance And Sale Of Shares Of Our Common Stock
Or Other Equity Securities, Including Pursuant To The Sales Agreement, Or By Our
Announcement That Such Issuances And Sales May Occur.We
cannot predict the size of future issuances or sales of our common stock or
other equity securities, including those made pursuant to the sales agreement
with CKCC, future acquisitions or capital raising activities, or the effect, if
any, that such issuances or sales may have on the market price of our common
stock. In addition, CKCC, as agent for sales under the sales agreement, will not
engage in any transactions that stabilize the price of our common stock. The
issuance and sale of substantial amounts of common stock or other equity
securities, including the issuances and sales pursuant to the sales agreement,
or announcement that such issuances and sales may occur, could adversely affect
the market price of our common stock.




Our Reduced Stock Price May
Adversely Affect Our Liquidity.  Our common stock has been
trading at less than $1.00 per share periodically in the past.  Many
market makers are reluctant to make a market in stock with a trading price of
less than $1.00 per share.  To the extent that we have fewer market
makers for our common stock, our volume and liquidity will likely decline, which
could further depress our stock price.




Failure to Comply with NYSE Amex
Listing Standards And Any Resulting Delisting Could Adversely Affect The Market
For Our Common Stock.  Our common stock is presently listed on
the NYSE Amex. The NYSE Amex will consider delisting a company's securities if,
among other things, the company fails to maintain minimum stockholder's equity
or the company has sustained losses which are so substantial in relation to its
overall operations or its existing financial resources, or its financial
condition has become so impaired that it appears questionable, in the opinion of
the NYSE Amex, as to whether such issuer will be able to continue operations
and/or meet its obligations as they mature. There can be no assurance that we
will be able to maintain our listing on the NYSE Amex indefinitely. In the event
that our common stock is delisted from the NYSE Amex, trading, if any, in the
common stock would be conducted in the over-the-counter market. As a result, our
shareholders would likely find it more difficult to dispose of, or to obtain
accurate quotations as to the market value of, our common stock.





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





Use
of Proceeds from Registered Securities





On
October 27, 2010, we filed a registration statement on Form S-3 to register
securities up to $15 million in value for future issuance in our capital raising
activities.  The registration statement became effective on November
13, 2010, and we filed a prospectus supplement relating to the Sales Agreement
described below on April 23, 2010.  The Commission file number
assigned to the registration statement is 333-162694.


17


On April
22, 2010, we entered into a Sales Agreement (the "Agreement") with C. K. Cooper
& Company, Inc. ("CKCC").  Pursuant to the terms of the Agreement,
the Company may offer and sell (the "Offering") from time to time through CKCC,
as the Company's sales agent, up to $4 million of shares of the Company's common
stock, par value $0.001 per share (the "Shares").  CKCC is not
required to sell any specific number or dollar amount of Shares but will use its
commercially reasonable efforts, as the Company's agent and subject to the terms
of the Agreement, to sell the Shares offered, as instructed by the Company.
Sales of the Shares, if any, may be made by means of ordinary brokers'
transactions on the NYSE AMEX at market prices and such other sales as agreed to
by the Company and CKCC. CKCC will receive from us a commission of 2.0% based on
the gross sales price per share for any Shares sold through it as agent under
the Agreement. Net proceeds from the sale of the Shares will be used for general
corporate purposes. The Company has also agreed to reimburse CKCC for certain
expenses incurred in connection with entering into the Agreement and has
provided CKCC with customary indemnification rights.  The offering of
Shares pursuant to the Agreement will terminate upon the earliest of (i) June
30, 2010, (ii) the sale of all Shares subject to the Agreement and (ii) the
termination of the Agreement by the Company or CKCC.




CKCC has
not yet commenced the Offering as it has not yet been instructed to do so by the
Company.


18





ITEM
6 – EXHIBITS




Exhibits:10.58
              
              Consulting
      and Severance Agreement dated January 12, 2010 between IsoRay, Inc. and
      Lori Woods31.1
              
              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




19


SIGNATURES





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




Dated:
May 10, 2010





ISORAY,
      INC., a Minnesota corporationBy
                  /s/ Dwight
      BabcockDwight
      Babcock, Chief Executive Officer(Prinicipal
      Executive
Officer)





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




20