*Table
        of Contents*







**United
      States**


**Securities
      and Exchange Commission**


Washington,
      D.C. 20549




**FORM
      10-K**




þ
            **Annual
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**
              For
                the fiscal year ended June 30, 2008




or





 ̈
            **Transition
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**
              For
                the transition period from __________ to
                ____________




Commission
      File No. 001-33407




**IsoRay,
      Inc.**


(Exact
      name of registrant as specified in its charter)




Minnesota
              (State
                of incorporation)
            41-1458152
              (I.R.S.
                Employer Identification No.)350
                Hills St., Suite 106
              Richland,
                Washington 99354
              (Address
                of principal executive offices)
            (509)
                375-1202
              (Registrant’s
                telephone number)





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





Securities
      registered pursuant to Section 12(b) of the Exchange Act – Common Stock – $0.001
      par value


(American
      Stock Exchange)





Securities
      registered pursuant to Section 12(g) of the Exchange Act – Series C Preferred
      Share Purchase Rights




Number
      of shares outstanding of each of the issuer's classes of common
      equity:





Class
            Outstanding
                as of September 16, 2008Common
                stock, $0.001 par value
            22,942,088





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No x




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes o No x




Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding
      12
      months (or for such shorter period that 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 if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the best
      of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. o




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


Large
      accelerated filer o Accelerated filer o Non-accelerated
      filer o Smaller
      reporting company x





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




State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      last sold, or the average bid and asked prices of such common equity, as of
      the
      last business day of the registrant’s most recently completed second fiscal
      quarter – $44,350,379 as of December 31, 2007.




Documents
      incorporated by reference – none.












*Table
        of Contents*




**ISORAY,
      INC.**





**Table
      of Contents**





PagePART
                IITEM
                1 – BUSINESS
            
            1ITEM
                1A – RISK FACTORS
            
            21ITEM
                1B – UNRESOLVED STAFF COMMENTS
            
            28ITEM
                2 – PROPERTIES
            
            28ITEM
                3 – LEGAL PROCEEDINGS
            
            28ITEM
                4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY
                HOLDERS
            
            28PART
                IIITEM
                5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
                STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
                SECURITIES
            
            28ITEM
                6 – SELECTED FINANCIAL DATA
            
            30ITEM
                7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
                CONDITION AND RESULTS OF OPERATIONS
            
            30ITEM
                7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
                MARKET RISK
            
            42ITEM
                8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY
                DATA
            
            42ITEM
                9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                ACCOUNTING AND FINANCIAL DISCLOSURE
            
            42ITEM
                9A – CONTROLS AND PROCEDURES
            
            43ITEM
                9B – OTHER INFORMATION
            
            44PART
                IIIITEM
                10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
                GOVERNANCE
            
            44ITEM
                11 – EXECUTIVE COMPENSATION
            
            48ITEM
                12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
                AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
            
            51ITEM
                13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
                AND DIRECTOR INDEPENDENCE
            
            52ITEM
                14 – PRINCIPAL ACCOUNTANT FEES AND
                SERVICES
            
            54ITEM
                15 – EXHIBITS AND REPORTS ON FORM
                8-K
            
            54SIGNATURES
            
            58




*Table
          of Contents*




**Caution
      Regarding Forward-Looking Information**





*In
      addition to historical information, this Form 10-K 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-K, other than statements of historical
      facts, that address future activities, events or developments are
      forward-looking statements, including, but not limited to, statements containing
      the words "believe," "expect," "anticipate," "intends," "estimate," "forecast,"
      "project," and similar expressions. All statements other than statements of
      historical fact are statements that could be deemed forward-looking statements,
      including any statements of the plans, strategies and objectives of management
      for future operations; any statements concerning proposed new products,
      services, developments or industry rankings; any statements regarding future
      revenue, economic conditions or performance; any statements of belief; and
      any
      statements of assumptions underlying any of the foregoing. These statements
      are
      based on certain assumptions and analyses made by us in light of our experience
      and our assessment of historical trends, current conditions and expected future
      developments as well as other factors we believe are appropriate under the
      circumstances. However, whether actual results will conform to the expectations
      and predictions of management is subject to a number of risks and uncertainties
      described under Item 1A – Risk Factors beginning on page 21 below that may cause
      actual results to differ materially.*





*Consequently,
      all of the forward-looking statements made in this Form 10-K 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.*





**PART
      I**





As
      used
      in this Form 10-K, unless the context requires otherwise, “we” or “us” or the
“Company” means IsoRay, Inc. and its subsidiaries.





**ITEM
      1 – BUSINESS**





**General**





Century
      Park Pictures Corporation (Century) was organized under Minnesota law in 1983.
      Century had no operations since its fiscal year ended September 30, 1999 through
      June 30, 2005.





On
      July
      28, 2005, IsoRay Medical, Inc. (Medical) became a wholly-owned subsidiary of
      Century pursuant to a merger. Century changed its name to IsoRay, Inc. (IsoRay
      or the Company). In the merger, the Medical stockholders received approximately
      82% of the then outstanding securities of the Company.





Medical,
      a Delaware corporation, was incorporated on June 15, 2004 to develop,
      manufacture and sell isotope-based medical products and devices for the
      treatment of cancer and other malignant diseases. Medical is headquartered
      in
      Richland, Washington.





IsoRay
      International LLC (International), a Washington limited liability company,
      was
      formed on November 27, 2007 to serve as an owner in a Russian LLC that will
      distribute the Company’s products to the Russian market and also license the
      Company’s technology for use in manufacturing Cs-131 brachytherapy seeds in
      Russia. International is a wholly-owned subsidiary of the Company.




1
 *Table
          of Contents*




**Available
      Information**





The
      Company electronically files its annual reports on Form 10-K, quarterly reports
      on Form 10-Q, current reports on Form 8-K, and all amendments to these reports
      and other information with the Securities and Exchange Commission (SEC). These
      reports can be obtained by accessing the SEC’s website at www.sec.gov. The
      public can also obtain copies by visiting the SEC’s Public Reference Room at 100
      F Street NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330.
      In
      addition, the Company makes copies of its annual and quarterly reports available
      to the public at its website at www.isoray.com. Information on this website
      is
      not a part of this report.





**Business
      Operations**





**Overview**





IsoRay
      began production and sales of Proxcelan Cesium-131 (Cs-131) brachytherapy seeds
      in October 2004 for the treatment of prostate cancer after clearance of its
      premarket notification (510(k)) by the Food and Drug Administration (FDA).
      In
      December 2007, IsoRay began selling its Proxcelan Cs-131 seeds for the treatment
      of ocular melanoma. Cs-131 could also be applied as a treatment for other solid
      tumor applications such as breast, lung, liver, brain and pancreatic cancer,
      expanding the total available market opportunity for Cs-131 brachytherapy.
      Management believes its Cs-131 technology will allow it to capture a major
      position in the brachytherapy market. The beneficial characteristics of the
      Cs-131 isotope are expected to result in decreased radiation exposure to the
      patient and reduced severity and duration of side effects, while treating cancer
      cells as effectively as other isotopes used in seed brachytherapy.





Brachytherapy
      seeds are small devices used in an internal radiation therapy procedure. In
      recent years the procedure has become one of the primary treatments for prostate
      cancer. The brachytherapy procedure places radioactive seeds as close as
      possible to (in or near) the cancerous tumor (the word “brachytherapy” means
      close therapy). The seeds deliver therapeutic radiation thereby killing the
      cancerous tumor cells while minimizing exposure to adjacent healthy tissue.
      This
      procedure allows doctors to administer a higher dose of radiation directly
      to
      the tumor. Each seed contains a radioisotope sealed within a welded titanium
      capsule. When brachytherapy is the only treatment (monotherapy), approximately
      70 to 120 seeds are permanently implanted in the prostate in an outpatient
      procedure lasting less than one hour. When brachytherapy is combined with
      external beam radiation or intensity modulated radiation therapy (dual therapy),
      then approximately 40-80 seeds are used in the procedure. The isotope decays
      over time and eventually the seeds become inert. The seeds may be used as a
      primary treatment or in conjunction with other treatment modalities, such as
      chemotherapy, or as treatment for residual disease after excision of primary
      tumors.





Management
      believes that the IsoRay Proxcelan Cesium-131 brachytherapy seed represents  the
      first
      major advancement in brachytherapy technology in over 20 years with attributes
      that could make it the long-term “seed of choice” for internal radiation therapy
      procedures. The Cs-131 seed has an FDA cleared 510(k) for treatment of malignant
      disease (e.g. cancers of the head and neck, brain, liver, lung, breast,
      prostate, etc.) and may be used in surface, interstitial, and intracavity
      applications for tumors with known radiosensitivity.





Increasingly,
      prostate cancer patients and their doctors who decide on seed brachytherapy
      choose Cs-131 because of its significant advantages over Palladium-103 (Pd-103)
      and Iodine-125 (I-125), two other isotopes currently in use.  These
      advantages include:





Higher
      Energy


Cs-131
      has a higher average energy than any other commonly used prostate brachytherapy
      isotope on the market.  Energy is a key factor in how uniformly the
      radiation dose can be delivered throughout the prostate.  This is known as
      homogeneity.  Early studies demonstrate Cs-131 implants are able to deliver
      the required dose while maintaining homogeneity across the gland itself and
      potentially reducing unnecessary dose to critical structures such as the urethra
      and rectum. (Prestidge B.R., Bice W.S., Jurkovic I., *et
      al.* Cesium-131 Permanent Prostate Brachytherapy:  An Initial Report. *Int.
      J. Radiation Oncology Biol. Phys* .
      2005:  63 (1) 5336-5337.)




2
 *Table
          of Contents*





Shorter
      Half-Life


Cs-131
      has the shortest half-life of any commonly used prostate brachytherapy isotope
      at 9.7 days.  Cs-131 delivers 90% of the prescribed dose in just 33 days
      compared to 58 days for Pd-103 and 204 days for I-125.  The short half-life
      of Cs-131 reduces the duration of time during which the patient experiences
      the
      irritating effects of the radiation.





Improved
      Coverage of the Prostate


Permanent
      prostate brachytherapy utilizing Cs-131 seeds allows for better dose homogeneity
      and sparing of the urethra and rectum while providing comparable prostate
      coverage compared to I-125 or Pd-103 seeds with comparable or fewer seeds and
      needles. (R Yang, J Wang, Dosimetric Comparison of Permanent Prostate
      Brachytherapy Plans Utilizing Cs-131, I-125 and Pd-103 Seeds. *Abstract
      presented at the AAPM Annual Meeting* ,
      July
      2008, Houston TX)





Rapid
      Resolution of Side effects


Studies
      demonstrate that objective measures of common side-effects showed an early
      peak
      in symptoms in the 2-week to 1-month time frame. Resolution of morbidity
      resolved rapidly within 4-6 months. (Prestidge B, et. al., Clinical Outcomes
      of
      a Phase-II, Multi-institutional Cesium-131 Permanent Prostate Brachytherapy
      Trial. *Brachytherapy.* 2007: 6
      (2); Prestidge B, *et
      al.* Cesium-131 Permanent Prostate Brachytherapy:  An Initial Report. *Int.
      J. Radiation Oncology Biol. Phys* .
      2005:  63 (1) 5336-5337)





Higher
      Biologically Effective Dose


Another
      benefit to the short half-life of Cs-131 is what is known as the “biological
      effective dose” or BED.  BED is a way for health care providers to predict
      how an isotope will perform against slow versus fast growing tumors. 
Studies have shown Cs-131 is able to deliver a higher BED across a wide range
      of
      tumor types than either I-125 or Pd-103. Although prostate cancer is typically
      viewed as a slow growing cancer it can present with aggressive features. 
Cs-131’s higher BED may be particularly beneficial in such situations. 
(Armpilia CI, Dale RG, Coles IP *et
      al.* The Determination of Radiobiologically Optimized Half-lives for Radionuclides
      Used in Permanent Brachytherapy Implants. *Int.
      J. Radiation Oncology Biol. Phys* .
      2003;
      55 (2):  378-385.)





PSA
      Control


Investigators
      tracking PSA in both single arm and randomized trials have concluded Cs-131’s
      PSA response rates show similar tumor control to I-125, long considered the
      gold
      standard in permanent seed brachytherapy. (Moran, B, et. al. Cesium-131 Prostate
      Brachytherapy” An Early Experience. *Brachytherapy* .
      2007; 6
      (2). Bice W, et. al. Recommendations for permanent prostate brachytherapy with
      131Cs: a consensus report from the Cesium Advisory Group. *Oral
      Presentation at ABS Annual Meeting* ,
      May
      2008, Boston MA)





The
      following graph was presented in William Bice, PhD’s presentation at the 2008
      ABS Annual Meeting in May 2008 and shows Cs-131’s PSA response rate compared to
      I-125 and Pd-103.




3
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          of Contents*










**Industry
      Information**





*Incidence
      of Prostate Cancer*





The
      prostate is a walnut-sized gland surrounding the male urethra, located below
      the
      bladder and adjacent to the rectum. Prostate cancer is a malignant tumor that
      begins most often in the periphery of the gland and, like other forms of cancer,
      may spread beyond the prostate to other parts of the body. According to the
      American Cancer Society, approximately one in six men will be diagnosed with
      prostate cancer during his lifetime. It is the most common form of cancer in
      men
      after skin cancer, and the second leading cause of cancer deaths in men. The
      American Cancer Society estimates there will be about 186,320 new cases of
      prostate cancer diagnosed and an estimated 28,660 deaths associated with the
      disease in the United States in 2008. Because of early detection techniques
      (e.g., screening for prostate specific antigen, or PSA), approximately nine
      out
      of ten prostate cancers are found in the local and regional stages (local means
      it is still confined to the prostate; regional means it has spread from the
      prostate to nearby areas, but not to distant sites, such as bone).





Prostate
      cancer accounts for about 9% of cancer related deaths in men. Prostate cancer
      incidence and mortality increase with age. The National Cancer Institute has
      reported that the incidence of prostate cancer increases dramatically in men
      over the age of 55. At the age of 70, the chance of having prostate cancer
      is 12
      times greater than at age 50.




4
 *Table
          of Contents*


The
      American Cancer Society recommends that men without symptoms, risk factors
      and
      who have a life expectancy of at least ten years, should begin regular annual
      medical exams at the age of 50, and believes that health care providers should
      offer as part of the exam the prostate-specific antigen (PSA) blood test and
      a
      digital rectal examination. The PSA blood test determines the amount of prostate
      specific antigen present in the blood. PSA is found in a protein secreted by
      the
      prostate, and elevated levels of PSA can be associated with either prostatitis
      (a noncancerous inflammatory condition) or a proliferation of cancer cells
      in
      the prostate. Transrectal ultrasound tests and biopsies are typically performed
      on patients with elevated PSA readings to confirm the existence of cancer.
      Early
      screening has fostered a decline in the prostate cancer death rate since 1990.
      When compared to men of the same age and race who do not have cancer (called
      relative survival), the 5-year relative survival rate for men when the cancer
      is
      found in the local and regional stages is nearly 100%.





*Brachytherapy*





There
      is
      a large potential market for the Company’s products.  Several significant
      clinical and market factors are contributing to the increasing popularity of
      the
      brachytherapy procedure. Over 61,000 procedures were forecasted to occur in
      the
      U.S. in 2007 (Source: iData Research, Inc., 2008). IsoRay’s management believes
      that the Proxcelan seed will add incremental growth to the existing
      brachytherapy seed market as physicians who are currently reluctant to recommend
      brachytherapy for their prostate patients due, in part, to side effects caused
      by longer-lived isotopes, become comfortable with the shorter half-life of
      Cs-131, and the anticipated related reduction of side effects that it
      offers.





In
      1996
      only 4% of prostate cancer cases were treated with brachytherapy, or about
      8,000
      procedures. The number of brachytherapy cases has consistently increased and
      in
      2007 approximately 61,000 brachytherapy procedures were performed to treat
      prostate cancer. (Source: iData Research Inc., 2008)





Minimally
      invasive brachytherapy has significant advantages over competing treatments
      including lower cost, equal or better survival data, fewer side effects, faster
      recovery time and the convenience of a single outpatient implant procedure
      that
      generally lasts less than one hour (Merrick, et al., Techniques in Urology,
      Vol.
      7, 2001; Potters, et al., Journal of Urology, May 2005; Sharkey, et al., Current
      Urology Reports, 2002).





Management
      expects that market growth in all brachytherapy in the U.S. will increase at
      the
      rate of 4% per year through 2011. Independent research firms have estimated
      Cs-131 growth alone in the U.S. marketplace to average 32% a year from 2009
      through 2014 (Source: iData Research Inc., 2008). The competing isotopes Pd-103
      and I-125 are projected to decrease by .5% and increase 1.6% respectively per
      year during this same time period (Source: iData Research Inc.,
      2008).





*Treatment
      Options and Protocol*





In
      addition to brachytherapy, localized prostate cancer can be treated with
      prostatectomy surgery (RP for radical prostatectomy), external beam radiation
      therapy (EBRT), intensity modulated radiation therapy (IMRT), dual or
      combination therapy, high dose rate brachytherapy (HDR), cryosurgery, hormone
      therapy, and watchful waiting. The success of any treatment is measured by
      the
      feasibility of the procedure for the patient, morbidities associated with the
      treatment, overall survival, and cost. When the cancerous tissue is not
      completely eliminated, the cancer typically returns to the primary site, often
      with metastases to other areas of the body.





*Prostatectomy
      Surgery Options.* Historically the
      most
      common treatment option for prostate cancer, radical prostatectomy is the
      removal of the prostate gland and some surrounding tissue through an invasive
      surgical procedure. RP is performed under general anesthesia and involves a
      hospital stay of three days on average for patient observation and recovery.
      Possible side affects of RP include impotence and incontinence. According to
      a
      study published in the *Journal
      of the*  *American
      Medical Association* in
      January 2000, approximately 60% of men who had a RP reported erectile
      dysfunction as a result of surgery. This same study stated that approximately
      40% of the patients observed reported at least occasional incontinence. New
      methods such as laparoscopic and robotic prostatectomy surgeries are currently
      being used more frequently in order to minimize the nerve damage that leads
      to
      impotence and incontinence, but these techniques require a high degree of
      surgical skill. RP and laparoscopic prostatectomy are projected to decrease
      approximately 31% in the U.S. from the 2004 high of 66,567 to 20,838 procedures
      in 2014. However, robotic surgeries are projected to more than replace the
      decrease in the RP and laparoscopic procedures (Source: iData Research Inc.,
      2008).




5
 *Table
          of Contents*




*Primary
      External Beam Radiation Therapy.*  EBRT
      involves directing a beam of radiation from outside the body at the prostate
      gland to destroy cancerous tissue. EBRT treatments are received on an outpatient
      basis five days per week usually over a period of eight or nine weeks. Some
      studies have shown, however, that the ten-year disease free survival rates
      with
      treatment through EBRT are less than the disease free survival rates after
      RP or
      brachytherapy treatment. Side effects of EBRT can include diarrhea, rectal
      leakage, irritated intestines, frequent urination, burning while urinating,
      and
      blood in the urine. Also the incidence of incontinence and impotence five to
      six
      years after EBRT is comparable to that for surgery. EBRT procedures are
      projected to increase slightly from 22,000 procedures in 2006 to 24,900 in
      2012
      (Source: Millennium Research Group, 2008).





*Intensity
      Modulated Radiation Therapy.* IMRT
      is
      considered a more advanced form of EBRT in which sophisticated computer control
      is used to aim the beam at the prostate from multiple different angles and
      to
      vary the intensity of the beam. Thus, damage to normal tissue and critical
      structures is minimized by distributing the unwanted radiation over a larger
      geometric area. This course of treatment is similar to EBRT and requires daily
      doses over a period of seven to eight weeks to deliver the total dose of
      radiation prescribed to kill the tumor. Because IMRT is a new treatment, less
      clinical data regarding treatment effectiveness and the incidence of side
      effects is available. One advantage of IMRT, and to some extent EBRT, is the
      ability to treat cancers that have begun to spread from the tumor site. An
      increasingly popular therapy for patients with more advanced prostate cancer
      is
      a combination of IMRT with seed brachytherapy, known as combination or dual
      therapy. IMRT in the U.S. (including dual therapy) is projected to grow 9%
      per
      year from 31,500 procedures in 2007 to 48,500 procedures in 2012 (Source:
      Millennium Research Group, 2008). IMRT is generally more expensive than other
      common treatment modalities.





*Dual
      or Combination Therapy.* Dual
      therapy is the combination of IMRT or 3-dimensional conformal external beam
      radiation and seed brachytherapy to treat extra-prostatic extensions or high
      risk prostate cancers that have grown outside the prostate. Combination therapy
      treats high risk patients with a full course of IMRT or EBRT over a period
      of
      several weeks. When this initial treatment is completed, the patient must then
      wait for several more weeks to months to have the prostate seed
      implant.





With
      the
      arrival of Proxcelan Cs-131, with its short half life, patients may now complete
      their course of treatment sooner and have shorter duration of side-effects.
      Management estimates that at least 30% of all prostate implants are now dual
      therapy cases.





*High
      Dose Rate Temporary Brachytherapy.* HDR
      temporary brachytherapy involves placing very tiny plastic catheters into the
      prostate gland, and then giving a series of radiation treatments through these
      catheters. The catheters are then removed, and no radioactive material is left
      in the prostate gland. A computer-controlled machine inserts a single highly
      radioactive iridium seed into the catheters one by one. This procedure is
      typically repeated at least three times while the patient is hospitalized for
      at
      least 24 hours. HDR is projected to grow approximately 1.3% per year from 26,200
      procedures in 2007 through 2012 (Source: Millennium Research Group,
      2008).





*Cryosurgery.* Cryosurgery
      involves placing cold metal probes into the prostate and freezing the tissue
      in
      order to destroy the tumor. Cryosurgery patients typically stay in the hospital
      for a day or two and have had higher rates of impotence and other side effects
      than those who have used seed implant brachytherapy. Market research firms
      project that cryosurgery will grow steadily through 2012. To date the market
      has
      remained almost flat (Source: Millennium Research Group, 2008).




6
 *Table
          of Contents*




*Additional
      Treatments.* Additional
      treatments include hormone therapy and chemotherapy. Hormone therapy is
      generally used to shrink the tumor or make it grow more slowly but will not
      eradicate the cancer. Likewise, chemotherapy will not eradicate the cancer
      but
      can slow the tumor growth. Generally, these treatment alternatives are used
      by
      doctors to extend patients’ lives once the cancer has reached an advanced stage
      or in conjunction with other treatment methods. Hormone therapy can cause
      impotence, decreased libido, and breast enlargement. Most recently, hormone
      therapy has been linked to an increased risk of cardiovascular disease in men
      with certain pre-existing conditions such as heart disease or diabetes.
      Chemotherapy can cause anemia, nausea, hair loss, and fatigue.





*Watchful
      Waiting.* Watchful
      waiting is not a treatment but might be suggested by some healthcare providers
      depending on the age and life expectancy of the patient. Watchful waiting may
      be
      recommended if the cancer is diagnosed as localized and slow growing, and the
      patient is asymptomatic. Generally, this approach is chosen when patients are
      trying to avoid the side affects associated with other treatments or when they
      are not candidates for current therapies due to other health issues. Healthcare
      providers will carefully monitor the patient’s PSA levels and other symptoms of
      prostate cancer and may decide on active treatments at a later
      date.





*Brachytherapy
      Clinical Results*





Long-term
      survival data is now available for brachytherapy with I-125 and Pd-103, which
      support the efficacy of brachytherapy. Clinical data indicate that brachytherapy
      offers success rates for early-stage prostate cancer treatment that are equal
      to
      or better than those of RP or EBRT. While clinical studies of brachytherapy
      to
      date have focused primarily on results from brachytherapy with I-125 and Pd-103,
      management believes that these data are also relevant for brachytherapy with
      Cs-131. In fact, it appears that Cs-131 offers improved clinical outcomes over
      I-125 and Pd-103, given its shorter half-life and higher energy.





*Improved
      patient outcomes.* A number
      of published studies on the use of I-125 and Pd-103 brachytherapy in the
      treatment of early-stage prostate cancer have been very positive, the most
      recent of which was as follows:





§
            Results
                of a trial published in 2007 in the International Journal of Radiation
                Oncology looking at 15-year survival in 223 patients with stage T1-T3
                prostate cancer and treated with brachytherapy in combination with
                external beam demonstrated excellent long-term biochemical control.
                Fifteen-year biochemical relapse free survival (BRFS) for the entire
                treatment group was 74%. (Sylvester J. et al. “15-year biochemical relapse
                free survival in clinical stage T1-T3 prostate cancer following combined
                external beam radiotherapy and brachytherapy; Seattle experience”, Int. J.
                Rad. Onc. Biol., Vol. 67, 2007,
                57-64.).





*Reduced
      Incidence of Side Effects.* Sexual
      potency and urinary incontinence are two major concerns men face when choosing
      among various forms of treatment for prostate cancer. Because the Proxcelan
      Cesium-131 brachytherapy seed delivers a highly concentrated and confined dose
      of radiation directly to the prostate, healthy surrounding tissues and organs
      typically experience less radiation exposure. Management believes, and initial
      results appear to support, that this should result in lower incidence of side
      effects and complications than may be incurred with other conventional therapies
      or isotopes. Additionally when side effects do occur, they should resolve more
      rapidly than those experienced with I-125 and Pd-103 isotopes.




7
 *Table
          of Contents*




*Cs-131
      Clinical Results and Ongoing Trials*





A
      Cs-131
      monotherapy trial for the treatment of prostate cancer was fully enrolled in
      February 2007.  The trial was a 100 patient multi-institutional study to
      observe the dosimetric characteristics of Cs-131 and its side effect
      profile.  The results of the monotherapy trial have demonstrated that
      Cs-131 is a viable alternative as an isotope for permanent seed prostate
      brachytherapy.  Some of the significant and specific findings were as
      follows:




§
            Patient
                reported symptoms (IPSS Scores) were mild to moderate with relatively
                rapid resolution within 4-6 months.


§
            Prostate
                Specific Antigen, or PSA, response over 30 months has been very
                encouraging to date with similar tumor control rates to that of I-125.
                (Prestidge BR, Bice WS, “Clinical outcomes of a Phase II,
                multi-institutional Cesium-131 permanent prostate brachytherapy trial”.*Brachytherapy*,*Volume
                6, Issue 2*,*April-June
                2007*, Page
                78) (Moran BJ, Braccioforte MH, “Cesium-131 prostate brachytherapy: An
                early experience”.*Brachytherapy*,*Volume
                6, Issue 2*,*April-June
                2007*, Page
                80). (Bice, W, et. al. “Recommendations for permanent prostate
                brachytherapy with 131Cs: a consensus report from the Cesium Advisory
                Group”.*Oral
                Presentation at ABS Annual Meeting*,
                May 2008, Boston MA).


§
            The
                resolution of acute side effects proved to be much quicker with Cs-131
                compared to I-125 thus validating the theoretical argument that dose
                related side effects dissipate faster with shorter lived isotopes. 
                (Prestidge BR, “Cesium-131; the isotope of choice in permanent prostate
                brachytherapy”.  Oral Presentation at the American Brachytherapy
                Society annual conference, April 2007.).


§
            The
                dosimetric observations of the trial demonstrated that it was possible
                to
                deliver adequate dose to the prostate while maintaining dose uniformity
                across the gland.  The dose delivered to critical structures was well
                within acceptable limits. (Bice WS, Prestidge BR, “Cesium-131 permanent
                prostate brachytherapy: The dosimetric analysis of a multi-institutional
                Phase II trial”.  Brachytherapy 2007(6); 88-89.).





The
      monotherapy Cs-131 trial will continue to follow patients with annual updates
      on
      symptoms and patient long-term survival data.





The
      prospective randomized monotherapy trial headed by Dr. Brian Moran of The
      Chicago Prostate Cancer Center directly compared Cs-131 to I-125 PSA response
      and treatment related morbidities following brachytherapy for localized
      carcinoma of the prostate in low to intermediate risk patients. Dr. Moran
      concluded that prostate brachytherapy with Cs-131 is effective and
      well-tolerated; both PSA response and acute morbidity profile are very
      encouraging. Dr. Moran will continue to track these patients in order to collect
      long-term outcomes.





A
      third
      ongoing study first presented at the American Association of Physicists in
      Medicine (AAPM) meeting in July 2007 compared the dosimetry of Cs-131 and Pd-103
      directly.  The study showed a 17.5% reduction in the number of seeds, 6%
      reduction in planned needles, 35.5% reduction in V150 (percent of gland that
      receives more than 150% of the prescription dose), and 44.2% reduction in R100
      (percent of rectal tissue that receives the full prescription dose of
      radiation).  (Musmacher, J., “Dosimetric comparison of Cesium-131 and
      Palladium-103 for permanent prostate brachytherapy”, poster presented at
      49 th AAPM
      Annual Conference, Minneapolis, MN, April 22-26, 2007.)





Recently
      accepted for publication was the Cs-131 Advisory Group’s (CAG) article entitled
“Recommendations for permanent prostate brachytherapy with 131 Cs:
      a
      consensus report from the Cesium Advisory Group”. The objective of the article
      was to **** provide
      consensus recommendations for Cs-131 prostate brachytherapy based on experience
      to date for physicians still unfamiliar with Cs-131. The recommendations are
      based on three clinical trials, one of which has completed accrual and has
      been
      published in the peer reviewed literature, and combined CAG experience of more
      than 1,200 Cs-131 implants. The recommendations from the group are designed
      to
      aid practitioners in the safe and effective delivery of Cs-131 prostate
      brachytherapy. The Consensus Paper is slated to be published in Brachytherapy
      in
      the fourth quarter of calendar year 2008. The CAG is sponsored by the
      Company.





The
      Company has also commissioned a dual therapy protocol.  This
      multi-institutional trial observes the dosimetric characteristics of Cs-131
      and
      health related quality of life (HRQOL) results following combined Cs-131
      transperineal permanent prostate brachytherapy and external beam radiotherapy
      in
      patients with intermediate to high risk prostate cancer.  This protocol is
      being conducted to confirm clinically what radiobiological data suggests
      regarding this treatment modality.  The quantified dosimetric variables
      collected will be correlated to the reported HRQOL data and ultimately compared
      to existing data in the literature for similar investigations using I-125 and
      Pd-103.  Patient enrollment for this study began in April 2007 and to date
      50 patients have been enrolled.




8
 *Table
          of Contents*


In
      addition to establishing the dosimetric and quality of life impact of Proxcelan
      Cesium-131 brachytherapy seeds in different treatment modalities, all trials
      have been designed to collect ongoing PSA results for the purposes of
      establishing long-term survival rates using Cs-131 seed implant
      brachytherapy.





**Our
      Strategy**





The
      key
      elements of IsoRay’s strategy for fiscal year 2009 include:





§
            *Continue
                to introduce the Proxcelan Cs-131 brachytherapy seed into the U.S.
                market*.
                Utilizing our direct sales organization, IsoRay intends to continue
                expanding the use of Proxcelan Cs-131 seeds in brachytherapy procedures
                for prostate cancer by increasing the number of treatment centers
                offering
                Cs-131 and increasing the number of patients treated at each center
                using
                Cs-131. IsoRay hopes to capture much of the incremental market growth
                in
                seed implant brachytherapy and take market share from existing
                competitors.





§
            *Develop
                an enriched barium manufacturing process*.Working
                with leading scientists, IsoRay is working to design and create a
                proprietary process for manufacturing enriched barium, a key source
                material for Cs-131. This will ensure adequate future supply of Cs-131
                and
                greater efficiencies in producing the
                isotope.





§
            *Introduce
                Cs-131 therapies for other cancers*.
                The Company’s first sale for ocular melanoma occurred in late 2007 and
                periodic sales have occurred since then. Although the ocular melanoma
                market is not a large one, this continues to support the application
                of
                Cs-131 in other solid tumors. IsoRay will continue to explore partnering
                with other companies to develop the appropriate technologies and
                therapeutic delivery systems for treatment of other solid tumors
                such as
                breast, lung, liver, pancreas, neck, and brain cancers.





§
            *Support
                clinical research and sustained product development*.
                The Company plans to structure and support clinical studies on the
                therapeutic benefits of Cs-131 for the treatment of solid tumors
                and other
                patient benefits. We are and will continue to support clinical studies
                with several leading radiation oncologists to clinically document
                patient
                outcomes, provide support for our product claims, and compare the
                performance of our seeds to competing seeds. IsoRay plans to sustain
                long-term growth by implementing research and development programs
                with
                leading medical institutions in the U.S. and other countries to identify
                and develop other applications for IsoRay’s core radioisotope
                technology.





§
            *Improve
                our manufacturing efficiencies.*Over the past several months the Company has been working on improving
                its
                gross margin by reviewing its manufacturing processes. Over the next
                year,
                the Company will continue reviewing its manufacturing processes,
                implementing improvements, and automating either certain portions
                or all
                of its manufacturing process. Management believes that it will be
                able to
                lower its costs of production relative to its sales revenue through
                this
                evaluation.





§
            *Introduce
                Proxcelan Cesium-131 brachytherapy seeds to the Canadian and Russian
                market.*In
                August 2008, the Company obtained its ISO 13485 certification. This
                was an
                important step to allow the Company to register and eventually sell
                its
                Proxcelan Cs-131 brachytherapy seeds in Canada and Russia. The Company
                anticipates finalizing its registrations of Proxcelan Cs-131 brachytherapy
                seeds in Canada and Russia during fiscal year 2009. The Company is
                now
                focusing on the Canadian and Russian markets and is no longer pursuing
                sales in the European Union (EU). Management does not believe a strategic
                alliance with IBt, SA, a Belgian company, will be consummated nor
                will
                management leverage IBt’s distribution channels in the
                EU.




9
 *Table
          of Contents*


**Products**





IsoRay
      markets the Proxcelan Cs-131  brachytherapy
      seed for the treatment of prostate cancer and ocular melanomas, and intends
      to
      market Cs-131 for the treatment of other malignant disease in the future.
      Additionally, the Company may market other radioactive isotopes in the
      future.





*Competitive
      Advantages of Proxcelan Cs-131*





*General.* Management believes that the Proxcelan Cesium-131 brachytherapy seed has
      specific clinical advantages for treating cancer over I-125 and Pd-103, the
      other isotopes currently used in brachytherapy seeds. The table below highlights
      the key differences of the three seeds. The Company believes that the short
      half-life, high-energy characteristics of Cs-131 will increase industry growth
      and facilitate meaningful penetration into the treatment of other forms of
      cancer such as lung cancer.





**Brachytherapy
      Isotope Comparison**





**Cesium-131**
            
            **Palladium-103**
            
            **Iodine-125****Half
                Life**
            
            9.7
                Days
            
            17.5
                days
            
            60
                days**Avg.
                Energy**
            
            30.4
                keV+
            
            20.8
                keV+
            
            28.5
                keV+**Dose
                Delivery**
            
            90%
                in 33 days
            
            90%
                in 58 days
            
            90%
                in 204 days**Total
                Dose**
            
            115
                Gy
            
            125
                Gy
            
            145
                Gy**Anisotropy
                Factor*******
            
            0.969
            
            0.877
                (TheraSeed® 200)
            
            0.930
                (OncoSeed® 6711)





* Degree
      of
      symmetry of therapeutic dose, a factor of 1.00 indicates symmetry.


+ keV
      =
      kiloelectron volt, a standard unit of measurement for electrical
      energy.





*Shorter
      half-life* . ** The
      Company believes that Cs-131’s shorter half-life of 9.7 days will prove to have
      greater biological effectiveness, will mitigate the negative effects of long
      radiation periods on healthy tissue, and will reduce the duration of any side
      effects. Our early clinical data supports the Company’s belief that there is a
      reduced duration of side effects post implant. A shorter half-life produces
      more
      intense therapeutic radiation over a shorter period of time and may reduce
      the
      potential for cancer cell survival and tumor recurrence. Radiobiological studies
      indicate that shorter-lived isotopes are more effective against faster growing
      tumors (Dicker, et. al., *Semin.
      Urol. Onc.* 18:2,
      May 2000). Other researchers conclude that “half-lives in the approximate range
      4-17 days are likely to be significantly better for a wide range of tumor types
      for which the radiobiologic characteristics may not be precisely known in
      advance.” (Armpilia CI, et. al., *Int.
      J. Rad. Oncol. Biol. Phys.* 55:2,
      February 2003).





*Higher
      energy* .
      The
      Cs-131 isotope average decay energy of 30.4 keV (versus 21 keV for Pd-103 and
      28.5 keV for I-125) generates a therapeutic radiation field that extends beyond
      the current dosimetry reference point of one centimeter. Pd-103 seeds emit
      radiation that does not penetrate as far into tissue (up to 40% lower than
      Cs-131). To compensate for this lack of penetration, more Pd-103 seeds are
      required to attain the equivalent dose than are required for Proxcelan seeds.
      This increase in the number of seeds implanted increases the time and cost
      required to perform Pd-103-based procedures.





*Quality
      of Life* .  Because
      IsoRay’s Proxcelan Cesium-131 brachytherapy seed delivers a highly concentrated
      and confined dose of radiation directly to the prostate, healthy surrounding
      tissues and organs are exposed to less radiation than with other treatments.
      Initial results indicate that the side effects experienced, if any, are mild
      to
      moderate and urinary symptoms resolve more rapidly, within 4-6 months, when
      compared to I-125. Management believes that as the data matures it will continue
      to support fewer and less severe side effects and complications when compared
      to
      other conventional therapies.




10
 *Table
          of Contents*




*Shape
      of radiation field* . ** The
      shape
      of the radiation field generated by a Proxcelan seed is more uniform than most
      brachytherapy seed designs, and this uniformity may result in better radiation
      dose coverage and improved therapeutic effectiveness. The higher energy of
      Cs-131 makes the isotope more “forgiving” for treatment planning purposes.
      IsoRay has conducted extensive computer modeling of its Proxcelan Cs-131 seed
      design. The dosimetric characteristics of the Cs-131 seed were recently
      confirmed through American Association of Physicists in Medicine (AAPM)
      evaluations of the seed design (Med Phys, 34:2). The results of these tests
      showed superior dose characteristics relative to the leading I-125 and Pd-103
      seeds. The IsoRay seed has also met all Nuclear Regulatory Commission (NRC)
      requirements for sealed radioactive sources.





**Cs-131
      Manufacturing Process and Suppliers**





*Product
      Overview.* Cs-131
      is a radioactive isotope that can be produced by the neutron bombardment of
      Barium-130 (Ba-130). When placed into a nuclear reactor and exposed to a flux
      of
      neutrons, Ba-130 becomes Ba-131, the radioactive material that is the parent
      isotope of Cs-131. The radioactive isotope Cs-131 is normally produced by
      placing a quantity of stable non-radioactive barium (ideally barium enriched
      in
      isotope Ba-130) into the neutron flux of a nuclear reactor. The irradiation
      process converts a small fraction of this material into a radioactive form
      of
      barium (Ba-131). The Ba-131 decays by electron capture to the radioactive
      isotope of interest (Cs-131).





To
      produce the Proxcelan seed, the purified Cs-131 isotope is adsorbed onto a
      ceramic core containing a gold X-ray marker. This internal core assembly is
      subsequently inserted into a titanium capsule that is then welded shut and
      becomes a sealed radioactive source and a biocompatible medical device. The
      dimensional tolerances for the ceramic core, gold X-ray marker, and the titanium
      capsule are extremely important. To date the Company has used sole-source
      providers for certain components such as the gold X-ray marker and the titanium
      capsule as these suppliers have been validated by our quality department and
      they have been cost effective.





*Barium
      Enrichment Device* .
      The
      Company has retained an independent contractor to develop an enrichment device
      to produce “enriched barium” having a higher concentration of the Ba-130 isotope
      than is found in naturally occurring barium. Irradiating enriched barium will
      result in higher yields of Cs-131. The Company anticipates the use of enriched
      barium will also streamline the manufacturing process and reduce Cs-131
      production costs. The Company’s prototype enrichment device is expected to be
      tested in October 2008 but there is no assurance this testing will occur by
      then
      or whether or not it will be successful.





*Isotope
      Suppliers.* Due to
      the short half-life of both the Ba-131 and Cs-131 isotopes, potential suppliers
      must be capable of removing irradiated materials from the reactor core on a
      routine basis for subsequent processing to produce ultra-pure Cs-131. In
      addition, the supplier’s nuclear reactor facility must have sufficient
      irradiation capacity to accommodate barium targets and the nuclear reactors
      must
      have sufficient neutron flux to economically produce commercially viable
      quantities of Cs-131. Ideally, the irradiation facility will also have a
      radiochemical separation infrastructure to carry out the initial separation
      steps. The Company has identified key reactor facilities in the U.S. and the
      former Soviet Union that are capable of meeting these requirements. As of the
      date of this report, IsoRay has agreements in place with three suppliers of
      irradiated Ba-131 or Cs-131. For the fiscal year ended June 30, 2008,
      approximately sixty-five percent (65%) of our Cs-131 was supplied by one of
      two
      Russian suppliers, but the Company has begun taking steps to reduce its reliance
      on a single source for Cs-131.





With
      the
      development of barium enrichment capabilities, the Company plans to expand
      Cs-131 manufacturing capability at the MURR reactor in the United States but
      will continue to obtain Cs-131 from multiple suppliers. Failure to obtain
      deliveries of Cs-131 from multiple sources could have a material adverse effect
      on seed production. Management believes it will continue to rely solely on
      its
      three suppliers in the near future and shutdowns from these suppliers could
      cause delays in deliveries and production.




11
 *Table
          of Contents*




*Quality
      Controls.* We have
      established procedures and controls to comply with the FDA’s Quality System
      Regulation. The Company constantly monitors these procedures and controls to
      ensure that they are operating properly, thereby working to maintain a
      high-quality product. Also, the quality, production, and customer service
      departments maintain open communications to ensure that all regulatory
      requirements for the FDA, DOT, and applicable nuclear radiation and health
      authorities are fulfilled.





In
      July
      2008, IsoRay had its baseline inspection by the FDA at its manufacturing and
      administrative offices in Richland, WA. This inspection was carried out over
      a
      five day period of time during which the investigator performed an inspection
      following Quality Systems Inspection Techniques (QSIT). This was a complete
      and
      very thorough inspection. At the end of the inspection no report of deviations
      from Good Manufacturing Practices or list of observations (form FDA 483) was
      issued to IsoRay.





*Order
      Processing.* The
      Company has implemented a just-in-time production process that is responsive
      to
      customer input and orders to ensure that individual customers receive a higher
      level of customer service than received from our competitors who have the luxury
      of longer lead times due to longer half-life products. Time from order
      confirmation to completion of product manufacture is reduced to several working
      days, including receipt of irradiated barium (from a supplier’s reactor),
      separation of Cs-131, isotope labeling of the core, and loading of cores into
      pre-welded titanium “cans” for final welding, testing, quality assurance and
      shipping.





It
      is up
      to each physician to determine the dosage necessary for implants and acceptable
      dosages vary among physicians. Many of the physicians who order our seeds order
      more seeds than necessary to assure themselves that they have a sufficient
      quantity. Upon receipt of an order, the Company either delivers the seeds from
      its facility directly to the physician or sends the order to an independent
      preloading service that delivers the seeds preloaded into needles or cartridges
      just prior to implant. If the implant is postponed or rescheduled, the short
      half-life of the seeds makes them unsuitable for use and therefore they must
      be
      re-ordered.





Due
      to
      the lead time for obtaining and processing the Cs-131 isotope and the short
      half-life, the Company relies on sales forecasts and historical knowledge to
      estimate the proper inventory levels of isotope needed to fulfill all customer
      orders. Consequently, some portion of the isotope is lost through decay and
      is
      not used in an end product. Management continues to reduce the variances between
      ordered isotope and isotope deliveries and is continually improving its ordering
      process efficiencies.





*Automated
      Manufacturing Process*





Based
      on
      evaluations of automation options by management, IsoRay has elected to automate
      its current manufacturing process in phases. Phased implementation of automation
      is expected to be less costly than fully automated production lines and will
      benefit IsoRay by reducing labor costs and ensuring consistent manufacturing
      quality. The Company has purchased some automation equipment and is reviewing
      options for the development of additional automated equipment. The Company
      also
      has a contract with a third party to outsource certain sub-processes.





*Manufacturing
      Facility*





The
      Company has replaced its original manufacturing facility located at PEcoS-IsoRay
      Radioisotope Laboratory (PIRL) with a
      production facility located at Applied Process Engineering Laboratory (APEL).
      The APEL facility became operational in September 2007, which was three months
      earlier than the original scheduled opening. The facility has over 15,000 square
      feet and includes space for isotope separation, seed production, order
      dispensing, a clean room for radiopharmacy work, and a dedicated shipping area.
      A description of the lease terms for the APEL facility is located in the Other
      Commitments and Contingencies section of Item 7 below. Management believes
      that
      the APEL facility will be utilized for manufacturing space through fiscal year
      2016 which is the original lease term plus the two three-year renewal options.
      Management currently anticipates exercising both three-year renewal options
      to
      extend the APEL facility lease through April 2016.




12
 *Table
          of Contents*




*Isotope
      Testing in Idaho*





On
      December 14, 2005, IsoRay and Idaho’s Advanced Test Reactor (ATR) entered into a
      collaboration and partnership agreement for the design, analysis and fabrication
      of a capsule containing barium carbonate, to be irradiated at the ATR and then
      shipped to IsoRay for processing and analysis of the Cs-131 product.  As an
      adjunct to this testing, IsoRay and the Pocatello Development Authority entered
      into an Economic Development Agreement, dated December 14, 2005, under which
      the
      Pocatello Development Authority provided IsoRay with $200,000 (subject to
      repayment under certain conditions) to apply to the cost of testing at the
      ATR.  ATR is currently working to install a shuttle system that would make
      the production of Cs-131 possible in the reactor. There is no assurance that
      even though the capsules irradiated in 2006 performed as designed that the
      shuttle system will provide adequate conditions for Cs-131 production. The
      Company has no agreement with ATR to either produce Cs-131 or irradiate Ba-130
      and there is no assurance that this will ultimately occur.





*Repackaging
      Services*





Most
      brachytherapy manufacturers offer their seed product to the end user packaged
      in
      four principal configurations provided in a sterile or non-sterile package
      depending on the customer’s preference. These include:





§
            *Loose
                seeds*


§
            *Pre-loaded
                needles*(loaded typically with three to five seeds and
                spacers)


§
            *Strands
                of seeds*(consists of seeds and spacers in a biocompatible “shrink wrap”)


§
            *Pre-loaded
                Mick cartridges*(fits the Mick applicator)





In
      2008,
      the Millenium Research Group reported that the estimated market shares for
      each
      of the four packaging types are: loose seeds and preloaded loose seeds (8%),
      Mick cartridges (26%), and all strand configurations including preloaded strands
      (66%). Market trends indicate significant movement toward the stranded
      configuration, as there are some clinical data suggesting less potential for
      post-implant seed migration when a stranded configuration is used.




The
      role
      of the preloading service is to package, assay and certify the contents of
      the
      final product configuration shipped to the customer. A commonly used method
      of
      providing this service is through independent radiopharmacies. Manufacturers
      send loose seeds along with the physician's instructions to the radiopharmacy
      which, in turn, loads needles and/or strands the seeds according to the doctor's
      instructions. These radiopharmacies then sterilize the product and certify
      the
      final packaging prior to shipping directly to the end user.




IsoRay
      currently has agreements with several independent radiopharmacies to assay,
      preload, and sterilize loose seeds. This creates additional loss of our isotope
      due to decay and is prohibitive on a long-term basis. While the Company
      pre-loads many of its current orders, we have continued to utilize these
      services to supplement our own custom preloading operation and when they are
      requested by the ordering physician.





We
      currently load most Mick cartridges in our own facility which in recent months
      accounted for approximately 53% of total orders. The
      remaining approximately 47% of total orders are strand configurations including
      preloaded strands. During
      fiscal year 2008, t he
      Company began offering a 100% confirmation assay performed by in-house
      analytical services. Providing the assay and ultimately the preloading services in-house allows
      the
      Company to eliminate approximately 25% loss in isotope activity due to
      radioactive decay. The cost of priority overnight shipment of each order of
      seeds to a third-party provider is also eliminated. However, we will
      continue to utilize the independent radiopharmacies to back up our own
      preloading operation, to handle periodic increases in demand, and to cater
      to
      certain doctor’s preferences.




13
 *Table
          of Contents*




Independent
      radiopharmacies usually provide the final packaging of the product delivered
      to
      the end user thereby eliminating the opportunity for reinforcing the "branding"
      of our seed product. By providing our own repackaging service, we will preserve
      the product branding opportunity and eliminate any concerns related to the
      handling of our product by a third party prior to delivery to the end
      user.




Providing
      custom packaging configurations enhances our product while providing an
      additional revenue stream and incremental margins to the Company through pricing
      premiums charged to our customers. The end users of these packaging options
      are
      willing to pay a premium because of the savings  they
      realize by eliminating the need for loose seed handling and loading capabilities
      on site, eliminating the need for additional staffing to sterilize seeds and
      needles, and eliminating the expense of additional assaying of the
      seeds.




**Marketing
      and Sales**





*Marketing
      Strategy*





The
      Company is marketing Proxcelan Cesium-131 brachytherapy seeds as the “seed of
      choice” for prostate brachytherapy. Based on current and preliminary clinical
      studies, management believes there is no apparent clinical reason to use other
      isotopes when Cs-131 is available. The advantages associated with a higher
      energy and shorter half-life isotope are generally accepted within the clinical
      community and the Company intends to help educate potential patients about
      the
      clinical benefits from Cs-131 for their brachytherapy seed
      treatment.





IsoRay
      has chosen to identify its proprietary Cs-131 seed with the brand of
“Proxcelan.” Management is using this brand to differentiate Cs-131 seeds from
      seeds using the other isotopes. We continue to target the competing isotope
      products of iodine and palladium rather than the various manufacturers and
      distributors of these isotopes. Using this strategy, the choice of brachytherapy
      isotopes should be less dependent on the name and distribution strengths of
      the
      various iodine and palladium manufacturers and distributors and more dependent
      on the therapeutic benefits of Cs-131.





The
      professional and patient market segments each play a role in the ultimate choice
      of cancer treatment and the specific isotope chosen for seed brachytherapy
      treatment. The Company has developed a customized brand message for each
      audience. For medical professionals, IsoRay has created print and visual medias
      (including physician brochures discussing the clinical advantages of Cs-131,
      clinical information binders, informational DVDs, single sheet glossies with
      targeted clinical data, etc.), advertisements in the leading medical journals
      and a physician targeted website. In addition, the Company attends national
      professional meetings, including the following:




§
            American
                Brachytherapy Society (ABS),


§
            American
                Society for Therapeutic Radiation and Oncology (ASTRO),
                and


§
            Association
                of American Physicists in Medicine
                (AAPM).





The
      Company also continues to consult with noted contributors from the medical
      physics community and will have articles submitted to professional journals
      such
      as *Medical
      Physics, the Brachytherapy Journal,* and the *International
      Journal of Radiation*  *Oncology,
      Biology, and Physics* regarding the benefits of and clinical trials involving Cs-131.





Beginning
      in January 2008, IsoRay implemented a variety of physician Cs-131 training
      outreach programs including the following: a two day training course held
      approximately three times per year at Chicago Prostate Cancer Center (CPCC);
      proctoring and mentoring programs led by Steve Kurtzman, MD, IsoRay’s Medical
      Director; and a training DVD for physicians who choose not to leave their
      practices to attend a training course.





The
      objective of the training programs is to increase the physician’s confidence in
      using the product. To track the impact of the courses held in January 2008
      and
      in May 2008, IsoRay has compared physicians’ average monthly order activity for
      the six month periods prior to and after attending the course. To date there
      has
      been a 42% increase in average monthly order activity when comparing these
      two
      time periods for those physicians participating in the January and May training
      courses.




14
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In
      today’s U.S. health care market, patients are more informed and involved in the
      management of their health than in the past. Many physicians relate incidents
      of
      their patients coming for consultations armed with articles researched on the
      Internet and other sources describing new treatments and medications. In many
      cases, these patients are demanding a certain therapy or drug and the physicians
      are complying when medically appropriate.





Because
      of this consumer-driven market factor, we also promote our products directly
      to
      the general public. We target the prostate cancer patient, his spouse, family
      and care givers. We emphasize to these segments the specific advantages of
      the
      Proxcelan Cesium-131 brachytherapy seed through our websites (located at
      www.isoray.com, www.cesium.com, and www.proxcelan.com), patient advocacy
      efforts, informational patient brochures and DVDs with patient testimonials,
      patient focused informational website (www.proxcelan.com), and advertisements
      in
      specific markets supporting brachytherapy. None of the websites mentioned in
      the
      preceding sentence are part of this report.





In
      addition, the Company continues to promote the clinical findings of the various
      protocols through presentations by respected thought leaders. The Company will
      continually review and update all marketing materials as more clinical
      information is gathered from the protocols and studies.





Apart
      from clinical studies and papers sponsored by the Company, several physicians
      across the country are now independently publishing papers and studies extolling
      the benefits of Cs-131.





*Sales
      and Distribution*





According
      to a recent industry survey, approximately 2,000 hospitals and free standing
      clinics are currently offering radiation oncology services in the United States.
      Not all of these facilities offer seed brachytherapy services. These
      institutions are staffed with radiation oncologists and medical physicists
      who
      provide expertise in radiation therapy treatments and serve as consultants
      for
      urologists and prostate cancer patients. We target the radiation oncologists
      and
      the medical physicists as well as urologists as key clinical decision-makers
      in
      the type of radiation therapy offered to prostate cancer patients.





IsoRay
      has a direct sales organization to introduce Proxcelan Cesium-131 brachytherapy
      seeds to radiation oncologists and medical physicists. Currently IsoRay has
      six
      direct sales persons and a National Sales Director. These sales people include
      those experienced in the brachytherapy market and the medical device market.
      IsoRay is evaluating all options for distribution of the Proxcelan Cesium-131
      seed and may in the future add additional distribution channels.





With
      the
      restructuring of the compensation structure by new management, the Company
      lost
      several members of its sales force who did not want to rely on a reduced base
      salary and increased commissions approach. From the date of the changes in
      compensation structure until September 22, 2008, the Company has lost four
      sales
      representatives and replaced them with four new sales representatives. As
      management increasingly focuses on improving sales, additional changes may
      be
      necessary.





The
      Company expects to continue to expand its customer base in fiscal year 2009.
      When the Company implements its plans to expand outside the U.S. market, it
      plans to use established distributors in the key markets in these other
      countries. This strategy should reduce the time and expenses required to
      identify, train and penetrate the key implant centers and establish
      relationships with the key opinion leaders in these markets. Using established
      distributors also should reduce the time spent acquiring the proper radiation
      handling licenses and other regulatory requirements of these
      markets.




15
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*Reimbursement*





Payment
      for IsoRay products comes from third-party payers including the Centers for
      Medicare and Medicaid Services (CMS) and private insurance companies. These
      payers reimburse the hospitals and clinics via well-established payment
      procedures. In 2003, the Company was approved for an initial HCPCS code for
      Cs-131 brachytherapy seeds. In July 2007 CMS divided the HCPCS code into two
      codes for all manufacturers of brachytherapy seeds. The current method has
      assigned one HCPCS code for loose seeds and a second HCPCS code for stranded
      seeds. Medicare is the most significant U.S. payer for prostate brachytherapy
      services, and is the payer in approximately 65% of all U.S. prostate
      brachytherapy cases.





Prostate
      brachytherapy is typically performed in an outpatient setting, and as such,
      is
      covered by the CMS Outpatient Prospective Payment System. Currently, when
      charges for the seeds are correctly submitted to CMS, the total cost of the
      seeds is reimbursed to the hospital or clinic by CMS. CMS had proposed that
      a
      fixed price per seed be reimbursed; however, Congress (after postponing a
      decision on the Medical Bill which included brachytherapy seed reimbursement)
      voted on July 15, 2008 to continue the pass-through reimbursement for
      brachytherapy seeds through December 31, 2009. Other insurance companies have
      historically followed CMS’s reimbursement policies.





**Other
      Information**





*Customers*





Customers
      representing ten percent or more of total Company sales for the twelve months
      ended June 30, 2008 include:


Various
                  Northern California facilities (a)
              18.6%
                  of revenueChicago
                  Prostate Cancer Center  Westmont, IL
              15.7%
                  of revenue




(a)
            The
                following facilities located in northern California are used by one
                doctor
                (the Company’s Medical Director): Community Hospital of Los Gatos (11.0%
                of total revenue), Mills Peninsula Health Services (4.3%), and all
                others
                used by this doctor combined
                (3.3%).





The
      loss
      of any of these significant customers would have an adverse effect on the
      Company’s revenues, which would continue until the Company located new customers
      to replace them.





*Proprietary
      Rights*





The
      Company relies on a combination of patent, copyright and trademark laws, trade
      secrets, software security measures, license agreements and nondisclosure
      agreements to protect its proprietary rights. Some of the Company’s proprietary
      information may not be patentable.





The
      Company intends to vigorously defend its proprietary technologies, trademarks,
      and trade secrets. Members of management, employees, and certain equity holders
      have previously signed non-disclosure, non-compete agreements, and future
      employees, consultants, advisors, with whom the Company engages, and who are
      privy to this information, will be required to do the same. A patent for the
      cesium separation and purification process was granted on May 23, 2000 by the
      U.S. Patent and Trademark Office (USPTO) under Patent Number 6,066,302, with
      an
      expiration date of May 23, 2020. The process was developed by Lane Bray, Chief
      Chemist and a shareholder of the Company, and has been assigned exclusively
      to
      IsoRay. IsoRay’s predecessor also filed for patent protection in four European
      countries under the Patent Cooperation Treaty. Those patents have been assigned
      to IsoRay.




16
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          of Contents*


Our
      management believes that certain aspects of the IsoRay seed design and
      construction techniques are patentable innovations. These innovations have
      been
      documented in IsoRay laboratory records, and a patent application was filed
      with
      the USPTO on November 12, 2003. In August 2008, this patent was granted by
      the
      USPTO under Patent Number 7,410,458, with an expiration date of November 12,
      2023. Certain methodologies regarding isotope production, separation, and seed
      manufacture are retained as trade secrets and are embodied in IsoRay’s
      procedures and documentation. In June 2004, July 2004, and February 2007, five
      patent applications were filed relating to methods of deriving Cs-131 developed
      by IsoRay employees. The Company is currently working on developing and
      patenting additional methods of deriving Cs-131 and other isotopes.





There
      are
      specific conditions attached to the assignment of the Cs-131 patent from Lane
      Bray. In particular, the associated Royalty Agreement provides for 1% of gross
      profit payment from seed sales to Lane Bray and 1% of gross profit from any
      use
      of the Cs-131 process patent for non-seed products. If IsoRay reassigns the
      Royalty Agreement to another company, these royalties increase to 2%. The
      Royalty Agreement has an anti-shelving clause which requires IsoRay to return
      the patent if IsoRay permanently abandons sales of products using the invention.
      During fiscal years 2008 and 2007, the Company recorded royalty expense of
      $21,219 and $2,161, respectively, related to this patent.





The
      terms
      of a license agreement with the Lawrence Family Trust (successor to Don
      Lawrence) for a patent application and related “know-how” 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 remains applicable. To date, management
      believes that there have been no product sales incorporating the “know-how;” and
      therefore believes 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
      Lawrence Family Trust 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.





The
      Company’s Proxcelan trademark has been preliminarily approved and the Company is
      currently waiting for the final approval letter from the USPTO.





*Research
      and Development*





During
      the three-year period ended June 30, 2008, IsoRay and its predecessor companies
      incurred more than $3.2 million in costs related to research and development
      activities. The Company expects to continue ongoing research and development
      activities for the foreseeable future.





Whether
      successful or not, the Company anticipates ending its major research and
      development project to develop a proprietary separation process to manufacture
      enriched barium during fiscal year 2009. During fiscal year 2008, the Company
      spent approximately $483,000 on this project. The remaining project costs are
      anticipated to be approximately $150,000.





*Government
      Regulation*





The
      Company's present and future intended activities in the development, manufacture
      and sale of cancer therapy products are subject to extensive laws, regulations,
      regulatory approvals and guidelines. Within the United States, the Company's
      therapeutic radiological devices must comply with the U.S. Federal Food, Drug
      and Cosmetic Act, which is enforced by the FDA. The Company is also required
      to
      adhere to applicable FDA Quality System Regulations, also known as the Good
      Manufacturing Practices, which include extensive record keeping and periodic
      inspections of manufacturing facilities. The Company's predecessor obtained
      FDA
      510(k) clearance in March 2003 to market the Proxcelan Cs-131 seed for the
      treatment of localized solid tumors and other malignant disease and IsoRay
      obtained FDA 510(k) clearance in November 2006 to market preloaded brachytherapy
      seeds.




17
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          of Contents*




In
      the
      United States, the FDA regulates, among other things, new product clearances
      and
      approvals to establish the safety and efficacy of these products. We are also
      subject to other federal and state laws and regulations, including the
      Occupational Safety and Health Act and the Environmental Protection
      Act.





The
      Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations
      govern or influence the research, testing, manufacture, safety, labeling,
      storage, record keeping, approval, distribution, use, reporting, advertising
      and
      promotion of such products. Noncompliance with applicable requirements can
      result in civil penalties, recall, injunction or seizure of products, refusal
      of
      the government to approve or clear product approval applications,
      disqualification from sponsoring or conducting clinical investigations,
      preventing us from entering into government supply contracts, withdrawal of
      previously approved applications, and criminal prosecution.





In
      the
      United States, medical devices are classified into three different categories
      over which the FDA applies increasing levels of regulation: Class I, Class
      II,
      and Class III. Most Class I devices are exempt from premarket notification
      (510(k)); most Class II devices require premarket notification (510(k)); and
      most Class III devices require premarket approval. Our Proxcelan Cs-131 seed
      is
      a Class II device and received 510(k) clearance in March 2003.





Approval
      of new Class III medical devices is a lengthy procedure and can take a number
      of
      years and require the expenditure of significant resources. There is a shorter
      FDA review and clearance process for Class II medical devices, the premarket
      notification or 510(k) process, whereby a company can market certain Class
      II
      medical devices that can be shown to be substantially equivalent to other
      legally marketed devices. Since brachytherapy seeds have been classified by
      the
      FDA as a Class II device, we have been able to achieve market clearance for
      our
      Cs-131 seed using the 510(k) process.





As
      a
      registered medical device manufacturer with the FDA, we are subject to
      inspection to ensure compliance with their current Good Manufacturing Practices,
      or cGMP. These regulations require that we and any of our contract manufacturers
      design, manufacture and service products, and maintain documents in a prescribed
      manner with respect to manufacturing, testing, distribution, storage, design
      control, and service activities. Modifications or enhancements that could
      significantly affect the safety or effectiveness of a device or that constitute
      a major change to the intended use of the device require a new 510(k) notice
      for
      any product modification.





The
      Medical Device Reporting regulation requires that we provide information to
      the
      FDA on deaths or serious injuries alleged to be associated with the use of
      our
      devices, as well as product malfunctions that are likely to cause or contribute
      to death or serious injury if the malfunction were to recur. Labeling and
      promotional activities are regulated by the FDA and, in some circumstances,
      by
      the Federal Trade Commission.





As
      a
      medical device manufacturer, we are also subject to laws and regulations
      administered by governmental entities at the federal, state and local levels.
      For example, our facility is licensed as a medical product manufacturing
      facility in the State of Washington and is subject to periodic state regulatory
      inspections. Our customers are also subject to a wide variety of laws and
      regulations that could affect the nature and scope of their relationships with
      us.





In
      support of IsoRay’s global strategy to expand marketing to Canada and Russia, as
      well as other foreign markets, we initiated the process in fiscal year 2008
      to
      obtain the European CE Mark, Canadian registration, and certification to ISO
      13485, an internationally recognized quality system. European law requires
      that
      medical devices sold in any EU Member State comply with the requirements of
      the
      European Medical Device Directive (MDD) or the Active Implantable Medical Device
      Directive (AIMDD). IsoRay’s products are classified in Europe as an active
      implantable and are subject to the AIMDD. Compliance with AIMDD and obtaining
      a
      CE Mark involves being certified to ISO 13485 and obtaining approval of the
      product technical file by a notified body that is recognized by competent
      authorities of a Member State. Compliance with ISO 13485 is also required for
      registration of a company for sale of its products in Canada. Many of the
      recognized EU Notified Bodies are also recognized by Health Canada to conduct
      the ISO 13485 inspections for Canadian registration. In August 2008, the Company
      received its certification to ISO 13485 and is continuing to seek Canadian
      registration and the European CE Mark. The Company is now focusing on the
      Canadian and Russian markets and is no longer pursuing sales in the European
      Union (EU). Management does not believe a strategic alliance with IBt, SA,
      a
      Belgian company, will be consummated nor will management leverage IBt’s
      distribution channels in the EU.




18
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          of Contents*




In
      the
      United States, as a manufacturer of medical devices and devices utilizing
      radioactive byproduct material, we are subject to extensive regulation by not
      only federal governmental authorities, such as the FDA, but also by state and
      local governmental authorities, such as the Washington State Department of
      Health, **** to
      ensure
      such devices are safe and effective. In Washington State, the Department of
      Health, by agreement with the federal Nuclear Regulatory Commission (NRC),
      regulates the possession, use, and disposal of radioactive byproduct material
      as
      well as the manufacture of radioactive sealed sources to ensure compliance
      with
      state and federal laws and regulations. Our Cs-131 brachytherapy seeds
      constitute both medical devices and radioactive sealed sources and are subject
      to these regulations.





Moreover,
      our use, management, and disposal of certain radioactive substances and wastes
      are subject to regulation by several federal and state agencies depending on
      the
      nature of the substance or waste material. We believe that we are in compliance
      with all federal and state regulations for this purpose.





Washington
      voters approved Initiative 297 in late 2004, which may impose additional
      restrictions on sites at which mixed radioactive and hazardous wastes are
      generated and stored, as it prohibits additional mixed radioactive and hazardous
      waste from being brought to sites until the existing on-site waste conforms
      to
      all state and federal environment laws. In June 2006, a U.S. District court
      judge ruled that Initiative 297 was unconstitutional in its entirety and the
      Ninth Circuit upheld this decision in May 2008. However, the State of Washington
      may choose to appeal the decision. If this decision is overturned and Initiative
      297 is enforced it could impact our ability to manufacture our seeds in the
      State of Washington.





*Seasonality*





The
      Company believes that some seed implantation procedures are deferred around
      physician vacations (particularly in the summer months), holidays, and medical
      conventions and conferences resulting in a seasonal influence on the Company’s
      business. These factors cause a momentary decline in revenue which management
      believes is ultimately realized later. Because almost thirty percent (30%)
      of
      the Company's business relies on three physicians, simultaneous vacations by
      these three physicians could cause significant drops in the Company's
      productivity during those periods.





*Employees*





As
      of
      September 12, 2008, IsoRay employed 49 full-time individuals and one part-time
      individual. The Company's future success will depend, in part, on its ability
      to
      attract, retain, and motivate highly qualified sales, technical and management
      personnel. From time to time, the Company may employ independent consultants
      or
      contractors to support its research and development, marketing, sales, and
      administrative organizations. None of the Company's employees are represented
      by
      any collective bargaining unit. IsoRay estimates that successful implementation
      of its growth plan would result in up to five to seven additional employees
      by
      the end of fiscal year 2009. The significant decrease in anticipated employees
      from those projected in fiscal year 2008 is a result of the greater
      manufacturing efficiencies realized by the Company and lower than anticipated
      sales growth.




19
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          of Contents*


*Competition*





The
      Company competes in a market characterized by technological innovation,
      extensive research efforts, and significant competition. In general, the
      Proxcelan Cesium-131 brachytherapy seed competes with conventional methods
      of
      treating localized cancer, including, but not limited to, all forms of
      prostatectomy surgery and external beam radiation therapy which includes
      intensity modulated radiation therapy, as well as competing permanent
      brachytherapy devices. Surgery has historically represented the most common
      medical treatment for early-stage, localized prostate cancer but radical
      prostatectomies have declined in recent years. EBRT is also a well-established
      method of treatment and is widely accepted for patients who represent a poor
      surgical risk or whose prostate cancer has advanced beyond the stage for which
      surgical treatment is indicated. Management believes that if general conversion
      from these treatment options (or other established or conventional procedures)
      to the Proxcelan Cesium-131 brachytherapy seed does occur, such conversion
      will
      likely be the result of a combination of equivalent or better efficacy, reduced
      incidence and duration of side effects and complications, lower cost, better
      quality of life outcomes, and pressure by health care providers and
      patients.





History
      has shown the advantage of being the first to market a new brachytherapy
      product. For example, Theragenics Corp., which introduced the original Pd-103
      seed, currently claims over 59% of the Pd-103 market share (through CR Bard,
      other distributors, and direct distribution). Although factors other than being
      first to market contribute to becoming a market leader, the Company believes
      it
      has the opportunity to obtain a similar and significant advantage by being
      the
      first to introduce a Cs-131 seed. (Source: Millennium Research Corp,
      2008)





The
      Company’s patented Cs-131 separation process is likely to provide a sustainable
      competitive advantage. Production of Cs-131 also requires specialized facilities
      that represent high cost and long lead time if not readily available. In
      addition, a competitor would need to develop a method for isotope attachment
      and
      seed assembly, would need to conduct testing to meet NRC and FDA requirements,
      and would need to obtain regulatory clearances before marketing a competing
      device.





Several
      companies have obtained regulatory clearance to produce and distribute Pd-103
      and I-125 seeds, which compete directly with our seed. Six of those companies
      represent nearly 100% of annual brachytherapy seed sales worldwide: CR Bard,
      Inc
      (32.3%), Oncura (21.7%) (part of GE Healthcare), Theragenics Corp (direct sales
      9.5%), North American Scientific, Inc. (13.1%), Core Oncology (10.7%), and
      Best
      Medical International, Inc. (6.5%) (Source: Millennium Research Corp, 2008).





It
      is
      possible that three or four of the current I-125 or Pd-103 seed manufacturers
      (e.g., CR Bard, Oncura, Theragenics, North American Scientific, etc.) are
      capable of producing and marketing a Cs-131 seed, but none have reported efforts
      to do so. Best Medical obtained a seed core patent in 1992 that named ten
      different isotopes, including Cs-131, for use in their seeds. Best Medical
      received FDA 510(k) clearance to market a Cs-131 seed on June 6, 1993 but to
      date has not produced any products for sale. In addition to the FDA and the
      NRC,
      Best Medical would be required to submit a Cs-131 seed to the TG-43 task group
      of the American Association of Physicists in Medicine to determine the seed’s
      characteristics such as anisotropy, dose rate constant, etc. To date there
      has
      been no submission to the TG-43 task group for a competing Cs-131
      seed.





*Additional
      Growth Opportunities*





Management
      of the Company sees growth opportunities through expansion into international
      markets and additional treatment applicability to cancers other than prostate.
      The Company plans to introduce Cs-131 for prostate brachytherapy initially
      into
      Canada and Russia and later into Europe and other international markets through
      partnerships and strategic alliances with channel partners for manufacturing
      and
      distribution.





Cs-131
      has FDA clearance to be used for treatments for a broad spectrum of cancers
      including breast, brain, lung, and liver cancer, and the Company believes that
      a
      major opportunity exists as an adjunct therapy for the treatment of residual
      lung cancer and ocular melanoma. The Company has already begun treating ocular
      melanoma. The Company has had discussions with prominent physicians and is
      looking at treatment of lung and brain cancer.




20
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          of Contents*


There
      is
      also an opportunity to develop and market other radioactive isotopes to the
      United States market, and to market Cs-131 isotope itself, separate from its
      use
      in our seeds. The Company is also in the preliminary stages of exploring
      alternate methods of delivering our isotopes to various organs of the body,
      as
      it may be advantageous to use delivery methods other than a
      titanium-encapsulated seed to deliver radiation to certain organs.





**ITEM
      1A – RISK FACTORS**





*Our
      Revenues Depend Upon One Product.* Until
      such time as we develop additional products, our revenues depend upon the
      successful production, marketing, and sales of the Proxcelan Cs-131
      brachytherapy seed. The rate and level of market acceptance of this product
      may
      vary depending on the perception by physicians and other members of the
      healthcare community of its safety and efficacy as compared to that of competing
      products, if any; the clinical outcomes of the patients treated; the
      effectiveness of our sales and marketing efforts in the United States, Canada,
      and Russia; any unfavorable publicity concerning our product or similar
      products; our product’s price relative to other products or competing
      treatments; any decrease in current reimbursement rates from the Centers for
      Medicare and Medicaid Services or third-party payers; regulatory developments
      related to the manufacture or continued use of the product; availability of
      sufficient supplies of enriched barium (now coming from Russia) for Cs-131
      seed
      production; ability to produce sufficient quantities of this product; and the
      ability of physicians to properly utilize the device and avoid excessive levels
      of radiation to patients. Because of our reliance on this product as the sole
      source of our revenue, any material adverse developments with respect to the
      commercialization of this product may cause us to continue to incur losses
      rather than profits in the future.





*Although
      Cleared To Treat Any Malignant Tissue, Our Sole Product Is Currently Used To
      Treat Two Types Of Cancer.*  Currently, the Proxcelan Cs-131 seed is used exclusively for the treatment
      of
      prostate cancer and ocular melanoma (less than one percent of our sales). We
      believe the Proxcelan Cs-131 seed will be used to treat other types of cancers,
      as is currently the case with our competitors’ I-125 and Pd-103 seeds. However,
      we believe that clinical data gathered by select groups of physicians under
      treatment protocols specific to other organs will be needed prior to widespread
      acceptance of our product for treating other cancer sites. If our current and
      future products do not become accepted in treating cancers of other sites,
      our
      sales will depend solely on treatment of prostate cancer and will require ever
      increasing market share to increase revenues.





*We
      Have Increasing Cash Requirements* . ** IsoRay
      has generated material operating losses since inception. We expect to continue
      to experience significant net operating losses. Due to previous capital
      investments, management believes cash and cash equivalents on hand at
      June 30, 2008 will be sufficient to meet our anticipated cash requirements
      for operations, debt service, and capital expenditure requirements through
      at
      least the next twelve months. If operating costs expand proportionately with
      revenue increases, other applications are pursued for seed usage outside the
      prostate market, if protocols are expanded to support the integrity of our
      product, and marketing expenses increase, management believes approximately
      $1.5
      million in monthly revenue will be needed to reach break-even. This is a
      decrease from the previous estimate of $2 million in monthly revenue due to
      recent improvements in the Company’s production operating efficiencies and its
      cost structure implemented by new management. However, there is no assurance
      as
      to when break-even will occur.  If we are unable to generate profits and
      unable to obtain additional financing to meet our working capital requirements,
      we may have to curtail our business.





*We
      Rely Heavily On A Limited Number Of Suppliers.*  Some
      materials used in our products are currently available only from a limited
      number of suppliers. In fiscal 2008, approximately sixty-five percent (65%)
      of
      our cesium was supplied through either the Institute of Nuclear Materials (INM)
      or from the Russian Research Institute of Atomic Reactors (RIAR) both of which
      are located in Russia. Beginning in January 2008, we were unable to obtain
      any
      Cs-131 from INM and instead obtained all of our supply of Cs-131 in Russia
      from
      RIAR until August 2008, when RIAR was shut down for regularly scheduled
      maintenance and we resumed purchasing from INM. However, beginning in October
      2008, we will obtain Cs-131 from both INM and RIAR. At current production levels
      the Company cannot meet the minimum purchase requirements necessary to purchase
      the product at the reduced prices presently offered. Unless the Company
      substantially increases its purchase requirements resulting from significant
      increases in demand for its product, the cost of Cs-131 in Russia could
      significantly increase from current pricing. Management will seek to negotiate
      favorable pricing but there is no assurance as to the outcome of these
      negotiations.




21
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          of Contents*




If
      the
      development of barium enrichment capabilities is successful, the Company plans
      to expand Cs-131 manufacturing capability at the MURR reactor in the United
      States. Reliance on any single supplier increases the risks associated with
      concentrating isotope production at a single reactor facility which are subject
      to unanticipated shutdowns. Failure to obtain deliveries of cesium from multiple
      sources could have a material adverse effect on seed production and there may
      be
      a delay before we could locate alternative suppliers beyond the three currently
      used.





We
      may
      not be able to locate additional suppliers outside of Russia capable of
      producing the level of output of cesium at the quality standards we require.
      Additional factors that could cause interruptions or delays in our source of
      materials include limitations on the availability of raw materials or
      manufacturing performance experienced by our suppliers and a breakdown in our
      commercial relations with one or more suppliers. Some of these factors may
      be
      completely out of our and our suppliers’ control.





Virtually
      all titanium tubing used in brachytherapy seed manufacture comes from a single
      source, Accellent Corporation. We currently obtain a key component of our seed
      core from another single supplier. We do not have formal written agreements
      with
      Accellent Corporation. Any interruption or delay in the supply of materials
      required to produce our products could harm our business if we were unable
      to
      obtain an alternative supplier or substitute equivalent materials in a
      cost-effective and timely manner. To mitigate any potential interruptions,
      the
      Company continually evaluates its inventory levels and management believes
      that
      the Company maintains a sufficient quantity on hand to alleviate any potential
      disruptions.





*Future
      Production Increases Will Depend on Our Ability to Acquire Larger Quantities
      of
      Cs-131 and Hire More Employees* *.*  IsoRay
      currently obtains Cs-131 through its contracts with INM and RIAR, and through
      reactor irradiation of natural barium and subsequent separation of cesium from
      the irradiated barium targets. The amount of Cs-131 that can be produced from
      a
      given reactor source is limited by the power level and volume available within
      the reactor for irradiating targets. This limitation can be overcome by
      utilizing barium feedstock that is enriched in the stable isotope Ba-130.
      However, the number of suppliers of enriched barium is limited and they may
      be
      unable to produce this material in sufficient quantities at a reasonable
      price.





IsoRay
      has entered into exclusive agreements with INM and RIAR in Russia to provide
      Cs-131 in quantities sufficient to supply a significant percentage of future
      demand for this isotope. Delivery of the isotope from INM began in January
      2006
      and delivery from RIAR began in January 2008. INM has unique capabilities due
      to
      its large irradiation capacity which will allow the Company to meet all of
      its
      Cs-131 demands without the use of enriched material for the foreseeable future.
      Due to the purchase of enriched barium in June 2007, IsoRay has access to
      sufficient quantities of enriched barium that may be recycled to increase the
      production of Cs-131. Although the agreements provide for supplying Cs-131
      in
      significant quantities, there is no assurance that this will result in IsoRay
      gaining access to a continuing sufficient supply of enriched barium feedstock.
      If we were unable to obtain supplies of isotopes from Russia in the future,
      our
      overall supply of cesium and barium would be reduced significantly unless the
      Company has a source of enriched barium for utilization in domestic
      reactors.





*We
      Are Subject To Uncertainties Regarding Reimbursement For Use Of Our
      Products.*  Hospitals and freestanding clinics may be less likely to purchase our products
      if they cannot be assured of receiving favorable reimbursement for treatments
      using our products from third-party payers, such as Medicare and private health
      insurance plans. Currently, Medicare reimburses hospitals, clinics and
      physicians for the cost of seeds used in brachytherapy procedures on a pass
      through basis, and will continue this method of reimbursement through December
      31, 2009. Historically, private insurers have followed Medicare guidelines
      in
      establishing reimbursement rates. However, third-party payers are increasingly
      challenging the pricing of certain medical services or devices, and we cannot
      be
      sure that they will reimburse our customers at levels sufficient for us to
      maintain favorable sales and price levels for our products. There is no uniform
      policy on reimbursement among third-party payers, and we can provide no
      assurance that our products will continue to qualify for reimbursement from
      all
      third-party payers or that reimbursement rates will not be reduced. A reduction
      in or elimination of third-party reimbursement for treatments using our products
      would likely have a material adverse effect on our revenues.




22
 *Table
          of Contents*




In
      2003,
      we applied to the Centers for Medicare and Medicaid Services (CMS) and received
      a reimbursement code for use of our Cs-131 seed. As of July 1, 2007, CMS revised
      the coding system for brachytherapy seeds and separated the single code into
      two
      codes – one code for loose seeds and a second code for stranded seeds. This
      methodology was applied to all companies manufacturing and distributing
      brachytherapy seeds. Reimbursement amounts are reviewed and revised annually.
      Adjustments could be made to these reimbursement amounts or policies, which
      could result in reduced reimbursement for brachytherapy services, which could
      negatively affect market demand for our products.





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





*Our
      Operating Results Will Be Subject To Significant Fluctuations.*  Our
      quarterly revenues, expenses, and operating results are likely to fluctuate
      significantly in the future. Fluctuation may result from a variety of factors,
      which are discussed in detail throughout this “RISK FACTORS” section,
      including:




§
            our
                achievement of product development objectives and
                milestones;


§
            demand
                and pricing for the Company’s
                products;


§
            effects
                of aggressive competitors;


§
            hospital,
                clinic and physician buying
                decisions;


§
            research
                and development and manufacturing
                expenses;


§
            patient
                outcomes from our therapy;


§
            physician
                acceptance of our products;


§
            government
                or private healthcare reimbursement
                policies;


§
            our
                manufacturing performance and
                capacity;


§
            incidents,
                if any, that could cause temporary shutdown of our manufacturing
                facility;


§
            the
                amount and timing of sales orders;


§
            rate
                and success of future product
                approvals;


§
            timing
                of FDA clearance, if any, of competitive products and the rate of
                market
                penetration of competing products;


§
            seasonality
                of purchasing behavior in our
                market;


§
            overall
                economic conditions; and


§
            the
                successful introduction or market penetration of alternative
                therapies.





*We
      Have Limited Data on the Clinical Performance of Cs-131* .
      As of
      June 1, 2008, the Proxcelan Cs-131 seed has been implanted in over
      2,800 **** patients
      and research papers are being published on the use of the Proxcelan seed.
      However, we have less statistical data than is available for I-125 and Pd-103
      seeds. While this limited data may prevent us from drawing statistically
      significant conclusions, the side effects experienced by these patients were
      less severe than side effects observed in seed brachytherapy with I-125 and
      Pd-103 and in other forms of treatment such as radical prostatectomy. These
      early results indicate that the onset of side effects generally occurs between
      one and three weeks post-implant, and the side effects are resolved between
      five
      and eight weeks post-implant, side effects resolved more quickly than the side
      effects that occur with competing seeds or with other forms of treatment. These
      limited findings support management’s belief that the Cs-131 seed will result in
      less severe side effects than competing treatments, but we may have to gather
      data on outcomes from additional patients before we can establish statistically
      valid conclusions regarding the incidence of side effects from our
      seeds.




23
 *Table
          of Contents*




*We
      Are Subject To The Risk That Certain Third Parties May Mishandle Our
      Product.*  We rely
      on third parties, such as Federal Express, to deliver our Proxcelan Cs-131
      seed,
      and on other third parties, including various radiopharmacies, to package our
      Proxcelan Cs-131 seed in certain specialized packaging forms requested by
      customers. We are subject to the risk that these third parties may mishandle
      our
      product, which could result in adverse effects, particularly given the
      radioactive nature of our product.





*It
      Is
      Possible That Other Treatments May Be Deemed Superior To
      Brachytherapy.*  Our
      Proxcelan Cs-131 seed faces competition not only from companies that sell other
      radiation therapy products, but also from companies that are developing
      alternative therapies for the treatment of cancers. It is possible that advances
      in the pharmaceutical, biomedical, or gene therapy fields could render some
      or
      all radiation therapies, whether conventional or brachytherapy, obsolete. If
      alternative therapies are proven or even perceived to offer treatment options
      that are superior to brachytherapy, physician adoption of our product could
      be
      negatively affected and our revenues from our product could
      decline.





*Our
      Industry Is Intensely Competitive.*  The
      medical device industry is intensely competitive. We compete with both public
      and private medical device, biotechnology and pharmaceutical companies that
      have
      been in existence longer than we have, have a greater number of products on
      the
      market, have greater financial and other resources, and have other technological
      or competitive advantages. In addition, centers that wish to offer the Proxcelan
      Cs-131 seed must comply with licensing requirements specific to the state in
      which they do business and these licensing requirements may take a considerable
      amount of time to comply with. Certain centers may choose to not offer our
      Proxcelan Cs-131 seed due to the time required to obtain necessary license
      amendments. We also compete with academic institutions, government agencies,
      and
      private research organizations in the development of technologies and processes
      and in acquiring key personnel. Although we have patents granted and patents
      applied for to protect our isotope separation processes and Cs-131 seed
      manufacturing technology, we cannot be certain that one or more of our
      competitors will not attempt to obtain patent protection that blocks or
      adversely affects our product development efforts. To minimize this potential,
      we have entered into exclusive agreements with key suppliers of isotopes and
      isotope precursors, which are subject to becoming non-exclusive as we have
      failed to meet minimum purchase requirements.





*We
      May Be Unable To Adequately Protect Or Enforce Our Intellectual Property Rights
      Or Secure Rights To Third-Party Patents.*  Our
      ability and the abilities of our partners to obtain and maintain patent and
      other protection for our products will affect our success. We are assigned,
      have
      rights to, or have exclusive licenses to patents and patents pending in the
      U.S.
      and numerous foreign countries. The patent positions of medical device companies
      can be highly uncertain and involve complex legal and factual questions. Our
      patent rights may not be upheld in a court of law if challenged. Our patent
      rights may not provide competitive advantages for our products and may be
      challenged, infringed upon or circumvented by our competitors. We cannot patent
      our products in all countries or afford to litigate every potential violation
      worldwide.





Because
      of the large number of patent filings in the medical device and biotechnology
      field, our competitors may have filed applications or been issued patents and
      may obtain additional patents and proprietary rights relating to products or
      processes competitive with or similar to ours. We cannot be certain that U.S.
      or
      foreign patents do not exist or will not be issued that would harm our ability
      to commercialize our products and product candidates.





*The
      Value Of Our Granted Patent, and Our Patents Pending, Is
      Uncertain.*  Although
      our management strongly believes that our patent on the process for producing
      Cs-131, our patent pending on the manufacture of the brachytherapy seed, our
      patent applications on additional methods for producing Cs-131 and other
      isotopes which have been filed, and anticipated future patent applications,
      which have not yet been filed, have significant value, we cannot be certain
      that
      other like-kind processes may not exist or be discovered, that any of these
      patents is enforceable, or that any of our patent applications will result
      in
      issued patents.




24
 *Table
          of Contents*




*Failure
      To Comply With Government Regulations Could Harm Our Business* .
      As a
      medical device and medical isotope manufacturer, we are subject to extensive,
      complex, costly, and evolving governmental rules, regulations and restrictions
      administered by the FDA, by other federal and state agencies, and by
      governmental authorities in other countries. Compliance with these laws and
      regulations is expensive and time-consuming, and changes to or failure to comply
      with these laws and regulations, or adoption of new laws and regulations, could
      adversely affect our business.





In
      the
      United States, as a manufacturer of medical devices and devices utilizing
      radioactive by-product material, we are subject to extensive regulation by
      federal, state, and local governmental authorities, such as the FDA and the
      Washington State Department of Health, **** to
      ensure
      such devices are safe and effective. Regulations promulgated by the FDA under
      the U.S. Food, Drug and Cosmetic Act, or the FDC Act, govern the design,
      development, testing, manufacturing, packaging, labeling, distribution,
      marketing and sale, post-market surveillance, repairs, replacements, and recalls
      of medical devices. In Washington State, the Department of Health, by agreement
      with the federal Nuclear Regulatory Commission (NRC), regulates the possession,
      use, and disposal of radioactive byproduct material as well as the manufacture
      of radioactive sealed sources to ensure compliance with state and federal laws
      and regulations. Our Proxcelan Cs-131 brachytherapy seeds constitute both
      medical devices and radioactive sealed sources and are subject to these
      regulations.





Under
      the
      FDC Act, medical devices are classified into three different categories, over
      which the FDA applies increasing levels of regulation: Class I,
      Class II, and Class III. Our Proxcelan Cs-131 seed has been classified
      as a Class II device and has received clearance from the FDA through the 510(k)
      pre-market notification process. Any modifications to the device that would
      significantly affect safety or effectiveness, or constitute a major change
      in
      intended use, would require a new 510(k) submission. As with any submittal
      to
      the FDA, there is no assurance that a 510(k) clearance would be granted to
      the
      Company.





In
      addition to FDA-required market clearances and approvals for our products,
      our
      manufacturing operations are required to comply with the FDA's Quality System
      Regulation, or QSR, which addresses requirements for a company's quality program
      such as management responsibility, good manufacturing practices, product and
      process design controls, and quality controls used in manufacturing. Compliance
      with applicable regulatory requirements is monitored through periodic
      inspections by the FDA Office of Regulatory Affairs (ORA). We anticipate both
      announced and unannounced inspections by the FDA. Such inspections could result
      in non-compliance reports (Form 483) which, if not adequately responded to,
      could lead to enforcement actions. The FDA can institute a wide variety of
      enforcement actions, ranging from public warning letters to more severe
      sanctions such as fines, injunctions, civil penalties, recall of our products,
      operating restrictions, suspension of production, non-approval or withdrawal
      of
      pre-market clearances for new products or existing products, and criminal
      prosecution. There can be no assurance that we will not incur significant costs
      to comply with these regulations in the future or that the regulations will
      not
      have a material adverse effect on our business, financial condition and results
      of operations.





The
      marketing of our products in foreign countries will, in general, be regulated
      by
      foreign governmental agencies similar to the FDA. Foreign regulatory
      requirements vary from country to country. The time and cost required to obtain
      regulatory approvals could be longer than that required for FDA clearance in
      the
      United States and the requirements for licensing a product in another country
      may differ significantly from FDA requirements. We will rely, in part, on
      foreign distributors to assist us in complying with foreign regulatory
      requirements. We may not be able to obtain these approvals without incurring
      significant expenses or at all, and the failure to obtain these approvals would
      prevent us from selling our products in the applicable countries. This could
      limit our sales and growth.





*Our
      Business Exposes Us To Product Liability Claims.*  Our
      design, testing, development, manufacture, and marketing of products involve
      an
      inherent risk of exposure to product liability claims and related adverse
      publicity. Insurance coverage is expensive and difficult to obtain, and,
      although we currently have a five million dollar policy, in the future we may
      be
      unable to obtain or renew coverage on acceptable terms, if at all. If we are
      unable to obtain or renew sufficient insurance at an acceptable cost or if
      a
      successful product liability claim is made against us, whether fully covered
      by
      insurance or not, our business could be harmed.




25
 *Table
          of Contents*


*Our
      Business Involves Environmental Risks.*  Our
      business involves the controlled use of hazardous materials, chemicals,
      biologics, and radioactive compounds. Manufacturing is extremely susceptible
      to
      product loss due to radioactive, microbial, or viral contamination; material
      or
      equipment failure; vendor or operator error; or due to the very nature of the
      product’s short half-life. Although we believe that our safety procedures for
      handling and disposing of such materials comply with state and federal standards
      there will always be the risk of accidental contamination or injury. In
      addition, radioactive, microbial, or viral contamination may cause the closure
      of the respective manufacturing facility for an extended period of time. By
      law,
      radioactive materials may only be disposed of at state-approved facilities.
      At
      our leased facility we use commercial disposal contractors. We may incur
      substantial costs related to the disposal of these materials. If we were to
      become liable for an accident, or if we were to suffer an extended facility
      shutdown, we could incur significant costs, damages, and penalties that could
      harm our business.




*We
      Rely Upon Key Personnel* *.*  Our
      success will depend, to a great extent, upon the experience, abilities and
      continued services of our executive officers, sales staff and key scientific
      personnel. If we lose the services of several officers, sales personnel, or
      key
      scientific personnel, our business could be harmed. Our success also will depend
      upon our ability to attract and retain other highly qualified scientific,
      managerial, sales, and manufacturing personnel and their ability to develop
      and
      maintain relationships with key individuals in the industry. Competition for
      these personnel and relationships is intense and we compete with numerous
      pharmaceutical and biotechnology companies as well as with universities and
      non-profit research organizations. We may not be able to continue to attract
      and
      retain qualified personnel.





*Our
      Ability To Operate In Foreign Markets Is Uncertain.*  Our
      future growth will depend in part on our ability to establish, grow and maintain
      product sales in foreign markets, particularly in Canada and Russia. However,
      we
      have limited experience in marketing and distributing products in other
      countries. Any foreign operations would subject us to additional risks and
      uncertainties, including our customers’ ability to obtain reimbursement for
      procedures using our products in foreign markets; the burden of complying with
      complex and changing foreign regulatory requirements; speedy delivery
      requirements due to the short half-life of our product; language barriers and
      other difficulties in providing long-range customer service; potentially longer
      accounts receivable collection times; significant currency fluctuations, which
      could cause third-party distributors to reduce the number of products they
      purchase from us because the cost of our products to them could fluctuate
      relative to the price they can charge their customers; reduced protection of
      intellectual property rights in some foreign countries; and the possibility
      that
      contractual provisions governed by foreign laws would be interpreted differently
      than intended in the event of a contract dispute. Any future foreign sales
      of
      our products could also be adversely affected by export license requirements,
      the imposition of governmental controls, political and economic instability,
      trade restrictions, changes in tariffs, and difficulties in staffing and
      managing foreign operations. Many of these factors may also affect our ability
      to import Cs-131 from Russia under our contracts with INM and RIAR.





*Our
      Ability To Expand Operations And Manage Growth Is Uncertain.*  Our
      efforts to expand our operations will result in new and increased
      responsibilities for management personnel and will place a strain upon the
      entire company. To compete effectively and to accommodate growth, if any, we
      may
      be required to continue to implement and to improve our management,
      manufacturing, sales and marketing, operating and financial systems, procedures
      and controls on a timely basis and to expand, train, motivate and manage our
      employees. There can be no assurance that our personnel, systems, procedures,
      and controls will be adequate to support our future operations. If the Proxcelan
      Cs-131 seed were to rapidly become the “seed of choice,” it is unlikely that we
      could meet demand. We could experience significant cash flow difficulties and
      may have difficulty obtaining the working capital required to manufacture our
      products and meet demand. This would cause customer discontent and invite
      competition.




26
 *Table
          of Contents*




*Our
      Reporting Obligations As A Public Company Are Costly.*  Operating
      a public company involves substantial costs to comply with reporting obligations
      under federal securities laws that are continuing to increase as provisions
      of
      the Sarbanes Oxley Act of 2002 are implemented. As a smaller reporting company,
      the Company needs to implement additional provisions of the Sarbanes Oxley
      Act
      during fiscal year 2009. These reporting obligations will increase our operating
      costs.





*Our
      Stock Price Is Likely To Be Volatile.*  There is
      generally significant volatility in the market prices and limited liquidity
      of
      securities of early stage companies, and particularly of early stage medical
      product companies. Contributing to this volatility are various events that
      can
      affect our stock price in a positive or negative manner. These events include,
      but are not limited to: governmental approvals of or refusals to approve
      regulations or actions; market acceptance and sales growth of our products;
      litigation involving the Company or our industry; developments or disputes
      concerning our patents or other proprietary rights; changes in the structure
      of
      healthcare payment systems; departure of key personnel; future sales of our
      securities; fluctuations in our financial results or those of companies that
      are
      perceived to be similar to us; swings in seasonal demands of purchasers;
      investors’ general perception of us; and general economic, industry and market
      conditions. If any of these events occur, it could cause our stock price to
      fall.





*Future
      Sales By Shareholders, Or The Perception That Such Sales May Occur, May Depress
      The Price Of Our Common Stock* *.*  The
      sale
      or availability for sale of substantial amounts of our shares in the public
      market, including shares issuable upon conversion of outstanding preferred
      stock
      or exercise of common stock warrants and options, or the perception that such
      sales could occur, could adversely affect the market price of our common stock
      and also could impair our ability to raise capital through future offerings
      of
      our shares. As of June 30, 2008, we had 22,942,088 outstanding shares of common
      stock, and the following additional shares were reserved for issuance: 2,803,393
      shares upon exercise of outstanding options, 3,245,082 shares upon exercise
      of
      outstanding warrants, and 59,065 shares upon conversion of preferred stock.
      Any
      decline in the price of our common stock may encourage short sales, which could
      place further downward pressure on the price of our common stock and may impair
      our ability to raise additional capital through the sale of equity
      securities.





*The
      Issuance Of Shares Upon Exercise Of Derivative Securities May Cause Immediate
      And Substantial Dilution To Our Existing Shareholders* *.*  The
      issuance of shares upon conversion of the preferred stock and the exercise
      of
      common stock warrants and options may result in substantial dilution to the
      interests of other shareholders since these selling shareholders may ultimately
      convert or exercise and sell all or a portion of the full amount issuable upon
      exercise. If all derivative securities were converted or exercised into shares
      of common stock, there would be approximately an additional 6,100,000 shares
      of
      common stock outstanding as a result. The issuance of these shares will have
      the
      effect of further diluting the proportionate equity interest and voting power
      of
      holders of our common stock.





*We
      Do
      Not Expect To Pay Any Dividends For The Foreseeable Future* *.*  We do
      not anticipate paying any dividends to our shareholders for the foreseeable
      future. The terms of certain of our and our subsidiary's outstanding
      indebtedness substantially restrict the ability of either company to pay
      dividends. Accordingly, shareholders must be prepared to rely on sales of their
      common stock after price appreciation to earn an investment return, which may
      never occur. Any determination to pay dividends in the future will be made
      at
      the discretion of our Board of Directors and will depend on our results of
      operations, financial conditions, contractual restrictions, restrictions imposed
      by applicable laws and other factors our Board deems relevant.




27
 *Table
          of Contents*


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




**ITEM
      1B – UNRESOLVED STAFF COMMENTS**





None.





**ITEM
      2 – PROPERTIES**





The
      Company’s executive offices are located at 350 Hills Street, Suite 106,
      Richland, WA 99354, (509) 375-1202, where IsoRay currently leases approximately
      17,600 square feet of office and laboratory space for approximately $24,200
      per
      month plus monthly janitorial expenses of approximately $600 from Energy
      Northwest, the owner of the Applied Process Engineering Laboratory (the APEL
      facility). The Company is not affiliated with this lessor. The monthly rent
      is
      subject to annual increases based on the Consumer Price Index. The current
      lease
      was entered into in May 2007, expires on April 30, 2010, and has two three-year
      renewal options.





The
      Company’s management believes that all facilities occupied by the Company are
      adequate for present requirements, and that the Company’s current equipment is
      in good condition and is suitable for the operations involved.





**ITEM
      3 – LEGAL PROCEEDINGS**





The
      Company is not involved in any material legal proceedings as of the date of
      this
      Report.





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





No
      matter
      was submitted to a vote of the Company’s security holders during the fourth
      quarter of the fiscal year covered by this Annual Report.





**PART
      II**





**ITEM
      5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
      MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**





The
      Company’s Articles of Incorporation provide that the Company has the authority
      to issue 200,000,000 shares of capital stock, which are currently divided into
      two classes as follows: 194,000,000 shares of common stock, par value of $0.001
      per share; and 6,000,000 shares of preferred stock, par value of $0.001 per
      share. As of September 16, 2008, we had 22,942,088 outstanding shares of Common
      Stock and 59,065 outstanding shares of Preferred Stock.




28
 *Table
          of Contents*


On
      April
      19, 2007, our common stock began trading on the American Stock Exchange (AMEX)
      under the symbol "ISR." Prior to this our common stock was quoted on the OTC
      Bulletin Board and the Pink Sheets under the symbols “ISRY.OB” and “ISRY.PK,”
respectively. Even though we have obtained our AMEX listing, there is still
      limited trading activity in our securities.





The
      following table sets forth, for the fiscal quarters indicated, the high and
      low
      sales prices for our common stock as reported on the American Stock Exchange
      and
      the OTC Bulletin Board. The OTC Bulletin Board quotations are high and low
      last
      reported bid prices representing inter-dealer prices without retail mark-ups,
      mark-downs or commissions, and may not necessarily represent actual
      transactions.  The quotations may be rounded for presentation.  In the
      past, there was an absence of an established trading market for the Company's
      common stock, as the market was limited, sporadic and highly volatile, which
      may
      have affected the prices listed below.





**Year
                ended June 30, 2008**
            
            **High**
            
            **Low**First
                quarter
            
            $
            5.20
            
            $
            3.44Second
                quarter
            
            
            3.51
            
            
            1.85Third
                quarter
            
            
            2.27
            
            
            1.00Fourth
                quarter
            
            
            1.00
            
            
            0.55




**Year
                ended June 30, 2007**
            
            **High**
            
            **Low**First
                quarter
            
            $
            3.50
            
            $
            2.75Second
                quarter
            
            
            6.00
            
            
            3.00Third
                quarter
            
            
            4.90
            
            
            3.80Fourth
                quarter
            
            
            5.18
            
            
            3.51





The
      Company has never paid any cash dividends on its Common Stock and does not
      plan
      to pay any cash dividends in the foreseeable future. On February 1, 2007, the
      Board of Directors declared a dividend on the Series B Preferred Stock of all
      outstanding and cumulative dividends through December 31, 2006. There is no
      Series A Preferred Stock outstanding. The total Series B dividends of $38,458
      were paid on February 15, 2007. The Company does not plan on paying any cash
      dividends on the Series B Preferred Stock in the foreseeable future. There
      is no
      Series A Preferred Stock outstanding.





As
      of
      September 16, 2008, we had approximately 365 shareholders of record, exclusive
      of shares held in street name.





Equity
      Compensation Plans





On
      May
      27, 2005, the Company adopted the 2005 Stock Option Plan (the Option Plan)
      and
      the 2005 Employee Stock Option Plan (the Employee Plan), pursuant to which
      it
      may grant equity awards to eligible persons. On August 15, 2006, the Company
      adopted the 2006 Director Stock Option Plan (the Director Plan) pursuant to
      which it may grant equity awards to eligible persons. Each of the Plans has
      subsequently been amended. The Option Plan allows the Board of Directors to
      grant options to purchase up to 1,800,000 shares of common stock to directors,
      officers, key employees and service providers of the Company, and the Employee
      Plan allows the Board of Directors to grant options to purchase up to 2,000,000
      shares of common stock to officers and key employees of the Company. The
      Director Plan allows the Board of Directors to grant options to purchase up
      to
      1,000,000 shares of common stock to directors of the Company. Options granted
      under all 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 (based on the
      trading price on the American Stock Exchange or the OTC Bulletin Board) on
      the
      date of the grant, and with varying vesting periods as determined by the
      Board.




29
 *Table
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As
      of
      June 30, 2008, the following options had been granted under the option
      plans.





**Plan
                Category**
            
            Number
                of
              securities
                to
              be
                issued on
              exercise
                of
              outstanding
              options,
              warrants,
              and
                rights
              #
            
            Weighted-
              average
              exercise
              price
                of
              outstanding
              options,
              warrants,
              and
                rights
              $
            
            Number
                of
              securities
              remaining
              available
                for
              future
              issuance
              under
                equity
              compensation
              plansEquity
                compensation plans approved by shareholders
            
            
            N/A
            
            
            N/A
            
            
            N/AEquity
                compensation plans not approved by shareholders
            
            
            2,803,393
            
            $
            2.62
            
            
            1,129,824Total
            
            
            2,803,393
            
            $
            2.62
            
            
            1,129,824





Issuer
      Purchases of Equity Securities





In
      June
      2008, the Board of Directors of Isoray authorized the repurchase of up to
      1,000,000 shares of the Company’s common stock (FY2009 Plan). The FY2009 Plan
      will expire on June 30, 2009. The table below shows the activity in the FY2009
      Plan from inception to June 30, 2008.





**FY 2009 PLAN**
            
            Total
              Number
              of Shares
              Purchased
            
            Maximum
              Number of
              Shares thatPeriod
            
            Total
              Number
              of Shares
            
            Average
              Price
              Paid
            
            as Part of
              Publicly
              Announced
            
            May Yet be
              Purchased
              Under theBeginning
            
            Ending
            
            Purchased(1)
            
            per Share
            
            Plan
            
            Plan(2)June
                1, 2008
            
            
            June
                30, 2008
            
            
            5,000
            
            $
            0.731
            
            
            5,000
            
            
            995,000Total
            
            
            
            
            
            5,000
            
            $
            0.731
            
            
            5,000
            
            
            995,000




(1)
              There
                  were no shares purchased during fiscal year 2008 other than in
                  June
                  2008.
 (2)
              In
                  June 2008, the Company announced a new stock repurchase plan to
                  purchase
                  up to 1,000,000 shares of the Company's common stock. The Plan
                  will expire
                  on June 30, 2009.





Sales
      of Unregistered Securities





All
      sales
      of unregistered securities were previously reported.





**ITEM
      6 – SELECTED FINANCIAL DATA**





As
      a
      smaller reporting company, the Company is not required to provide Item 6
      disclosure in this Annual Report.





**ITEM
      7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS**





**Critical
      Accounting Policies and Estimates**





Management’s
      discussion and analysis of the Company’s financial condition and results of
      operations is 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 disclosures 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.




30
 *Table
          of Contents*


The
      Company believes the following critical accounting policies affect its more
      significant judgments and estimates used in the preparation of its consolidated
      financial statements.





Short-Term
      Investments





The
      Company invests certain excess cash in marketable securities consisting
      primarily of commercial paper, auction rate securities, and money market funds.
      The Company classifies all debt securities as “available-for-sale” and records
      the debt securities at fair value with unrealized gains and temporary unrealized
      losses included in other comprehensive income/loss within shareholders’ equity,
      if material. Declines in fair values that are considered other than temporary
      are recorded in the Consolidated Statements of Operations.





Accounts
      Receivable





Accounts
      receivable are stated at the amount that management of the Company expects
      to
      collect from outstanding balances. Management provides for probable
      uncollectible amounts through an allowance for doubtful accounts. Additions
      to
      the allowance for doubtful accounts are based on management’s judgment,
      considering historical write-offs, collections and current credit conditions.
      Balances which remain outstanding after management has used reasonable
      collection efforts are written off through a charge to the allowance for
      doubtful accounts and a credit to the applicable accounts receivable. Payments
      received subsequent to the time that an account is written off are considered
      bad debt recoveries.





Inventory





Inventory
      is reported at the lower of cost or market. Cost of raw materials is determined
      using the weighted average method. Cost of work in process and finished goods
      is
      computed using standard cost, which approximates actual cost, on a first-in,
      first-out basis. As the Company has operated at a gross loss throughout the
      past
      fiscal years, inventories have generally been recorded at market or net
      realizable value.





Fixed
      Assets





Fixed
      assets are capitalized and carried at the lower of cost or net realizable value.
      Normal maintenance and repairs are charged to expense as incurred. When assets
      are sold or otherwise disposed of, the cost and accumulated depreciation are
      removed from the accounts and any resulting gain or loss is recognized in
      operations.





Depreciation
      is computed using the straight-line method over the following estimated useful
      lives:




Production
                equipment
            3
                to 7 yearsOffice
                equipment
            2
                to 5 yearsFurniture
                and fixtures
            2
                to 5 years





Leasehold
      improvements and capital lease assets are amortized over the shorter of the
      life
      of the lease or the estimated useful life of the asset.





The
      Company has adopted the provisions of Statement of Financial Accounting
      Standards (SFAS) No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* .
      The
      provisions of SFAS No. 144 require that an impairment loss be recognized when
      the estimated future cash flows (undiscounted and without interest) expected
      to
      result from the use of an asset are less than the carrying amount of the asset.
      Measurement of an impairment loss is based on the estimated fair value of the
      asset if the asset is expected to be held and used.




31
 *Table
          of Contents*




Management
      of the Company periodically reviews the net carrying value of all of its
      equipment on an asset by asset basis. These reviews consider the net realizable
      value of each asset, as measured in accordance with the preceding paragraph,
      to
      determine whether an impairment in value has occurred, and the need for any
      asset impairment write-down.





Although
      management has made its best estimate of the factors that affect the carrying
      value based on current conditions, it is reasonably possible that changes could
      occur which could adversely affect management's estimate of net cash flows
      expected to be generated from its assets, and necessitate asset impairment
      write-downs.





Deferred
      Financing Costs





Financing
      costs related to the acquisition of debt are deferred and amortized over the
      term of the related debt using the effective interest method.  Deferred
      financing costs include the fair value of common shares issued to certain
      shareholders for their guarantee of certain Company debt in accordance with
      Accounting Principles Board (APB) Opinion No. 21, *Interest
      on Receivables and Payables* and
      Emerging Issues Task Force (EITF) Issue No. 95-13, *Classification
      of Debt Issue Costs in the Statement of Cash Flows* .
      The
      value of the shares issued was the estimated market price of the shares as
      of
      the date of issuance. Amortization of deferred financing costs, totaling $30,504
      and $178,633 for the years ended June 30, 2008 and 2007, respectively, is
      included in financing expense on the statements of operations.





Licenses





Amortization
      of licenses is computed using the straight-line method over the estimated
      economic useful lives of the assets. In fiscal year 2006, the Company entered
      into an agreement with IBt, SA, a Belgian company (IBt) to use IBt’s proprietary
“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 $225,000 and $275,000 during fiscal years 2008 and 2006, respectively,
      and is amortizing the license over the 15-year term of the license
      agreement.





In
      the
      fourth quarter of fiscal year 2008, the Company reviewed the carrying values
      of
      licenses. Although the Company has not currently integrated this technology
      into
      its products, management will reevaluate the potential of this technology during
      fiscal year 2009 after the Company has further improved its current processes.
      Therefore, the Company did not believe that any impairment had occurred to
      this
      intangible asset.




Amortization
      of licenses was $43,452 and $23,426 for the years ended June 30, 2008 and 2007,
      respectively. Based on the licenses recorded at June 30, 2008, and assuming
      no
      subsequent impairment of the underlying assets, the annual amortization expense
      for each fiscal year ending June 30 is expected to be as follows: $47,670 for
      2009, $35,354 for 2010, $35,208 for 2011, $35,208 for 2012, $35,208 for 2013,
      and $266,998 thereafter.





Other
      Assets





Other
      assets, which include deferred charges and patents, are stated at cost, less
      accumulated amortization. Amortization of patents is computed using the
      straight-line method over the estimated economic useful lives of the assets.
      The
      Company periodically reviews the carrying values of patents and any impairments
      are recognized when the expected future operating cash flows to be derived
      from
      such assets are less than their carrying value.





Based
      on
      the patents and other intangible assets recorded in other assets at June 30,
      2008, and assuming no subsequent impairment of the underlying assets, the annual
      amortization expense for each fiscal year ending June 30 is expected to be
      as
      follows: $7,798 for 2009, $4,353 for 2010, $2,632 for 2011, $2,632 for 2012,
      $2,632 for 2013, and $9,560 thereafter.




32
 *Table
          of Contents*


Asset
      Retirement Obligation





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 is discounted using the Company’s
      credit-adjusted risk free-rate and is reviewed periodically for changes in
      the
      estimated future costs underlying the obligation. The Company amortizes the
      initial amount capitalized to property and equipment and recognizes accretion
      expense in connection with the discounted liability over the estimated remaining
      useful life of the leased assets.





In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represented the discounted cost of cleanup that the Company
      anticipated it would have to incur at the end of its equipment and property
      leases in its old production facility. This amount was determined based on
      discussions with qualified production personnel and on historical evidence.
      During fiscal year 2007, the Company reevaluated its obligations based on
      discussions with the Washington Department of Health and determined that the
      initial asset retirement obligation should be increased by an additional
      $56,120. During the second quarter of fiscal year 2008, the Company removed
      all
      radioactive residuals and tenant improvements from its old production facility
      and returned the facility to the lessor. The Company had an asset retirement
      obligation of $135,120 accrued for this facility but total costs incurred to
      decommission the facility were $274,163 resulting in an additional expense
      of
      $139,043 that is included in cost of products sold. The additional expense
      was
      mainly due to unanticipated construction costs to return the facility to its
      previous state. The Company originally believed that the lessor would retain
      many of the leasehold improvements in the building, but the lessor instead
      required their removal.





In
      September 2007, another asset retirement obligation of $473,096 was established
      representing the discounted cost of the Company’s estimate of the obligations to
      remove any residual radioactive materials and all leasehold improvements at
      the
      end of the lease term at its new production facility. The estimate was developed
      by qualified production personnel and the general contractor of the new
      facility. The Company has reviewed the estimate again based on its experience
      with decommissioning its old facility and believes that the original estimate
      continues to be applicable.





During
      the years ended June 30, 2008 and 2007, the asset retirement obligation changed
      as follows:





2008
            
            2007Beginning
                balance
            
            $
            131,142
            
            $
            67,425New
                obligations
            
            
            473,096
            
            
            –Settlement
                of existing obligation
            
            
            (135,120
            )
            
            –Changes
                in estimates of existing obligations
            
            
            –
            
            
            56,120Accretion
                of discount
            
            
            36,887
            
            
            7,597Ending
                balance
            
            $
            506,005
            
            $
            131,142





Because
      the Company does not expect to incur any expenses related to its asset
      retirement obligations in fiscal year 2009, the entire balance as of June 30,
      2008 is classified as a noncurrent liability.





Financial
      Instruments





The
      Company discloses the fair value of financial instruments, both assets and
      liabilities, recognized and not recognized in the balance sheet, for which
      it is
      practicable to estimate the fair value. The fair value of a financial instrument
      is the amount at which the instrument could be exchanged in a current
      transaction between willing parties, other than a forced liquidation
      sale.




33
 *Table
          of Contents*


The
      carrying amounts of financial instruments, including cash and cash equivalents,
      short-term investments, accounts receivable, accounts payable, notes payable,
      and capital lease obligations, approximated their fair values at June 30, 2008
      and 2007.





Revenue
      Recognition





The
      Company applies the provisions of SEC Staff Accounting Bulletin (SAB)
      No. 104, *Revenue
      Recognition* .
      SAB
      No. 104, which supersedes SAB No. 101, *Revenue
      Recognition in Financial Statements* ,
      provides guidance on the recognition, presentation and disclosure of revenue
      in
      financial statements. SAB No. 104 outlines the basic criteria that must be
      met to recognize revenue and provides guidance for the disclosure of revenue
      recognition policies. The Company recognizes revenue related to product sales
      when (i) persuasive evidence of an arrangement exists, (ii) shipment
      has occurred, (iii) the fee is fixed or determinable, and
      (iv) collectability is reasonably assured.




Revenue
      for the fiscal years ended June 30, 2008 and 2007 was derived solely from sales
      of the Proxcelan Cs-131 brachytherapy seed, which is used in the treatment
      of
      cancer. The Company recognizes revenue once the product has been shipped to
      the
      customer. Prepayments, if any, received from customers prior to the time that
      products are shipped are recorded as deferred revenue. In these cases, when
      the
      related products are shipped, the amount recorded as deferred revenue is
      recognized as revenue. The Company accrues for sales returns and other
      allowances at the time of shipment. Although the Company does not have an
      extensive operating history upon which to develop sales returns estimates,
      we
      have used the expertise of our management team, particularly those with
      extensive industry experience and knowledge, to develop a proper
      methodology.





Stock-Based
      Compensation





The
      Company measures and recognizes expense for all share-based payments at fair
      value in accordance with SFAS No. 123 (Revised 2004), *Share-Based
      Payment* (SFAS
      No. 123R). The Company uses the Black-Scholes option valuation model to estimate
      fair value for all stock options on the date of grant. For stock options that
      vest over time, the Company recognizes compensation cost on a straight-line
      basis over the requisite service period for the entire award.





Research
      and Development Costs





Research
      and development costs, including salaries, research materials, administrative
      expenses and contractor fees, are charged to operations as incurred. The cost
      of
      equipment used in research and development activities which has alternative
      uses
      is capitalized as part of fixed assets and not treated as an expense in the
      period acquired. Depreciation of capitalized equipment used to perform research
      and development is classified as research and development expense in the year
      recognized.





Legal
      Contingencies





In
      the
      ordinary course of business, the Company is involved in legal proceedings
      involving contractual and employment relationships, product liability claims,
      patent rights, environmental matters, and a variety of other matters. The
      Company is also 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 and has recorded an asset retirement obligation for
      these expenses.




34
 *Table
          of Contents*




The
      Company records contingent liabilities resulting from asserted and unasserted
      claims against it, when it is probable that a liability has been incurred and
      the amount of the loss is reasonably estimable. Estimating probable losses
      requires analysis of multiple factors, in some cases including judgments about
      the potential actions of third-party claimants and courts. Therefore, actual
      losses in any future period are inherently uncertain. Currently, the Company
      does not believe any probable legal proceedings or claims will have a material
      adverse effect on its financial position or results of operations. However,
      if
      actual or estimated probable future losses exceed the Company’s recorded
      liability for such claims, it would record additional charges as other expense
      during the period in which the actual loss or change in estimate
      occurred.





Income
      Taxes





Income
      taxes are accounted for under the liability method. Under this method, the
      Company provides deferred income taxes for temporary differences that will
      result in taxable or deductible amounts in future years based on the reporting
      of certain costs in different periods for financial statement and income tax
      purposes. This method also requires the recognition of future tax benefits
      such
      as net operating loss carryforwards, to the extent that realization of such
      benefits is more likely than not. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in operations in the period that includes the enactment
      of
      the change.





On
      July
      1, 2007, the Company adopted Financial Accounting Standards Board Interpretation
      No. 48, *Accounting
      for Uncertainty in Income Taxes* (FIN No.
      48). 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 are subject to examination of
      their income tax filings in the United States and state jurisdictions for the
      2005 through 2007 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 year ended
      June 30, 2008 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.





Income
      (Loss) Per Common Share





The
      Company accounts for its income (loss) per common share according to SFAS No.
      128, *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 and options to
      purchase the Company's common stock, are excluded from the calculations when
      their effect is antidilutive. At June 30, 2008 and 2007, 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 antidilutive due to the Company’s net loss position.





Securities
      that could be dilutive in the future as of June 30, 2008 and 2007 are as
      follows:





2008
            
            2007Preferred
                stock
            
            
            59,065
            
            
            59,065Common
                stock warrants
            
            
            3,245,082
            
            
            3,627,764Common
                stock options
            
            
            2,803,393
            
            
            3,683,439Total
                potential dilutive securities
            
            
            6,107,540
            
            
            7,370,268




35
 *Table
          of Contents*


Use
      of
      Estimates





The
      preparation of financial statements in accordance with accounting principles
      generally accepted in the United States of America requires management of the
      Company to make estimates and assumptions that affect the amounts reported
      in
      the financial statements and accompanying notes. Accordingly, actual results
      could differ from those estimates and affect the amounts reported in the
      financial statements.





**Results
      of Operations**





Financial
      Presentation





The
      following sets forth a discussion and analysis of the Company’s financial
      condition and results of operations for the two years ended June 30, 2008 and
      2007. This discussion and analysis should be read in conjunction with our
      consolidated financial statements appearing elsewhere in this Annual Report
      on
      Form 10-K. The following discussion contains forward-looking statements.
      Our actual results may differ significantly from the results discussed in such
      forward-looking statements. Factors that could cause or contribute to such
      differences include, but are not limited to, those discussed in
“Item 1A — Risk Factors,” beginning on page 21 of this Annual Report
      on Form 10-K.





Year
      ended June 30, 2008 compared to year ended June 30, 2007





**Product
      sales.** Sales
      for the year ended June 30, 2008 were $7,158,690 compared to sales of $5,738,033
      for the year ended June 30, 2007. The increase of $1,420,657 or 25% was due
      to
      increased sales volume of the Company’s Proxcelan Cs-131 brachytherapy seeds.
      During the year ended June 30, 2008 the Company sold its Cs-131 seeds to 99
      different medical centers as compared to 79 centers during the fiscal year
      ended
      June 30, 2007.





**Cost
      of product sales.** Cost of
      product sales were $7,310,124 for the year ended June 30, 2008 which represents
      an increase of $1,517,494 or 26% compared to cost of product sales of $5,792,630
      for the year ended June 30, 2007. The major components of the increase were
      depreciation, materials, preload expenses, occupancy costs, and expenses related
      to the transition to the Company’s new production facility and decommissioning
      the Company’s old production facility. These increases were partially offset by
      decreases in consulting and shipping expenses.





Depreciation
      increased approximately $613,000 due to moving operations into a new production
      facility and purchasing new production equipment. This new production facility
      allowed the Company to increase its available capacity by approximately 300%
      using its current production techniques and should fulfill the Company’s
      production needs for the near future. The cost of materials increased
      approximately $313,000 mainly due to higher sales volumes. Preload expenses
      increased approximately $250,000 due to higher sales volumes and due to the
      start-up costs of the Company’s internal preload facility. Occupancy costs
      increased approximately $164,000 as the Company entered into a lease for a
      new
      production facility in March 2007 and continued to pay rent on its old
      production facility through mid-December 2007. The Company also recorded an
      impairment charge of $85,000 in fiscal year 2008 for a hot cell that is not
      currently in use.





The
      Company also experienced increases in cost of product sales expenditures
      directly related to the new facility that was opened in September 2007. 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.




36
 *Table
          of Contents*




The
      Company removed all radioactive residuals and tenant improvements from its
      old
      production facility and returned the facility to the lessor. The Company had
      an
      asset retirement obligation of $135,120 accrued for this facility but total
      costs incurred to decommission the facility were $274,163 resulting in an
      additional expense of $139,043 that is included in cost of products sold. The
      additional expense was mainly due to unanticipated construction costs to return
      the facility to its previous state. The Company originally believed that the
      lessor would retain many of the leasehold improvements in the building, but
      instead required their removal.





These
      increases were partially offset by a decrease of approximately $75,000 in
      consulting expenses as the previous year included costs related to medical
      physics and equipment design and approximately $72,000 in shipping and freight
      as the Company eliminated certain shipping services.





**Gross
      loss.** Gross
      loss was $151,434 for the year ended June 30, 2008. This represents an increase
      of $96,837 or 177% over the prior year’s gross loss of $54,597. The increase is
      due to the increase in production costs more than offsetting the increase in
      revenues. However, the Company has worked to reduce its production costs over
      the past six months and is producing its Proxcelan Cs-131 brachytherapy seeds
      more efficiently now.





**Research
      and development expenses.** Research
      and development expenses for the year ended June 30, 2008 were $1,358,075 which
      represents an increase of $12,912 or 1% over the research and development
      expenses of $1,345,163 for the year ended June 30, 2007. Although the overall
      research and development expenses were consistent with the prior year,
      consulting expenses increased approximately $189,000 due to the Company’s
      ongoing project to increase the efficiency of isotope production and travel
      expenses increased approximately $25,000 due to work in Russia regarding isotope
      efficiencies. These increases were offset by a decrease of approximately
      $205,000 in legal expenses as the Company continues to focus on its key patents
      and trademarks in strategic countries and deemphasized the protection of patents
      and trademarks in less strategic countries.





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $3,725,164 for the year ended June 30, 2008. This
      represents an increase of $340,692 or 10% compared to the year ended June 30,
      2007 sales and marketing expenses of $3,384,472. The change is mainly due to
      increased personnel costs and consulting expenses partially offset by a decrease
      in conventions and tradeshows. Personnel costs increased approximately $333,000
      due to higher commissions paid on increased revenues and an increase in the
      average headcount. Consulting expenses increased approximately
      $103,000 **** mainly
      due to payments to consultants to develop technical publications and other
      materials, to represent the Company at professional society meetings, to serve
      as members of the Company’s Cesium Advisory Group, and increased expenses for a
      lobbying group. Conventions and tradeshows decreased approximately $130,000
      as
      the Company has reduced its budgets for many of the tradeshows, particularly
      the
      smaller tradeshows.





**General
      and administrative expenses.** General
      and administrative expenses for the year ended June 30, 2008 were $3,568,048
      compared to general and administrative expenses of $4,915,598 for the year
      ended
      June 30, 2007. The decrease of $1,347,550 or 27% is primarily due to a decrease
      in share-based compensation, personnel costs, and travel. These decreases were
      partially offset by an increase in legal expenses. Share-based compensation
      decreased approximately $1.2 million due to reduced option awards in fiscal
      year
      2008 and the reversal of expense for unvested and forfeited options for Roger
      Girard, the former CEO. Personnel costs decreased approximately $115,000 mainly
      due to the resignation of Mr. Girard in February 2008. Travel decreased
      approximately $104,000. Legal expenses increased approximately $159,000 due
      to
      costs to draft contracts regarding the Company’s interest in UralDial, LLC, a
      new Russian entity, the IBt strategic global alliance agreements, and mediation
      costs related to negotiations to settle a dispute with the Lawrence Family
      Trust.




37
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          of Contents*




**Operating
      loss.** The
      Company continues to focus its resources on marketing and sales and retaining
      the administrative infrastructure to increase the level of demand for the
      Company’s product. These costs, coupled with product revenues not covering
      production costs, and significant research and development expenditures, have
      resulted in operating losses since its inception. For the year ended June 30,
      2008, the Company had an operating loss of $8,802,721 which is a decrease of
      $897,109 or 9% below the operating loss of $9,699,830 for the year ended June
      30, 2007.





**Interest
      and investment income.** Interest
      and investment income was $612,077 for the year ended June 30, 2008 compared
      to
      interest income of $406,921 for the year ended June 30, 2007. Interest and
      investment income is mainly derived from excess funds held in money market
      and
      investment accounts. The increase of $205,156 or 50% was due to the higher
      average cash and short-term investment balances during the year ended June
      30,
      2008 partially offset by decreasing interest rates.





**Loss
      on short-term investments.** The loss
      of $274,000 for the year ended June 30, 2008 is due to the recent uncertainties
      in the credit markets particularly for certain auction rate securities held
      by
      the Company. The loss represents the amount to write-down these securities
      to
      their estimated fair market value. The Company has recognized these losses
      as
      other than temporary and recorded them in the statement of operations rather
      than in other comprehensive income as the Company may need access to these
      funds
      before the uncertainties in the credit markets are fully resolved.





**Financing
      expense.** Financing expense for the year ended June 30, 2008 was $92,863 or a decrease
      of
      $219,383 or 70% compared to financing expense of $312,246 for the year ended
      June 30, 2008. Included in financing expense is interest expense of
      approximately $62,000 and $134,000 for the years ended June 30, 2008 and 2007,
      respectively. The decrease is due to the lower average debt balances in the
      year
      ended June 30, 2008. The remaining balance of financing expense represents
      the
      amortization of deferred financing costs which decreased due to the write-off
      in
      fiscal year 2007 of the deferred financing costs relating to the Columbia River
      Bank line of credit.





**Liquidity
      and capital resources.** We have
      historically financed our operations through the sale of common stock and
      related warrants. During fiscal year 2008, the Company’s primary source of cash
      was the exercise of common stock warrants and options for $1,022,813 and the
      Company used existing cash reserves to fund its operations and capital
      expenditures.





*Cash
      flows from operating activities*





Cash
      used
      in operating activities was $7.7 million in fiscal year 2008 compared to $7.2
      million in fiscal year 2007, an increase of approximately $500,000. Cash used
      by
      operating activities is net loss adjusted for non-cash items and changes in
      operating assets and liabilities.





*Cash
      flows from investing activities*





In
      2008,
      the Company invested its excess cash generated from shareholder investments.
      During 2008, the Company purchased approximately $13.3 million of various
      short-term investments (mainly commercial paper and municipal auction rate
      securities) and sold approximately $19.4 million of short-term investments.
      As
      of June 30, 2008, short-term investments held by the Company amounted to
      approximately $3.7 million.




38
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Cash
      expenditures for fixed assets were approximately $3.1 million in fiscal 2008
      and
      approximately $2.4 million in fiscal 2007. The increase is mainly due to
      construction to complete our new production facility and equipment purchases
      for
      the new facility.





*Cash
      flows from financing activities*





The
      Company issued 300,876 shares of common stock pursuant to the exercise of common
      stock options and warrants. The Company received $1,022,813 in cash pursuant
      to
      these exercises.





*Projected
      2009 Liquidity and Capital Resources*





At
      June
      30, 2008, cash and cash equivalents amounted to $4,820,033 and short-term
      investments amounted to $3,726,000 compared to $9,335,730 of cash and cash
      equivalents and $9,942,840 of short-term investments at June 30,
      2007.





The
      Company had approximately $4.0 million of cash and $3.7 million of short-term
      investments as of September 16, 2008. As of that date management believed that
      the Company’s monthly required cash operating expenditures were approximately
      $400,000. Management believes that approximately $200,000 to $500,000 will
      be
      spent on capital expenditures during fiscal year 2009, but there is no assurance
      that unanticipated needs for capital equipment may not arise.





If
      the
      Company is able to complete its major research and development project to
      develop a proprietary separation process to manufacture enriched barium, this
      process should improve isotope production efficiency during fiscal year 2009.
      Regardless of whether the Company is ultimately successful in developing this
      process, the remaining project costs are anticipated to be approximately
      $150,000.





During
      fiscal year 2009, the Company intends to continue its existing protocol studies
      and is currently budgeting approximately $278,000 for protocol expense in fiscal
      year 2009.





Assuming
      operating costs expand proportionately with revenue increases, other
      applications are pursued for seed usage outside the prostate market, protocols
      are continued supporting the integrity of our product and sales and marketing
      expenses remain steady, management believes the Company will reach breakeven
      with revenues of approximately $1.5 million per month. This is a decrease from
      the previous estimate of $2 million in monthly revenue based on actions taken
      by
      new management that have over the past six months begun to improve the Company’s
      production operating efficiencies and its cost structure.





Based
      on
      the foregoing assumptions, management believes cash, cash equivalents, and
      short-term investments on hand at June 30, 2008 will be sufficient to meet
      our anticipated cash requirements for operations, debt service, and capital
      expenditure requirements through at least the next twelve months. Management’s
      plans to attain breakeven and generate additional cash flows include increasing
      revenues from both new and existing customers 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
      we do
      not experience the necessary increases in sales or if we experience unforeseen
      manufacturing constraints, we may need to obtain additional
      funding.





The
      Company expects to finance its future 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. 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.




39
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*Long-Term
      Debt and Capital Lease Agreements*





The
      Company has two loan facilities in place as of June 30, 2008. 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 60-month term with a final balloon payment. As of
      June 30, 2008, the principal balance owed was $145,745. This loan is secured
      by
      certain equipment, materials and inventory of IsoRay, and also required personal
      guarantees, for which the guarantors were issued approximately 70,455 shares
      of
      common stock. The second loan is from the Hanford Area Economic Investment
      Fund
      Committee (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 principal balance owed on the
      loan as of June 30, 2008 was $263,639. This loan is secured by receivables,
      equipment, materials and inventory, and certain life insurance policies and
      also
      required personal guarantees.





The
      BFEDD
      has granted the Company a waiver from enforcing violations of paying officers
      in
      excess of $100,000 per year and maintaining a certain current asset ratio.
      The
      waiver is effective through June 30, 2009 and also waives non-compliance with
      covenants prohibiting fixed asset or lease obligations in excess of $24,000
      per
      year, covenants prohibiting mergers, and covenants requiring maintenance of
      a
      certain long-term debt to equity ratio.





HAEIFC
      has also granted the Company a waiver from enforcing a fixed charge coverage
      ratio. The waiver is effective through June 30, 2009.





The
      Company has certain capital leases for production equipment that expire at
      various times from September 2008 to April 2009. These leases currently call
      for
      total monthly payments of $3,876. The total of all capital lease obligations
      at
      June 30, 2008 was $25,560.





Principal
      maturities on notes payable as of June 30, 2008 are due as follows:





Year
                ending June 30,2009
            
            $
            64,4862010
            
            
            168,0082011
            
            
            49,7362012
            
            
            54,3792013
            
            
            59,503Thereafter
            
            
            13,272$
            409,384





Future
      minimum lease payments under capital lease obligations are as follows:





Year
                ending June 30, 2009
            
            $
            27,627Total
                future minimum lease payments
            
            
            27,627Less
                amounts representing interest
            
            
            (2,067
            )Present
                value of net minimum lease payments
            
            
            25,560Less
                amounts due in one year
            
            
            (25,560
            )Amounts
                due after one year
            
            $
            –




40
 *Table
          of Contents*




*Other
      Commitments and Contingencies*





On
      May 2,
      2007, Medical entered into a lease for its new production facility with Energy
      Northwest, the owner of the Applied Process Engineering Laboratory (the APEL
      lease). The
      APEL
      lease has a three-year term expiring on April 30, 2010, an option to renew
      for
      two additional three-year terms, and original monthly rent of approximately
      $26,700, subject to annual increases based on the Consumer Price Index, plus
      monthly janitorial expenses of approximately $700. This new facility became
      operational in September 2007.





Future
      minimum lease payments under operating leases, including the two three-year
      renewals of the APEL lease, are as follows:





Year
                ending June 30,2009
            
            $
            315,0272010
            
            
            314,8842011
            
            
            310,7822012
            
            
            299,5402013
            
            
            297,015Thereafter
            
            
            841,541$
            2,378,789





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





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 new
      production facility. This asset retirement obligation will be for obligations
      to
      remove any residual radioactive materials and to remove all leasehold
      improvements.





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





The
      Company has no off-balance sheet arrangements.





**Inflation**





Management
      does not believe that the current levels of inflation in the United States
      have
      had a significant impact on the operations of the Company. If current levels
      of
      inflation hold steady, management does not believe future operations will be
      negatively impacted.




41
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          of Contents*




**New
      Accounting Standards**





In
      December 2007, FASB issued SFAS No. 141(R), *Business
      Combinations* (“SFAS 141R”), which replaces SFAS No. 141, *Business
      Combinations* (“SFAS 141”).
      SFAS 141R applies to all transactions and other events in which one entity
      obtains control over one or more other businesses. The standard requires the
      fair value of the purchase price, including the issuance of equity securities,
      to be determined on the acquisition date. SFAS 141R requires an acquirer to
      recognize the assets acquired, the liabilities assumed, and any noncontrolling
      interests in the acquiree at the acquisition date, measured at their fair values
      as of that date, with limited exceptions specified in the statement.
      SFAS 141R requires acquisition costs to be expensed as incurred and
      restructuring costs to be expensed in periods after the acquisition date.
      Earn-outs and other forms of contingent consideration are to be recorded at
      fair
      value on the acquisition date. Changes in accounting for deferred tax asset
      valuation allowances and acquired income tax uncertainties after the measurement
      period will be recognized in earnings rather than as an adjustment to the cost
      of the acquisition. SFAS 141R generally applies prospectively to business
      combinations for which the acquisition date is on or after the beginning of
      the
      first annual reporting period beginning on or after December 15, 2008 with
      early adoption prohibited. The implementation of this standard did not have
      a
      material impact on the Company’s consolidated financial position or results of
      operations.





In
      December 2007, the FASB issued statement No. 160, *Noncontrolling
      Interests in Consolidated Financial Statements – an amendment of ARB No.
      51* (SFAS
      160). The statement requires noncontrolling interests or minority interests
      to
      be treated as a separate component of equity, not as a liability or other item
      outside of permanent equity. Upon a loss of control, the interest sold, as
      well
      as any interest retained, is required to be measured at fair value, with any
      gain or loss recognized in earnings. Based on SFAS 160, assets and liablities
      will not change for subsequent purchase of sales transactions with
      noncontrolling interests as long as control is maintained. Differences between
      the fair value of consideration paid or received and the carrying value of
      noncontrolling interests are to be recognized as an adjustment to the parent
      interest’s equity. SFAS 160 is effective for fiscal years beginning on or after
      December 15, 2008 and earlier adoption is prohibited. The Company is currently
      evaluating the impact that the implementation of SFAS 160 will have with respect
      to the Company’s interest in UralDial.





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.





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.





**ITEM
      7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





As
      a
      smaller reporting company, the Company is not required to provide Item 7A
      disclosure in this Annual Report.





**ITEM
      8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY
      DATA**





The
      required accompanying financial statements begin on page F-1 of this
      document.




**ITEM
      9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE**





There
      were no disagreements or reportable events with DeCoria, Maichel & Teague,
      P.S.




42
 *Table
          of Contents*




**ITEM
      9A – CONTROLS AND PROCEDURES**





**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 June 30, 2008. Based on that evaluation, our principal executive
      officer and our principal financial officer concluded that the design and
      operation of our disclosure controls and procedures were effective in timely
      alerting them to material information required to be included in the Company's
      periodic reports filed with the SEC under the Exchange Act. The design of any
      system of controls is based in part upon certain assumptions about the
      likelihood of future events, and there can be no assurance that any design
      will
      succeed in achieving its stated goals under all potential future conditions,
      regardless of how remote. However, management believes that our system of
      disclosure controls and procedures is designed to provide a reasonable level
      of
      assurance that the objectives of the system will be met.





**Management’s
      Report on Internal Control over Financial Reporting**





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Rule 13a-15(f)
      of
      the Exchange Act. 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 effectiveness of our internal control
      over financial reporting based on the framework in *Internal
      Control – Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission. Based
      on our evaluation under the framework in *Internal
      Control – Integrated Framework* ,
      our
      management concluded that our internal control over financial reporting was
      effective as of June 30, 2008.





This
      annual report does not include an attestation report of our registered public
      accounting firm regarding internal control over financial reporting.
      Management’s report was not subject to attestation by our registered public
      accounting firm pursuant to temporary rules of the Securities and Exchange
      Commission that permit us to provide only management’s report in this annual
      report.





**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.





**Limitations
      on the Effectiveness of Controls**





Our
      management, including our principal executive officer and principal financial
      officer, does not expect that our disclosure controls and internal controls
      will
      prevent all errors and all fraud. A control system, no matter how well conceived
      and operated, can provide only reasonable, not absolute, assurance that the
      objectives of the control system are met. Further, the design of a control
      system must reflect the fact that there are resource constraints, and the
      benefits of controls must be considered relative to their costs. Because of
      the
      inherent limitations in all control systems, no evaluation of controls can
      provide absolute assurance that all control issues and instances of fraud,
      if
      any, within the Company have been detected. These inherent limitations include
      the realities that judgments in decision making can be faulty, and that
      breakdowns can occur because of a simple error or mistake. Additionally,
      controls can be circumvented by the individual acts of some persons, by
      collusion of two or more people, or by management or board override of the
      control.




43
 *Table
          of Contents*


The
      design of any system of controls also 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; over time, controls may become inadequate because of changes in
      conditions, or the degree of compliance with the policies or procedures may
      deteriorate. Because of the inherent limitations in a cost-effective control
      system, misstatements due to error or fraud may occur and not be
      detected.





**ITEM
      9B – OTHER INFORMATION**





There
      were no items required to be disclosed in a report on Form 8-K during the fourth
      quarter of the fiscal year ended June 30, 2008 that have not been already
      disclosed on a Form 8-K filed with the SEC.





**PART
      III**




**ITEM
      10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**





Each
      member of the Board of Directors serves a one-year term and is subject to
      reelection at the Company’s Annual Meeting of Shareholders held each
      year.





*Board
      Committees*





The
      Board
      has established an Audit Committee consisting of Thomas LaVoy (Chairman), Robert
      Kauffman, and Albert Smith; a Compensation Committee consisting of Albert Smith
      (Chairman) and Robert Kauffman; and a Nominating Committee consisting of Robert
      Kauffman (Chairman), Thomas LaVoy, and Albert Smith. No other committees have
      been formed.





*Audit
      Committee*





The
      Audit
      Committee was established on December 8, 2006, the date on which its Charter
      was
      adopted. The Audit Committee Charter lists the purposes of the Audit Committee
      as overseeing the accounting and financial reporting processes of the Company
      and audits of the financial statements of the Company and providing assistance
      to the Board of Directors in monitoring (1) the integrity of the Company’s
      financial statements, (2) the Company’s compliance with legal and regulatory
      requirements, (3) the independent auditor’s qualifications and independence, and
      (4) the performance of the Company’s internal audit function, if any, and
      independent auditor.





The
      Board
      of Directors has determined that Mr. LaVoy and Mr. Kauffman are each
      an “audit committee financial expert” as defined in Item 407(d)(5) of Regulation
      S-K promulgated by the Securities and Exchange Commission, and each Audit
      Committee member is independent. The Board’s conclusions regarding the
      qualifications of Mr. LaVoy as an audit committee financial expert were
      based on his service as a chief financial officer of a public company, his
      experience as a certified public accountant and his degree in accounting. The
      Board’s conclusions regarding the qualifications of Mr. Kauffman as an
      audit committee financial expert were based on his service as a chief executive
      officer of multiple public companies, his active supervision of the principal
      financial and accounting officers of the public companies for which he served
      as
      chief executive officer, and his M.B.A. in Finance.





*Executive
      Officers and Directors*





The
      executive officers and directors serving the Company as of June 30, 2008 were
      as
      follows:





Name
            
            Age
            
            Position
                Held
            
            Term*Dwight
                Babcock
            
            60
            
            Chairman,
                Interim Chief Executive Officer
            
            AnnualJonathan
                Hunt
            
            41
            
            Chief
                Financial Officer, TreasurerLori
                Woods
            
            46
            
            Acting
                Chief Operating OfficerRobert
                Kauffman
            
            67
            
            Vice-Chairman
            
            AnnualThomas
                LaVoy
            
            48
            
            Director
            
            AnnualAlbert
                Smith
            
            64
            
            Director
            
            Annual




*
        For
        directors only




44
 *Table
          of Contents*




Dwight
      Babcock – Mr. Babcock was appointed Chairman and Interim CEO of the Company on
      February 26, 2008 and has served as a Director of the Company since 2006. Mr.
      Babcock has served as Chairman and Chief Executive Officer of Apex Data Systems,
      Inc. an information technology company, since 1975. Apex Data Systems automates
      the administration and claims adjudication needs of insurance companies both
      nationally and internationally. Mr. Babcock was formerly President and CEO
      of
      Babcock Insurance Corporation (BIC) from 1974 until 1985. BIC was a nationally
      recognized third party administrator operating within 35 states. Mr. Babcock
      has
      knowledge and experience in the equity arena and has participated in various
      activities within the venture capital, private and institutional capital
      markets. Mr. Babcock studied marketing and economics at the University of
      Arizona where he currently serves on the University of Arizona Astronomy
      Board.





Jonathan
      Hunt – Mr. Hunt has over 15 years of finance and accounting experience,
      including financial reporting, SEC knowledge, and operational analysis. Before
      joining IsoRay in 2006, he was employed by Hypercom Corporation, a global
      provider of electronic payment solutions and manufacturer of credit card
      terminals, serving as its Assistant Corporate Controller from 2005 to 2006.
      His
      finance background also includes serving as both a Manager and Director of
      Financial Reporting and a Director of Operational Planning and Analysis for
      Circle K Corporation and its affiliates from 2000 to 2005 and working for
      PricewaterhouseCoopers LLP from 1992 to 1999 where his last position held was
      Business Assurance Manager. Mr. Hunt holds Masters of Accountancy and Bachelor
      of Science degrees from Brigham Young University and is a Certified Public
      Accountant.





Lori
      Woods – Ms. Woods joined the Company in July 2006 and was appointed Acting Chief
      Operating Officer on February 26, 2008. Ms. Woods has over 20 years experience
      in medical device technology and healthcare services. Ms. Woods served as the
      CEO of Pro-Qura, a medical services company focusing on brachytherapy quality
      assurance and education, from 2002 until joining the Company. During her tenure
      at Pro-Qura, Ms. Woods developed its business strategy, expanded its business
      portfolio in quality assurance beyond prostate brachytherapy into other areas
      of
      cancer, and increased funding by 50%. Prior to this, she served as the Vice
      President of Sales at ATI Medical in 2002, Vice President of Sales – West and
      Vice President of Marketing and Business Development for Imagyn Medical
      Technologies from 2000 to 2002, Director of Business Development for Seattle
      Prostate Institute from 1998 to 2000, and Regional Vice President and Regional
      Manager of Interdent from 1994 to 1998. Ms. Woods holds a Bachelor of Science
      degree in Business Administration – Marketing from Loma Linda
      University.





Robert
      Kauffman – Mr. Kauffman has been a Director of the Company since 2005 and was
      appointed Vice-Chairman of the Company on February 26, 2008. Mr. Kauffman
      has served as Chief Executive Officer and Chairman of the Board of Alanco
      Technologies, Inc. (NASDAQ: ALAN), an Arizona-based information technology
      company, since July 1, 1998. Mr. Kauffman was formerly President and Chief
      Executive Officer of NASDAQ-listed Photocomm, Inc., from 1988 until 1997 (since
      renamed Kyocera Solar, Inc.). Photocomm was the nation’s largest publicly owned
      manufacturer and marketer of wireless solar electric power systems with annual
      revenues in excess of $35 million. Prior to Photocomm, Mr. Kauffman was a
      senior executive of the Atlantic Richfield Company (ARCO) whose varied
      responsibilities included Senior Vice President of ARCO Solar, Inc., President
      of ARCO Plastics Company and Vice President of ARCO Chemical Company.
      Mr. Kauffman earned an M.B.A. in Finance at the Wharton School of the
      University of Pennsylvania, and holds a B.S. in Chemical Engineering from
      Lafayette College, Easton, Pennsylvania.




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Thomas
      LaVoy – Mr. LaVoy has been a Director of the Company since 2005. Mr. LaVoy has
      served as Chief Financial Officer of SuperShuttle International, Inc., since
      July 1997 and as Secretary since March 1998. SuperShuttle is one of the largest
      providers of shuttle services in major cities throughout the West and Southwest
      regions of the United States. He has also served as a director of Alanco
      Technologies, Inc. (NASDAQ: ALAN) since 1998. From September 1987 to February
      1997, Mr. LaVoy served as Chief Financial Officer of NASDAQ-listed Photocomm,
      Inc. Mr. LaVoy was a Certified Public Accountant with the firm of KPMG Peat
      Marwick from 1980 to 1983. Mr. LaVoy has a Bachelor of Science degree in
      Accounting from St. Cloud University, Minnesota, and is a Certified Public
      Accountant.





Albert
      Smith – Mr. Smith has been a Director of the Company since 2006. Mr. Smith was
      the co-founder of and served as Vice Chairman of CSI Leasing, Inc., a private
      computer leasing company from 1972 until March 2005. He founded Extreme Video
      Solutions, LLC, a private video conferencing company with headquarters in
      Scottsdale, Arizona in December 2005. In January 2008, he formed Face to Face
      Live, Inc. where he presently serves as CEO. Mr. Smith presently serves as
      Chairman of the Board for Doulos Ministries, Inc. Mr. Smith has extensive
      experience in marketing and sales having managed a national sales force of
      over
      fifty people while at CSI Leasing, Inc. Mr. Smith holds a BS in Business
      Administration from Ferris State College.





The
      Company’s directors, as named above, will serve until the next annual meeting of
      the Company’s shareholders or until their successors are duly elected and have
      qualified. Directors will be elected for one-year terms at the annual
      shareholders meeting. There is no arrangement or understanding between any
      of
      the directors or officers of the Company and any other person pursuant to which
      any director or officer was or is to be selected as a director or officer,
      and
      there is no arrangement, plan or understanding as to whether non-management
      shareholders will exercise their voting rights to continue to elect the current
      directors to the Company’s board. There are also no arrangements, agreements or
      understandings between non-management shareholders that may directly or
      indirectly participate in or influence the management of the Company’s
      affairs.





There
      are
      no agreements or understandings for any officer or director to resign at the
      request of another person, and none of the officers or directors are acting
      on
      behalf of, or will act at the direction of, any other person. There are no
      family relationships among our executive officers and directors.





*Significant
      Employees*





Certain
      significant employees of our subsidiary, IsoRay Medical, Inc., and their
      respective ages as of the date of this report are set forth in the table below.
      Also provided is a brief description of the experience of each significant
      employee during the past five years.





Name
            
            Age
            
            Position
                Held and TenureFredric
                Swindler
            
            60
            
            VP,
                Regulatory Affairs and Quality AssuranceLane
                Bray
            
            80
            
            ChemistOleg
                Egorov
            
            38
            
            Director
                of Research and Development





Fredric
      Swindler – Mr. Swindler joined the Company in October 2006 and has over 30 years
      experience in manufacturing and regulatory compliance. Mr. Swindler served
      as
      VP, Quality Assurance and Regulatory Affairs for Medisystems Corporation, a
      manufacturer and distributor of medical devices, from 1994 until joining the
      Company. During his tenure at Medisystems Corporation, Mr. Swindler developed
      a
      quality system to accommodate vertically integrated manufacturing, developed
      regulatory strategies, policies and procedures, and submitted nine pre-market
      notifications (510(k)) to the FDA. Prior to this, Mr. Swindler held various
      positions with Marquest Medical Products from 1989 to 1994, Sherwood Medical
      Products from 1978 to 1989, Oak Park Pharmaceuticals in 1978, and Mead Johnson
      & Company from 1969 to 1978. Mr. Swindler holds a Bachelor of Science degree
      in Biomedical Engineering from Rose Hulman Institute of Technology and a Masters
      of Business Administration from the University of Evansville.




46
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Lane
      Bray
– Mr. Bray is known nationally and internationally as a technical expert in
      separations, recovery, and purification of isotopes and is a noted authority
      in
      the use of cesium and strontium ion exchange for Department of Energy’s West
      Valley and Hanford nuclear waste cleanup efforts. In 2000, Mr. Bray
      received the ’Radiation Science and Technology’ award from the American Nuclear
      Society. Mr. Bray has authored or co-authored over 110 research
      publications, 12 articles for nine technical books, and holds 24 U.S. and
      foreign patents. Mr. Bray patented the USDOE/PNNL process for purifying
      medical grade Yttrium-90 that was successfully commercialized in 1999.
      Mr. Bray also invented and patented the proprietary isotope separation and
      purification process that is assigned to IsoRay. Mr. Bray was elected
‘Tri-Citian of the Year’ in 1988, nominated for ‘Engineer of the Year’ by the
      American Nuclear Society in 1995, and was elected ‘Chemist of the Year for 1997’
by the American Chemical Society, Eastern Washington Section. Mr. Bray
      retired from the Pacific Northwest National Laboratory in 1998. Since retiring
      in 1998, Mr. Bray worked part time for PNNL on special projects until
      devoting all of his efforts to IsoRay in 2004. Mr. Bray has been a
      Washington State Legislator, a Richland City Councilman, and a Mayor of
      Richland. Mr. Bray has a B.A. in Chemistry from Lake Forest
      College.





Oleg
      Egorov – Dr. Egorov is recognized nationally and internationally for his work in
      radiochemistry, radioanalytical chemistry, analytical chemistry and
      instrumentation. Prior to joining IsoRay in December of 2005 as Director of
      Radiochemical Development and then Director of Research and Development, Dr.
      Egorov worked from May 1998 as a Senior Research Scientist at the Pacific
      Northwest National Laboratory (PNNL). Prior to that time, he served the
      Environmental Molecular Sciences Laboratory at PNNL as a Graduate Research
      Fellow from August 1994 to May 1998 and as a Graduate Research Assistant to
      the
      University of Washington’s Center for Process Analytical Chemistry from
      September 1992 to August 1993. Former positions included a tenure as a Research
      Engineer at the Department of Radiochemistry at the Moscow State University,
      Moscow, Russia between September 1998 to August 1992, and Field Chemist at
      the
      Institute of Volcanology, at the Russian Academy of Science at
      Petropavlovsk-Kamchatsky, Russia, during the summers of 1989 and 1990 concurrent
      to studies that lead to his acquisition of Master of Science in Radiochemistry
      from the Moscow State University. During his tenure at PNNL, Dr. Egorov had
      led
      world-class basic and applied R&D programs directed at new chemistries and
      instrumentation for automated production of short-lived medical isotopes for
      the
      treatment of cancer, automated process monitoring, radionuclide sensors for
      groundwater monitoring, and laboratory automation. Dr. Egorov pioneered the
      application of flow-based techniques for automating radiochemical analyses
      of
      nuclear wastes, renewable surface sensing and separations, and
      equilibration-based radionuclide sensing. He has authored/co-authored numerous
      peer-reviewed publications in these areas, including several book chapters.
      Dr.
      Egorov holds four U.S./international patents, three of which have been licensed
      to industry. Dr. Egorov has been a recipient of numerous outstanding performance
      and key contributor awards. In 2003, Dr. Egorov was nominated for the American
      Chemical Society Arthur F. Findeis Award for Achievements by a Young Analytical
      Scientist. In 2004, Dr. Egorov was a recipient of a Federal Laboratory
      Consortium Award for Excellence in Technology Transfer for “Alpha Particle
      Immunotherapy for Treating Leukemia and Solid-Tumor Metastases”. Dr. Egorov
      holds a M.S. in Radiochemistry from Moscow State University, Moscow, Russia;
      a
      M.S. in Environmental and Analytical Chemistry; and a Ph.D. in Analytical
      Chemistry from the University of Washington.





Section
      16(a) Beneficial Ownership Reporting Compliance





Section
      16(a) of the Securities Exchange Act of 1934 (the Exchange Act) requires the
      Company’s directors and executive officers, and persons who beneficially own
      more than ten percent of a registered class of our equity securities, to file
      with the Securities and Exchange Commission (the Commission) initial reports
      of
      beneficial ownership and reports of changes in beneficial ownership of our
      Common Stock. The rules promulgated by the Commission under Section 16(a) of
      the
      Exchange Act require those persons to furnish us with copies of all reports
      filed with the Commission pursuant to Section 16(a). The information in this
      section is based solely upon a review of Forms 3, Forms 4, and Forms 5 received
      by us.





We
      believe that IsoRay’s executive officers, directors and 10% shareholders timely
      complied with their filing requirements during the year ended June 30, 2008
      except as follows: Albert Smith (two Form 4s) and Dwight Babcock (one Form
      4).
      We believe all of these forms have been filed as of the date of this
      Report.




47
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Code
      of Ethics





We
      have
      adopted a Code of Conduct and Ethics that applies to all of our officers,
      directors and employees and a separate Code of Ethics for Chief Executive
      Officer and Senior Financial Officers that supplements our Code of Conduct
      and
      Ethics. The Code of Conduct and Ethics was previously filed as Exhibit 14.1
      to
      our Form 10-KSB for the period ended June 30, 2006, and the Code of Ethics
      for
      Chief Executive Officer and Senior Financial Officers was previously filed
      as
      Exhibit 14.2 to this same report. The Code of Ethics for Chief Executive Officer
      and Senior Financial Officers is also available to the public on our website
      at
      http://www.isoray.com/ethicsForCeo.htm. Each of these policies comprises written
      standards that are reasonably designed to deter wrongdoing and to promote the
      behavior described in Item 406 of Regulation S-K promulgated by the Securities
      and Exchange Commission.





Nominating
      Procedures





There
      have been no material changes to the procedures by which our shareholders may
      recommend nominees to the Board of Directors during our last fiscal
      year.





**ITEM
      11 – EXECUTIVE COMPENSATION**





The
      following summary compensation table sets forth information concerning
      compensation for services rendered in all capacities during our past two fiscal
      years awarded to, earned by or paid to each of the following individuals. Salary
      and other compensation for these officers, employees and former officers are
      set
      by the Compensation Committee of the Board of Directors, except for employee
      compensation which is set by officers of the Company.




**Summary
                  Compensation Table**Name
                  and principal position
              Year
              Salary
                ($)
              Bonus
                ($)
              Stock
                  awards
                ($)
              Option
                  awards
                ($)
                  (1)
              Nonequity
                  incentive plan compensation ($)
              Nonqualified
                  deferred compensation earnings
                ($)
              All
                  other compensation ($)
              Total
                ($)Dwight
                  Babcock, Chairman
              2008
              22,000
              —
              —
              70,000
              —
              —
              —
              92,000and
                Interim CEO (2)
              2007
              —
              —
              —
              —
              —
              —
              —
              —Roger
                  Girard, former Chairman
              2008
              204,231
              —
              —
              —
              —
              —
              250,000
              454,231and
                CEO (3) (4)
              2007
              298,042
              —
              —
              600,500
              —
              —
              —
              898,542David
                  Swanberg, former Executive
              2008
              179,615
              50,000
              —
              —
              —
              —
              25,962
              255,577Vice
                  President - Operations (3) (5)
              2007
              161,539
              —
              —
              372,228
              —
              —
              —
              533,767(6)Lori
                  Woods, Vice President (7)
              2008
              179,615
              —
              —
              —
              —
              —
              —
              179,6152007
              155,692
              —
              —
              327,150
              —
              —
              —
              482,842Fred
                  Swindler, VP - Regulatory
              2008
              159,808
              —
              —
              —
              —
              —
              —
              159,808Affairs
                and Quality Assurance (8)
              2007
              109,615
              —
              —
              57,200
              —
              —
              9,973
              176,788Robert
                  Bilella, Territory
              2008
              117,283
              121,150
              —
              —
              —
              —
              —
              238,433Sales
                Manager
              2007
              131,557
              78,927
              —
              —
              —
              —
              —
              210,484




(1)
            Amounts
                represent the FAS 123R valuation for the fiscal years ended June
                30, 2008
                and 2007, respectively. All such options were awarded under one of
                the
                Company’s stock option plans. All options awarded (with the exception of
                Mr. Babcock’s fiscal year 2008 stock option grant that was immediately
                vested on the grant date) vest in three equal annual installments
                beginning with the first anniversary from the date of grant and expire
                ten
                years after the date of grant. All options were granted at the fair
                market
                value of the Company’s stock on the date of grant and the Company used a
                Black-Scholes methodology as discussed in the footnotes to the financial
                statements to value the options.


(2)
            Mr.
                Babcock became the Chairman and Interim CEO on February 26, 2008.
                He is
                serving as Interim CEO on a contract basis. Mr. Babcock also received
                compensation as a Director of the Company during fiscal year 2008
                which is
                disclosed in the Non-Employee Director Compensation
                table.






48
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(3)
            Mr.
                Girard and Mr. Swanberg were granted 150,000 and 100,000 options,
                respectively, on June 1, 2007. These options have an exercise price
                of
                $4.14 and vest over three years. On July 25, 2007, the Board discussed
                the
                issue of director compensation and each director (including Mr. Girard
                and
                Mr. Swanberg) elected to cancel 50,000 of their options from the
                June 1,
                2007 grant. After the cancellation, Mr. Girard and Mr. Swanberg had
                100,000 and 50,000 options, respectively, from the June 1, 2007 grant.
                The
                terms of these options were not changed as part of the cancellation.
                Under
                FAS 123R, the value of the cancelled options to Mr. Girard and Mr.
                Swanberg were $128,500 each. The value of these options has been
                included
                in the table above in fiscal year
                2007.


(4)
            On
                February 26, 2008, Mr. Girard resigned from all positions held with
                the
                Company and its subsidiaries, including resigning from Board service.
                In
                connection with Mr. Girard’s resignation, the Company made a one time
                payment to Mr. Girard of $250,000 and this amount is included in
                the “All
                other compensation” column.


(5)
            The
                value of Mr. Swanberg’s options includes $7,728 relating to options
                granted to his wife who was an employee of the Company at the time
                of the
                grant.


(6)
            Mr.
                Swanberg resigned from the Company on June 11, 2008. In connection
                with
                Mr. Swanberg’s resignation, the Company agreed to continue paying Mr.
                Swanberg his salary for an additional six months subject to the conditions
                of his agreement. These amounts have not been included in this table
                as
                the amounts had not been paid as of June 30, 2008. In addition, Mr.
                Swanberg was paid the balance of his vacation in a lump sum and this
                amount is included in the “All other compensation”
                column.


(7)
            Ms.
                Woods became an employee of the Company in July
                2006.


(8)
            Mr.
                Swindler became an employee of the Company in October 2006. The Company
                reimbursed Mr. Swindler for certain of his relocation costs and this
                amount is included in the “All other compensation” column for fiscal year
                2007.





Ms.
      Woods
      has an employment contract with the Company dated February 14, 2007. The
      agreement is for an initial term of two years but will be automatically extended
      for an additional year on each anniversary date unless terminated in accordance
      with the provisions of the agreement. The agreement entitles Ms. Woods to a
      salary of at least $160,000 with increases as determined by the Compensation
      Committee of the Board and annual bonus payments under a bonus plan as
      established by the Compensation Committee. In the event that Ms. Woods is
      terminated without cause, becomes disabled, or terminates her employment for
      good reason, she will be entitled to her salary and benefits for the remaining
      term of the agreement or 18 months, whichever is shorter. Good reason is defined
      in the agreement to mean a reduction of salary or benefits, a change in Ms.
      Woods’ title, position, authority, or responsibilities, causing Ms. Woods to
      relocate, or any breach by the Company of this agreement. If Ms. Woods is
      terminated within one year of a change of control then she shall be entitled
      to
      her salary and benefits for the remaining term of the agreement or 18 months,
      whichever is longer, in addition to a one-time payment equal to her most
      recently received bonus. In the event of Ms. Woods’ termination without cause or
      termination within one year of a change of control, all of her unvested stock
      options shall immediately vest in full and shall be exercisable as provided
      in
      the applicable stock option plan. The agreement also includes certain
      restrictive covenants that prohibit Ms. Woods from providing services to a
      competing business for the period of this agreement plus one year.




49
 *Table
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**Outstanding
                  Equity Awards at Fiscal Year-End**Option
                  awardsName
              Number
                  of securities underlying unexercised options
                (#)
                  exercisable
              Number
                  of securities underlying unexercised options
                (#)
                  unexercisable
              
              Equity
                  incentive plan awards: Number of securities underlying unexercised
                  unearned options
                (#)
              Option
                  exercise price
                ($)
              Option
                  expiration dateDwight
                  Babcock, Chairman and Interim CEO
              50,000
              —
              
              —
              6.30
              3/31/201650,000
              —
              
              —
              3.80
              6/23/201650,000
              —
              
              —
              3.11
              8/15/2016100,000
              —
              
              —
              0.75
              5/13/2018Roger
                  Girard, former Chairman and CEO
              513,840
              —
              
              —
              1.19
              5/31/200933,333
              —
              
              —
              3.11
              5/31/2009David
                  Swanberg, former Executive Vice President - Operations
              150,000
              —
              
              —
              1.00
              8/18/201516,666
              —
              
              —
              3.11
              8/15/201616,666
              —
              
              —
              4.14
              6/1/2017Lori
                  Woods, Vice President
              16,666
              33,334
              (1)
              —
              3.50
              7/5/201616,666
              33,334
              (2)
              —
              3.10
              10/17/20165,000
              15,000
              (3)
              —
              4.40
              3/2/20176,666
              13,334
              (4)
              —
              4.14
              6/1/2017Fred
                  Swindler, VP - Regulatory Affairs and Quality Assurance
              3,333
              6,667
              (3)
              —
              4.40
              3/2/20173,333
              6,667
              (4)
              —
              4.14
              6/1/2017Robert
                  Bilella, Territory Sales Manager
              84,236
              —
              
              —
              4.15
              6/23/2015




(1)
              Represents
                  a July 5, 2006 grant, one-third of which became exercisable on
                  July 1,
                  2007, one-third of which will become exercisable on July 1, 2008,
                  and the
                  final third will become exercisable on July 1,
                  2009.
 (2)
              Represents
                  the October 17, 2006 grant, one-third of which became exercisable
                  on
                  October 17, 2007, one-third of which will become exercisable on
                  October
                  17, 2008, and the final third will become exercisable on October
                  17,
                  2009.
 (3)
              Represents
                  the March 2, 2007 grant, one-third of which became exercisable
                  on March 2,
                  2008, one-third of which will become exercisable on March 2, 2009,
                  and the
                  final third will become exercisable on March 2,
                  2010.
 (4)
              Represents
                  the June 1, 2007 grant, one-third of which became exercisable on
                  June 1,
                  2008, one-third of which will become exercisable on June 1, 2009,
                  and the
                  final third will become exercisable on June 1,
                  2010.
 
 The
        Company has a 401(k) plan that covers all eligible full-time employees of
        the
        Company. Contributions to the 401(k) plan are made by participants to their
        individual accounts through payroll withholding. Additionally, the 401(k)
        plan
        provides for the Company to make contributions to the 401(k) plan in amounts
        at
        the discretion of management. The Company has not made any contributions
        to the
        401(k) plan and does not maintain any other retirement plans for its executives
        or employees.
  50
 *Table
            of Contents*
   **Non-Employee
                    Director Compensation**Name
                Fees
                    earned or paid in cash
                  ($)
                Stock
                    awards
                  ($)
                Option
                    awards
                  ($)
                Non-equity
                    incentive plan compensation
                  ($)
                Non-qualified
                    deferred compensation earnings
                  ($)
                All
                    other compensation
                  ($)
                Total
                  ($)Dwight
                    Babcock
                52,000
                —
                —
                —
                —
                —
                52,000Stephen
                    Boatwright
                11,500
                —
                —
                —
                —
                —
                11,500Robert
                    Kauffman
                48,000
                —
                —
                —
                —
                —
                48,000Thomas
                    LaVoy
                43,500
                —
                —
                —
                —
                —
                43,500Albert
                    Smith
                39,500
                —
                —
                —
                —
                —
                39,500
  Beginning
        in fiscal year 2008, each non-employee director received cash compensation
        of
        $3,000 per month, except for Mr. Boatwright who received $1,000 per month
        until
        his resignation in February 2008. In addition, each non-employee director
        received $1,000 per Board meeting attended in person or $500 per Board meeting
        attended via telephone and $500 per committee meeting attended. Beginning
        in
        March 2008, Mr. Babcock began receiving an additional $3,000 per month for
        serving as Chairman, Mr. Kauffman began receiving an additional $2,000 per
        month
        for serving as Vice-Chairman, and Mr. LaVoy began receiving an additional
        $1,000
        per month for serving as Audit Committee Chairman.
 
 Each
        director had stock options to purchase 150,000 shares of the Company’s common
        stock outstanding as of June 30, 2008, except for Mr. Babcock who was granted
        options to purchase an additional 100,000 shares of the Company’s common stock
        on May 13, 2008 for serving as Interim CEO. This grant of 100,000 shares
        is
        noted in the executives’ Outstanding Equity Awards at Fiscal Year-End table
        above.
 
 *Compensation
        Committee Interlocks and Insider Participation*
  As
        a
        smaller reporting company, the Company is not required to provide this
        disclosure.
 
 *Compensation
        Committee Report*
 
 As
        a
        smaller reporting company, the Company is not required to provide this
        disclosure.
 
 **ITEM
        12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
        MANAGEMENT AND RELATED STOCKHOLDER MATTERS**
  The
        following tables set forth certain information regarding the beneficial
        ownership of the Company’s common stock and preferred stock as of September 16,
        2008 for (a) each person known by the Company to be a beneficial owner of
        five
        percent or more of the outstanding common or preferred stock of the Company,
        (b)
        each executive officer, director and nominee for director of the Company,
        and
        (c) directors and executive officers of the Company as a group. As of September
        16, 2008, the Company had 22,942,088 shares of common stock and 59,065 shares
        of
        preferred stock outstanding.
  51
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            of Contents*
   **Common
                    Stock Share Ownership**Name
                    of Beneficial Owner
                Common
                  Shares
                    Owned
                Common
                    Stock Options Exercisable Within 60 Days
                Common
                  Warrants
                Percentof
                  Class
                    (1)Dwight
                    Babcock (2)
                66,002
                250,000
                12,500
                1.42%Roger
                    Girard
                222,922
                547,173
                —
                3.28%David
                    Swanberg (3)
                343,627
                196,665
                5,500
                2.36%Lori
                    Woods
                8,000
                78,332
                —
                —%Jonathan
                    Hunt
                —
                64,999
                —
                —%Robert
                    Kauffman
                63,802
                150,000
                —
                —%Thomas
                    LaVoy
                8,423
                150,000
                —
                —%Albert
                    Smith
                122,147
                150,000
                —
                1.18%Directors
                    and Executive Officers as a group
                268,374
                843,331
                12,500
                4.72%
  (1)
              Percentage
                  ownership is based on 22,942,088 shares of Common Stock outstanding
                  on
                  September 16, 2008. Shares of Common Stock subject to stock options
                  which
                  are currently exercisable or will become exercisable within 60
                  days after
                  September 16, 2008 are deemed outstanding for computing the percentage
                  ownership of the person or group holding such options, but are
                  not deemed
                  outstanding for computing the percentage ownership of any other
                  person or
                  group.
 (2)
              Mr.
                  Babcock’s common shares owned include 2,695 shares owned by his
                  spouse.
 (3)
              Mr.
                  Swanberg’s options include 13,333 options granted to his
                  spouse.
   **Preferred
                    Stock Share Ownership**Name
                    of Beneficial Owner
                Preferred
                  Shares
                    Owned
                Percent
                    of
                  Class
                    (1)Aissata
                    Sidibe (2)
                20,000
                33.86%William
                    and Karen Thompson Trust (3)
                14,218
                24.07%Jamie
                    Granger (4)
                10,529
                17.83%Hostetler
                    Living Trust (5)
                9,479
                16.05%Leslie
                    Fernandez (6)
                3,688
                6.24%
  (1)
              Percentage
                  ownership is based on 59,065 shares of Preferred Stock outstanding
                  on
                  September 16, 2008.
 (2)
              The
                  address of Ms. Sidibe is 229 Lasiandra Ct, Richland, WA
                  99352.
 (3)
              The
                  address of the William and Karen Thompson Trust is 285 Dondero
                  Way, San
                  Jose, CA 95119.
 (4)
              The
                  address of Jamie Granger is 53709 South Nine Canyon Road, Kennewick,
                  WA
                  99337.
 (5)
              The
                  address of the Hostetler Living Trust is 9257 NE 175th Street,
                  Bothell, WA
                  98011.
 (6)
              The
                  address of Leslie Fernandez is 2615 Scottsdale Place, Richland,
                  WA
                  99352.
 
 No
        officers or directors beneficially own shares of Preferred Stock.
 
 **ITEM
        13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
        DIRECTOR INDEPENDENCE**
 
 IsoRay
        Medical, Inc.’s patent rights to its Cs-131 process were acquired from Lane
        Bray, a shareholder and employee of the Company, and are subject to a 1%
        royalty
        on gross profits and certain contractual restrictions. Pursuant to the royalty
        agreement, the Company must also pay a royalty of 2% of Gross Sales, as defined,
        for any sub-assignments of the aforesaid patented process to any third parties.
        The royalty agreement will remain in force until the expiration of the patents
        on the assigned technology, unless earlier terminated in accordance with
        the
        terms of the underlying agreement. During fiscal year 2007, the Company achieved
        its first gross margin and began making quarterly payments to Mr. Bray as
        outlined in the royalty agreement. The Company recorded royalty expense of
        $21,219 and $2,161 for the years ended June 30, 2008 and 2007, respectively,
        related to these payments.
  52
 *Table
            of Contents*
 Roger
        Girard, the Company’s former Chairman and CEO, had personally guaranteed $20,000
        of the BFEDD loan, which was funded in December 2004. In exchange for his
        personal guaranty, Mr. Girard received 5,728 shares of common stock. As a
        condition of his resignation in February 2008, the Company prepaid $20,000
        on
        the BFEDD loan and obtained Mr. Girard’s release and Mr. Girard in turn
        surrendered the 5,728 shares to the Company. As part of his settlement, Mr.
        Girard also surrendered 30,072 shares of common stock he had received in
        2004
        for personally guaranteeing a portion of a line of credit for the
        Company.
 
 Mr.
        Girard and David Swanberg, the Company’s former Executive VP – Operations,
        personally guaranteed a portion of the HAEIFC loan. As part of their
        resignations, the Company obtained their releases from these personal guarantees
        by prepaying $60,000 and $40,000, respectively.
 
 Mr. Stephen
        Boatwright, a former Company director, has been actively involved in providing
        various legal services to the Company and IsoRay Medical, Inc. through the
        law
        firm of Keller Rohrback, PLC. During the fiscal years ended June 30, 2008
        and
        2007, the Company paid Keller Rohrback, PLC approximately $426,000 and $459,000,
        respectively, for legal services. In addition, the Company had accrued at
        June
        30, 2008 approximately $10,000 in legal fees to be paid.
 
 Patent
        and Know-How Royalty License Agreement
 
 Effective
        August 1, 1998, Pacific Management Associates Corporation (PMAC) transferred
        its
        entire right, title and interest in an exclusive license agreement with Donald
        Lawrence to IsoRay, LLC (a predecessor company) in exchange for a membership
        interest. The terms of the 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, 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.
 
 The
        licensor of the Lawrence “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
        still
        failed to reach a settlement. The parties may demand binding arbitration
        at any
        time.
 
 Director
        Independence
  Using
        the
        standards of the American Stock Exchange, the Company's Board has
        determined that Mr. Kauffman, Mr. LaVoy, and Mr. Smith each
        qualify under such standards as an independent director. Mr. Kauffman, Mr.
        LaVoy and Mr. Smith each meet the American Stock Exchange listing standards
        for
        independence both as a director and as a member of the Audit Committee, and
        Mr.
        Kauffman and Mr. Smith each meet the American Stock Exchange listing standards
        for independence both as a director and as a member of the Compensation
        Committee. No other directors are independent under these standards. The
        Company
        did not consider any relationship or transaction between itself and these
        independent directors not already disclosed in this report in making this
        determination.
  53
 *Table
            of Contents*
  **ITEM
        14 – PRINCIPAL ACCOUNTANT FEES AND
        SERVICES**
  The
        Company paid or accrued the following fees in each of the prior two fiscal
        years
        to its principal accountant, DeCoria, Maichel & Teague, P.S.:
 Year
                    ended
                
                Year
                    endedJune
                    30,
                
                June
                    30,2008
                
                20071.
                    Audit fees
                
                $
                42,107
                
                $
                41,0162.
                    Audit-related fees
                
                
                –
                
                
                1,8003.
                    Tax fees
                
                
                7,750
                
                
                4,2504.
                    All other fees
                
                
                –
                
                
                –Totals
                
                $
                49,857
                
                $
                47,066
 
 Audit
        fees include fees for the audit of our annual financial statements, reviews
        of
        our quarterly financial statements, and related consents for documents filed
        with the SEC. Audit-related fees include fees related to work on common stock
        offering memorandums. Tax fees include fees for the preparation of our federal
        and state income tax returns.
  As
        part
        of its responsibility for oversight of the independent registered public
        accountants, the Audit Committee has established a pre-approval policy for
        engaging audit and permitted non-audit services provided by our independent
        registered public accountants, DeCoria, Maichel & Teague, P.S. In accordance
        with this policy, each type of audit, audit-related, tax and other permitted
        service to be provided by the independent auditors is specifically described
        and
        each such service, together with a fee level or budgeted amount for such
        service, is pre-approved by the Audit Committee. The Audit Committee has
        delegated authority to its Chairman to pre-approve additional non-audit services
        (provided such services are not prohibited by applicable law) up to a
        pre-established aggregate dollar limit. All services pre-approved by the
        Chairman of the Audit Committee must be presented at the next Audit Committee
        meeting for review and ratification. All of the services provided by DeCoria,
        Maichel & Teague, P.S. described above were approved by our Audit
        Committee.
 
 The
        Company’s principal accountant, DeCoria, Maichel & Teague P.S., did not
        engage any other persons or firms other than the principal accountant’s
        full-time, permanent employees.
  **ITEM
        15 – EXHIBITS AND REPORTS ON FORM 8-K**
 
 **(except
        as otherwise indicated, all exhibits were previously filed)**
 **Exhibit #**
                
                **Description**2.1
                
                Merger
                    Agreement dated as of May 27, 2005, by and among Century Park
                    Pictures
                    Corporation, Century Park Transitory Subsidiary, Inc., certain
                    shareholders and IsoRay Medical, Inc. incorporated by reference
                    to the
                    Form 8-K filed on August 3, 2005.2.2
                
                Certificate
                    of Merger, filed with the Delaware Secretary of State on July
                    28, 2005
                    incorporated by reference to the Form 8-K filed on August 3,
                    2005.3.1
                
                Articles
                    of Incorporation and By-Laws are incorporated by reference to
                    the Exhibits
                    to the Company's Registration Statement of September 15,
                    1983.3.2
                
                Certificate
                    of Designation of Rights, Preferences and Privileges of Series
                    A and B
                    Convertible Preferred Stock, filed with the Minnesota Secretary
                    of State
                    on June 29, 2005 incorporated by reference to the Form 8-K filed
                    on August
                    3, 2005.3.3
                
                Restated
                    and Amended Articles of Incorporation incorporated by reference
                    to the
                    Form 10-KSB filed on October 11, 2005.3.4
                
                Text
                    of Amendments to the Amended and Restated By-Laws of the Company,
                    incorporated by reference to the Form 8-K filed on February 7,
                    2007.3.5
                
                Amended
                    and Restated By-Laws of the Company dated as of January 8, 2008,
                    incorporated by reference to the Form 8-K filed on January 14,
                    2008.4.2
                
                Intentionally
                    Omitted4.3
                
                Intentionally
                    Omitted
  54
 *Table
              of Contents*
  4.4
                
                Intentionally
                    Omitted4.5
                
                Intentionally
                    Omitted4.6
                
                Intentionally
                    Omitted4.7
                
                Amended
                    and Restated 2005 Stock Option Plan incorporated by reference
                    to the Form
                    S-8 filed on August 19, 2005.4.8
                
                Amended
                    and Restated 2005 Employee Stock Option Plan incorporated by
                    reference to
                    the Form S-8 filed on August 19, 2005.4.9
                
                Form
                    of Registration Right Agreement among IsoRay Medical, Inc., Meyers
                    Associates, L.P. and the other signatories thereto, dated October
                    15,
                    2004, incorporated by reference to the Form SB-2 filed on November
                    10,
                    2005.4.10
                
                Form
                    of Registration Rights Agreement among IsoRay, Inc., Meyers Associates,
                    L.P. and the other signatories thereto, dated February 1, 2006,
                    incorporated by reference to the Form SB-2/A1 filed on March
                    24,
                    2006.4.11
                
                Form
                    of IsoRay, Inc. Common Stock Purchase Warrant, incorporated by
                    reference
                    to the Form SB-2/A1 filed on March 24, 2006.4.12
                
                2006
                    Director Stock Option Plan, incorporated by reference to the
                    Form S-8
                    filed on August 18, 2006.4.13
                
                Form
                    of Registration Rights Agreement among IsoRay, Inc. and the other
                    signatories thereto, dated August 9, 2006, incorporated by reference
                    to
                    the Form 8-K filed on August 18, 2006.4.14
                
                Form
                    of IsoRay, Inc. Common Stock Purchase Warrant, dated August 9,
                    2006,
                    incorporated by reference to the Form 8-K filed on August 18,
                    2006.4.15
                
                Form
                    of Registration Rights Agreement among IsoRay, Inc., Meyers Associates,
                    L.P. and the other signatories thereto, dated October 17, 2005,
                    incorporated by reference to the Form SB-2 filed on October 16,
                    2006.4.16
                
                Amended
                    and Restated 2006 Director Stock Option Plan, incorporated by
                    reference to
                    the Form S-8/A1 filed on December 18, 2006.4.17
                
                Amended
                    and Restated 2005 Stock Option Plan, incorporated by reference
                    to the Form
                    S-8/A1 filed on December 18, 2006.4.18
                
                Intentionally
                    omitted.4.19
                
                Rights
                    Agreement, dated as of February 1, 2007, between the Computershare
                    Trust
                    Company N.A., as Rights Agent, incorporated by reference to Exhibit
                    1 to
                    the Company’s Registration Statement on Form 8-A filed on February 7,
                    2007.4.20
                
                Certificate
                    of Designation of Rights, Preferences and Privileges of Series
                    C Junior
                    Participating Preferred Stock, incorporated by reference to Exhibit
                    1 to
                    the Company’s Registration Statement on Form 8-A filed February 7,
                    2007.4.21
                
                2008
                    Employee Stock Option Plan, incorporated by reference to the
                    Form S-8
                    filed on January 14, 2008.10.2
                
                Universal
                    License Agreement, dated November 26, 1997 between Donald C.
                    Lawrence and
                    William J. Stokes of Pacific Management Associates Corporation,
                    incorporated by reference to the Form SB-2 filed on November
                    10,
                    2005.10.3
                
                Royalty
                    Agreement of Invention and Patent Application, dated July 12,
                    1999 between
                    Lane A. Bray and IsoRay LLC, incorporated by reference to the
                    Form SB-2
                    filed on November 10, 2005.10.4
                
                Intentially
                    Omitted10.5
                
                Section
                    510(k) Clearance from the Food and Drug Administration to market
                    Lawrence
                    CSERION Model CS-1, dated March 28, 2003, incorporated by reference
                    to the
                    Form SB-2 filed on November 10, 2005.10.6
                
                Battelle
                    Project No. 45836 dated June 20, 2003, incorporated by reference
                    to the
                    Form SB-2/A2 filed on April 27, 2006.10.7
                
                Intentionally
                    Omitted10.8
                
                Work
                    for Others Agreement No. 45658, R2, dated April 27, 2004 between
                    Battelle
                    Memorial Institute, Pacific Northwest Division and IsoRay Products
                    LLC,
                    incorporated by reference to the Form SB-2/A2 filed on April
                    27,
                    2006.10.9
                
                Development
                    Loan Agreement for $230,000, dated September 15, 2004 between
                    Benton-Franklin Economic Development District and IsoRay Medical,
                    Inc.,
                    incorporated by reference to the Form SB-2/A2 filed on April
                    27,
                    2006.
  55
 *Table
              of Contents*
  10.10
                
                Registry
                    of Radioactive Sealed Sources and Devices Safety Evaluation of
                    Sealed
                    Source, dated September 17, 2004, incorporated by reference to
                    the Form
                    SB-2/A2 filed on April 27, 2006.10.11
                
                CRADA
                    PNNL/245, "Y-90 Process Testing for IsoRay", dated December 22,
                    2004
                    between Pacific Northwest National Laboratory and IsoRay Medical
                    Inc.,
                    including Amendment No. 1, incorporated by reference to the Form
                    SB-2/A2
                    filed on April 27, 2006.10.12
                
                Intentionally
                    Omitted10.13
                
                Amendment
                    1 to Agreement 45658, dated February 23, 2005 between Battelle
                    Memorial
                    Institute Pacific Northwest Division and IsoRay Medical, Inc.,
                    incorporated by reference to the Form SB-2/A2 filed on April
                    27,
                    2006.10.14
                
                Equipment
                    Lease Agreement dated April 14, 2005 between IsoRay Medical,
                    Inc. and
                    Nationwide Funding, LLC, incorporated by reference to the Form
                    SB-2/A2
                    filed on April 27, 2006.10.15
                
                Intentionally
                    Omitted10.16
                
                Master
                    Lease Agreement Number 5209, dated May 7, 2005 between VenCore
                    Solutions
                    LLC and IsoRay Medical, Inc., incorporated by reference to the
                    Form
                    SB-2/A2 filed on April 27, 2006.10.17
                
                Contract
                    #840/08624332/04031 dated August 25, 2005 between IsoRay, Inc.
                    and the
                    Federal State Unitary Enterprise << Institute of Nuclear Materials
                    >>, Russia, incorporated by reference to the Form SB-2 filed on
                    November 10, 2005.10.18
                
                State
                    of Washington Radioactive Materials License dated October 6,
                    2005,
                    incorporated by reference to the Form SB-2 filed on November
                    10,
                    2005.10.19
                
                Express
                    Pricing Agreement Number 219889, dated October 5, 2005 between
                    FedEx and
                    IsoRay Medical, Inc., incorporated by reference to the Form 10-QSB
                    filed
                    on November 21, 2005.10.20
                
                Intentionally
                    Omitted10.21
                
                Contract
                    Modification Quality Class G, dated October 25, 2005 to Contract
                    Number
                    X40224 between Energy Northwest and IsoRay, Inc., incorporated
                    by
                    reference to the Form 10-QSB filed on November 21,
                    2005.10.22
                
                Agreement
                    dated August 9, 2005 between the Curators of the University of
                    Missouri
                    and IsoRay Medical, Inc., incorporated by reference to the Form
                    SB-2/A2
                    filed on April 27, 2006 (confidential treatment
                    requested).10.23
                
                Intentionally
                    Omitted10.24
                
                Intentionally
                    Omitted10.25
                
                Economic
                    Development Agreement, dated December 14, 2005, by and between
                    IsoRay,
                    Inc. and the Pocatello Development Authority, incorporated by
                    reference to
                    the Form 8-K filed on December 20, 2005.10.26
                
                License
                    Agreement, dated February 2, 2006, by and between IsoRay Medical,
                    Inc. and
                    IBt SA, incorporated by reference to the Form 8-K filed on March
                    24, 2006
                    (confidential treatment requested).10.27
                
                Intentionally
                    Omitted.10.28
                
                Service
                    Agreement between IsoRay, Inc. and Advanced Care Medical, Inc.,
                    dated
                    March 1, 2006, incorporated by reference to the Form SB-2/A2
                    filed on
                    April 27, 2006.10.29
                
                Intentionally
                    Omitted.10.30
                
                Intentionally
                    Omitted.10.31
                
                Loan
                    Agreement, dated June 15, 2006, by and between IsoRay Medical,
                    Inc. and
                    the Hanford Area Economic Investment Fund Committee, incorporated
                    by
                    reference to the Form 8-K filed on June 21, 2006.10.32
                
                Commercial
                    Security Agreement, dated June 15, 2006, by and between IsoRay
                    Medical,
                    Inc. and the Hanford Area Economic Investment Fund Committee,
                    incorporated
                    by reference to the Form 8-K filed on June 21, 2006.10.33
                
                Common
                    Stock and Warrant Purchase Agreement among IsoRay, Inc. and the
                    other
                    signatories thereto, dated August 9, 2006, incorporated by reference
                    to
                    the Form 8-K filed on August 18,
                    2006.
  56
 *Table
              of Contents*
  10.34
                
                Intentionally
                    Omitted.10.35
                
                Form
                    of Officer and Director Indemnification Agreement, incorporated
                    by
                    reference to the Form SB-2 Post Effective Amendment No. 2 filed
                    on October
                    13, 2006.10.36
                
                Contract
                    No. 840/20553876/11806-32, dated October 6, 2006, by and between
                    IsoRay
                    Medical, Inc. and FSUE “SSC-Research Institute of Atomic Reactors,”
                    incorporated by reference to the Form 8-K filed on November 6,
                    2006
                    (confidential treatment requested for redacted
                    portions).10.37
                
                Agreement
                    for Exclusive Right to Buy, dated October 6, 2006, by and between
                    IsoRay
                    Medical, Inc. and FSUE “SSC-Research Institute of Atomic Reactors,”
                    incorporated by reference to the Form 8-K filed on November 6,
                    2006
                    (confidential treatment requested for redacted
                    portions).10.38
                
                Form
                    of Securities Purchase Agreement by and among IsoRay, Inc. and the
                    Buyers dated March 22, 2007, incorporated by reference to the Form
                    8-K filed on March 23, 2007.10.39
                
                Form
                    of Common Stock Purchase Warrant dated March 21, 2007, incorporated
                    by
                    reference to the Form 8-K filed on March 23, 2007.10.40
                
                Placement
                    Agent Agreement by and between the Company and Punk, Ziegel & Company,
                    L.P. dated March 14, 2007, incorporated by reference to the Form
                    8-K filed
                    on March 23, 2007.10.41
                
                Placement
                    Agent Agreement by and between the Company and Maxim Group LLC
                    dated
                    February 2, 2006, incorporated by reference to the Form 8-K filed
                    on March
                    23, 2007.10.42
                
                Intentionally
                    Omitted.10.43
                
                Intentionally
                    Omitted.10.44
                
                Intentionally
                    Omitted.10.45
                
                Lease
                    Agreement, dated effective as of September 1, 2007, by and between
                    IsoRay,
                    Inc. and Perma-Fix Northwest Richland, Inc., incorporated by
                    reference to
                    the Form 8-K filed on October 16, 2007.10.46
                
                Amendment
                    No. 1 to License Agreement, dated October 12, 2007, by and between
                    IsoRay
                    Medical, Inc. and IBt, SA, incorporated by reference to the Form
                    8-K filed
                    on October 17, 2007.10.47
                
                Loan
                    Covenant Waiver Letter dated August 18, 2008 from the Benton-Franklin
                    Economic Development District, filed herewith.10.48
                
                Loan
                    Covenant Waiver Letter dated August 26, 2008 from the Hanford
                    Area
                    Economic Investment Fund Committee, filed herewith.21.1
                
                Subsidiaries
                    of the Company, filed herewith.23.1
                
                Consent
                    of DeCoria, Maichel & Teague, P.S., filed herewith.31.1
                
                Certification
                    Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Chief
                    Executive Officer, filed herewith.31.2
                
                Certification
                    Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Chief
                    Financial Officer, filed herewith.32.1
                
                Certifications
                    Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
                    herewith.
 Reports
        on Form 8-K
 
 On
        May
        13, 2008, the Company filed a Current Report on Form 8-K announcing its
        financial results for the third quarter of fiscal year 2008.
 
 On
        August
        20, 2008, the Company filed a Current Report on Form 8-K announcing its
        financial results for the fourth quarter of fiscal year 2008.
  57
 *Table
            of Contents*
 **IsoRay,
        Inc.**
 **Index
        to Financial Statements**
 
 PageReport
                  of Independent Registered Public Accounting Firm
              
              F-2Financial
                  Statements:Consolidated
                  Balance Sheets as of June 30, 2008 and 2007
              
              F-3Consolidated
                  Statements of Operations for the years ended June
                  30, 2008 and 2007
              
              F-4Consolidated
                  Statement of Changes in Shareholders’ Equity for
                  the years ended June 30, 2008 and 2007
              
              F-5Consolidated
                  Statements of Cash Flows for the years ended June
                  30, 2008 and 2007
              
              F-6Notes
                  to Consolidated Financial
                  Statements
              
              F-7




F-1
 *Table
          of Contents*





**Report
      of Independent Registered Public Accounting Firm**





Board
      of
      Directors and Shareholders


IsoRay,
      Inc.


Richland,
      Washington





We
      have
      audited the accompanying consolidated balance sheets of IsoRay, Inc. and
      Subsidiaries (“the Company”) (see Note 1) as of June 30, 2008 and 2007, and the
      related consolidated statements of operations, changes in shareholders’ equity
      and cash flows for the years then ended. These financial statements are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of IsoRay, Inc. and
      Subsidiaries as of June 30, 2008 and 2007, and the consolidated results of
      their
      operations and their cash flows for the years then ended, in conformity with
      accounting principles generally accepted in the United States of
      America.





/s/
      DeCoria, Maichel & Teague, P.S.





Spokane,
      Washington


September
      29, 2008




F-2
 *Table
          of Contents*


**IsoRay,
        Inc. and Subsidiaries**
 **Consolidated
        Balance Sheets**
 
 **June
                  30,****2008**
              
              **2007****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              4,820,033
              
              $
              9,355,730Short-term
                  investments
              
              
              3,726,000
              
              
              9,942,840Accounts
                  receivable, net of allowance for doubtful accounts of $33,031 and
                  $99,789,
                  respectively
              
              
              1,016,495
              
              
              1,092,925Inventory
              
              
              899,964
              
              
              880,834Prepaid
                  expenses and other current assets
              
              
              267,001
              
              
              458,123Total
                  current assets
              
              
              10,729,493
              
              
              21,730,452Fixed
                  assets, net of accumulated depreciation and amortization
              
              
              6,040,641
              
              
              3,665,551Deferred
                  financing costs, net of accumulated amortization
              
              
              65,221
              
              
              95,725Licenses,
                  net of accumulated amortization
              
              
              455,646
              
              
              262,074Restricted
                  cash
              
              
              175,852
              
              
              —Other
                  assets, net of accumulated amortization
              
              
              345,040
              
              
              322,360Total
                  assets
              
              $
              17,811,893
              
              $
              26,076,162**LIABILITIES
                  AND SHAREHOLDERS' EQUITY**Current
                  liabilities:Accounts
                  payable and accrued expenses
              
              $
              751,402
              
              $
              1,947,980Accrued
                  payroll and related taxes
              
              
              344,612
              
              
              459,068Deferred
                  revenue
              
              
              —
              
              
              23,874Notes
                  payable, due within one year
              
              
              64,486
              
              
              49,212Capital
                  lease obligations, due within one year
              
              
              25,560
              
              
              194,855Asset
                  retirement obligation, current portion
              
              
              —
              
              
              131,142Total
                  current liabilities
              
              
              1,186,060
              
              
              2,806,131Notes
                  payable, due after one year
              
              
              344,898
              
              
              528,246Capital
                  lease obligations, due after one year
              
              
              —
              
              
              25,560Asset
                  retirement obligation, noncurrent
              
              
              506,005
              
              
              —Total
                  liabilities
              
              
              2,036,963
              
              
              3,359,937Commitments
                  and contingencies (Note 16)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; 22,942,088
                  and
                  22,789,324 shares issued and outstanding
              
              
              22,942
              
              
              22,789Treasury
                  stock, at cost, 5,000 and 0 shares
              
              
              (3,655
              )
              
              —Additional
                  paid-in capital
              
              
              47,464,507
              
              
              45,844,793Accumulated
                  deficit
              
              
              (31,708,923
              )
              
              (23,151,416
              )Total
                  shareholders' equity
              
              
              15,774,930
              
              
              22,716,225Total
                  liabilities and shareholders' equity
              
              $
              17,811,893
              
              $
              26,076,162
 
 The
        accompanying notes are an integral part of these financial
        statements.
  F-3
 *Table
            of Contents*
  **IsoRay,
        Inc. and Subsidiaries**
 **Consolidated
        Statements of Operations**
 
 **June
                  30,****2008**
              
              **2007**Product
                  sales
              
              $
              7,158,690
              
              $
              5,738,033Cost
                  of product sales
              
              
              7,310,124
              
              
              5,792,630Gross
                  loss
              
              
              (151,434
              )
              
              (54,597
              )Operating
                  expenses:Research
                  and development expenses
              
              
              1,358,075
              
              
              1,345,163Sales
                  and marketing expenses
              
              
              3,725,164
              
              
              3,384,472General
                  and administrative expenses
              
              
              3,568,048
              
              
              4,915,598Total
                  operating expenses
              
              
              8,651,287
              
              
              9,645,233Operating
                  loss
              
              
              (8,802,721
              )
              
              (9,699,830
              )Non-operating
                  income (expense):Interest
                  and investment income
              
              
              612,077
              
              
              406,921Loss
                  on short-term investments
              
              
              (274,000
              )
              
              —Financing
                  expense
              
              
              (92,863
              )
              
              (312,246
              )Non-operating
                  income, net
              
              
              245,214
              
              
              94,675Net
                  loss
              
              $
              (8,557,507
              )
              $
              (9,605,155
              )Basic
                  and diluted loss per share
              
              $
              (0.37
              )
              $
              (0.54
              )Weighted
                  average shares used in computing net loss per share:Basic
                  and diluted
              
              
              23,028,075
              
              
              17,827,522
 
 The
        accompanying notes are an integral part of these financial
        statements.
  F-4
 *Table
            of Contents*
  **IsoRay,
        Inc. and Subsidiaries**
 **Consolidated
        Statement of Changes in Shareholders'
        Equity**
 **Series B Preferred Stock**
                
                **Common Stock**
                
                **Treasury Stock**
                
                **Subscriptions**
                
                **Additional
                    Paid-in**
                
                **Accumulated****Shares**
                
                **Amount**
                
                **Shares**
                
                **Amount**
                
                **Shares**
                
                **Amount**
                
                **Receivable**
                
                **Capital**
                
                **Deficit**
                
                **Total**Balances
                    at June 30, 2006
                
                
                144,759
                
                $
                145
                
                
                15,157,901
                
                $
                15,158
                
                
                —
                
                $
                —
                
                $
                (6,122,007
                )
                $
                22,538,675
                
                $
                (13,546,261
                )
                $
                2,885,710Issuance
                    of preferred stock pursuant to exercise of warrants
                
                
                37,322
                
                
                37
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                41,642
                
                
                
                
                
                41,679Issuance
                    of common stock pursuant to exercise of warrants
                
                
                
                
                
                
                
                
                2,295,506
                
                
                2,295
                
                
                
                
                
                
                
                
                
                
                
                6,857,385
                
                
                
                
                
                6,859,680Issuance
                    of common stock pursuant to exercise of options
                
                
                
                
                
                
                
                
                755,499
                
                
                755
                
                
                
                
                
                
                
                
                
                
                
                873,937
                
                
                
                
                
                874,692Conversion
                    of preferred stock to common stock
                
                
                (123,016
                )
                
                (123
                )
                
                123,016
                
                
                123
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                —Cancellation
                    of common stock issued to Mercatus subject to a subscription
                    receivable
                    agreement
                
                
                
                
                
                
                
                
                (1,748,146
                )
                
                (1,748
                )
                
                
                
                
                
                
                
                6,122,007
                
                
                (6,120,259
                )
                
                
                
                
                —Exchange
                    of convertible debentures payable for common stock
                
                
                
                
                
                
                
                
                12,048
                
                
                12
                
                
                
                
                
                
                
                
                
                
                
                49,987
                
                
                
                
                
                49,999Issuance
                    of common stock pursuant to the August 2006 Stock Purchase Agreement,
                    net
                    of offering costs (see Note 12)
                
                
                
                
                
                
                
                
                2,063,000
                
                
                2,063
                
                
                
                
                
                
                
                
                
                
                
                4,700,870
                
                
                
                
                
                4,702,933Issuance
                    of common stock pursuant to the Public Equity Offering, net of
                    offering
                    costs (see Note 12)
                
                
                
                
                
                
                
                
                4,130,500
                
                
                4,131
                
                
                
                
                
                
                
                
                
                
                
                15,112,900
                
                
                
                
                
                15,117,031Payment
                    of dividend to Preferred shareholders (see Note 12)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (38,458
                )
                
                
                
                
                (38,458
                )Share-based
                    compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,828,114
                
                
                
                
                
                1,828,114Net
                    loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (9,605,155
                )
                
                (9,605,155
                )Balances
                    at June 30, 2007
                
                
                59,065
                
                
                59
                
                
                22,789,324
                
                
                22,789
                
                
                —
                
                
                —
                
                
                —
                
                
                45,844,793
                
                
                (23,151,416
                )
                
                22,716,225Issuance
                    of common stock pursuant to exercise of warrants
                
                
                
                
                
                
                
                
                290,876
                
                
                291
                
                
                
                
                
                
                
                
                
                
                
                1,010,622
                
                
                
                
                
                1,010,913Issuance
                    of common stock pursuant to exercise of options
                
                
                
                
                
                
                
                
                10,000
                
                
                10
                
                
                
                
                
                
                
                
                
                
                
                11,890
                
                
                
                
                
                11,900Repurchase
                    of Company common stock (see Note 13)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                5,000
                
                
                (3,655
                )
                
                
                
                
                
                
                
                
                
                
                (3,655
                )Cancellation
                    of shares (see Note 20)
                
                
                
                
                
                
                
                
                (148,112
                )
                
                (148
                )
                
                
                
                
                
                
                
                
                
                
                148
                
                
                
                
                
                —Share-based
                    compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                597,054
                
                
                
                
                
                597,054Net
                    loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (8,557,507
                )
                
                (8,557,507
                )Balances
                    at June 30, 2008
                
                
                59,065
                
                $
                59
                
                
                22,942,088
                
                $
                22,942
                
                
                5,000
                
                $
                (3,655
                )
                $
                —
                
                $
                47,464,507
                
                $
                (31,708,923
                )
                $
                15,774,930
  The
          accompanying notes are an integral part of these financial
          statements.
  F-5
 *Table
            of Contents*
  **IsoRay,
        Inc. and Subsidiaries**
 **Consolidated
        Statements of Cash Flows**
 
 **Year ended June 30,****2008**
              
              **2007****CASH
                  FLOWS FROM OPERATING ACTIVITIES:**Net
                  loss
              
              $
              (8,557,507
              )
              $
              (9,605,155
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation
                  and amortization of fixed assets
              
              
              1,103,940
              
              
              491,643Impairment
                  of fixed assets
              
              
              85,000
              
              
              —Amortization
                  of deferred financing costs and other assets
              
              
              107,555
              
              
              223,604Amortization
                  of discount on short-term investments
              
              
              (150,621
              )
              
              —Loss
                  on short-term investments
              
              
              274,000
              
              
              —Settlement
                  of asset retirement obligation
              
              
              (135,120
              )
              
              —Accretion
                  of asset retirement obligation
              
              
              36,887
              
              
              7,597Share-based
                  compensation
              
              
              597,054
              
              
              1,828,114Changes
                  in operating assets and liabilities:Accounts
                  receivable, net
              
              
              76,430
              
              
              (496,478
              )Inventory
              
              
              (19,130
              )
              
              (719,453
              )Prepaid
                  expenses and other current assets
              
              
              191,122
              
              
              (296,577
              )Accounts
                  payable and accrued expenses
              
              
              (1,196,578
              )
              
              1,351,698Accrued
                  payroll and related taxes
              
              
              (114,456
              )
              
              (10,577
              )Deferred
                  revenue
              
              
              (23,874
              )
              
              23,874Net
                  cash used by operating activities
              
              
              (7,725,298
              )
              
              (7,201,710
              )**CASH
                  FLOWS FROM INVESTING ACTIVITIES:**Purchases
                  of fixed assets
              
              
              (3,090,934
              )
              
              (2,445,850
              )Additions
                  to licenses and other assets
              
              
              (293,303
              )
              
              (29,874
              )Change
                  in restricted cash
              
              
              (175,852
              )
              
              —Purchase
                  of short-term investments
              
              
              (13,273,653
              )
              
              (10,931,920
              )Proceeds
                  from the sale or maturity of short-term investments
              
              
              19,367,114
              
              
              989,080Net
                  cash provided (used) by investing activities
              
              
              2,533,372
              
              
              (12,418,564
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Repayment
                  of convertible debentures payable
              
              
              —
              
              
              (405,001
              )Principal
                  payments on notes payable
              
              
              (168,074
              )
              
              (55,450
              )Principal
                  payments on capital lease obligations
              
              
              (194,855
              )
              
              (183,554
              )Proceeds
                  from cash sales of common shares, net of offering costs
              
              
              —
              
              
              19,819,962Proceeds
                  from cash sales of preferred stock, pursuant to exercise of
                  warrants
              
              
              —
              
              
              41,679Proceeds
                  from cash sales of common stock, pursuant to exercise of
                  warrants
              
              
              1,010,913
              
              
              6,859,682Proceeds
                  from cash sales of common stock, pursuant to exercise of
                  options
              
              
              11,900
              
              
              729,692Repurchase
                  of Company common stock
              
              
              (3,655
              )
              
              —Payments
                  of dividends to preferred shareholders
              
              
              —
              
              
              (38,458
              )Net
                  cash provided by financing activities
              
              
              656,229
              
              
              26,768,552Net
                  (decrease) increase in cash and cash equivalents
              
              
              (4,535,697
              )
              
              7,148,278Cash
                  and cash equivalents, beginning of period
              
              
              9,355,730
              
              
              2,207,452**CASH
                  AND CASH EQUIVALENTS, END OF YEAR**
              
              $
              4,820,033
              
              $
              9,355,730Supplemental
                  disclosures of cash flow information:Cash
                  paid for interest
              
              $
              63,818
              
              $
              143,662Non-cash
                  investing and financing activities:Increase
                  in fixed assets related to asset retirement obligation
              
              $
              473,096
              
              $
              56,120Cashless
                  exercise of common stock options in lieu of severance pay
              
              
              —
              
              
              145,000Exchange
                  of convertible debentures payable for shares of common
                  stock
              
              
              —
              
              
              49,999
 
 The
        accompanying notes are an integral part of these financial
        statements.




F-6
 *Table
          of Contents*




**IsoRay,
      Inc.**


**Notes
      to Consolidated Financial Statements**


**For
      the years ended June 30, 2008 and 2007**





**1.**  **Organization**





Century
      Park Pictures Corporation (Century) was organized under Minnesota law in 1983.
      Century had no operations during the period from September 30, 1999 through
      June
      30, 2005.





On
      July
      28, 2005, IsoRay Medical, Inc. (Medical) became a wholly-owned subsidiary of
      Century pursuant to a merger. Century changed its name to IsoRay, Inc. (IsoRay
      or the Company). In the merger, the Medical stockholders received approximately
      82% of the then outstanding securities of the Company.





Medical,
      a Delaware corporation, was incorporated effective June 15, 2004 to develop,
      manufacture and sell isotope-based medical products and devices for the
      treatment of cancer and other malignant diseases. Medical is headquartered
      in
      Richland, Washington.





IsoRay
      International LLC, a Washington limited liability company, was formed on
      November 27, 2007 to serve as an owner in a Russian LLC that will distribute
      the
      Company’s products to the Russian market and also license the Company’s
      technology for use in manufacturing Cs-131 brachytherapy seeds in
      Russia.





**2.**  **Summary
      of Significant Accounting Policies**





Consolidation





The
      accompanying consolidated financial statements include the accounts of the
      Company and its wholly-owned subsidiaries (collectively the Company). All
      significant intercompany accounts and transactions have been
      eliminated.





Cash
      Equivalents





The
      Company considers all highly liquid investments with maturities of three months
      or less when purchased to be cash equivalents.





Short-Term
      Investments





The
      Company invests certain excess cash in marketable securities consisting
      primarily of commercial paper, auction rate securities, and money market funds.
      The Company classifies all debt securities as “available-for-sale” and records
      the debt securities at fair value with unrealized gains and temporary unrealized
      losses included in other comprehensive income/loss within shareholders’ equity,
      if material. Declines in fair values that are considered other than temporary
      are recorded in the Consolidated Statements of Operations.





Accounts
      Receivable





Accounts
      receivable are stated at the amount that management of the Company expects
      to
      collect from outstanding balances. Management provides for probable
      uncollectible amounts through an allowance for doubtful accounts. Additions
      to
      the allowance for doubtful accounts are based on management’s judgment,
      considering historical write-offs, collections and current credit conditions.
      Balances which remain outstanding after management has used reasonable
      collection efforts are written off through a charge to the allowance for
      doubtful accounts and a credit to the applicable accounts receivable. Payments
      received subsequent to the time that an account is written off are considered
      bad debt recoveries.




F-7
 *Table
          of Contents*




Inventory





Inventory
      is reported at the lower of cost or market. Cost of raw materials is determined
      using the weighted average method. Cost of work in process and finished goods
      is
      computed using standard cost, which approximates actual cost, on a first-in,
      first-out basis. As the Company has operated at a gross loss throughout the
      past
      fiscal years, inventories have generally been recorded at market or net
      realizable value.





Fixed
      Assets





Fixed
      assets are capitalized and carried at the lower of cost or net realizable value.
      Normal maintenance and repairs are charged to expense as incurred. When assets
      are sold or otherwise disposed of, the cost and accumulated depreciation are
      removed from the accounts and any resulting gain or loss is recognized in
      operations.





Depreciation
      is computed using the straight-line method over the following estimated useful
      lives:




Production
                  equipment
              3
                  to 7 yearsOffice
                  equipment
              2
                  to 5 yearsFurniture
                  and fixtures
              2
                  to 5 years


Leasehold
      improvements and capital lease assets are amortized over the shorter of the
      life
      of the lease or the estimated useful life of the asset.





The
      Company has adopted the provisions of Statement of Financial Accounting
      Standards (SFAS) No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets* .
      The
      provisions of SFAS No. 144 require that an impairment loss be recognized when
      the estimated future cash flows (undiscounted and without interest) expected
      to
      result from the use of an asset are less than the carrying amount of the asset.
      Measurement of an impairment loss is based on the estimated fair value of the
      asset if the asset is expected to be held and used.





Management
      of the Company periodically reviews the net carrying value of all of its
      equipment on an asset by asset basis. These reviews consider the net realizable
      value of each asset, as measured in accordance with the preceding paragraph,
      to
      determine whether an impairment in value has occurred, and the need for any
      asset impairment write-down.





Although
      management has made its best estimate of the factors that affect the carrying
      value based on current conditions, it is reasonably possible that changes could
      occur which could adversely affect management's estimate of net cash flows
      expected to be generated from its assets, and necessitate asset impairment
      write-downs.





Deferred
      Financing Costs





Financing
      costs related to the acquisition of debt are deferred and amortized over the
      term of the related debt using the effective interest method.  Deferred
      financing costs include the fair value of common shares issued to certain
      shareholders for their guarantee of certain Company debt (see Note 9) in
      accordance with Accounting Principles Board (APB) Opinion No. 21, *Interest
      on Receivables and Payables* and
      Emerging Issues Task Force (EITF) Issue No. 95-13, *Classification
      of Debt Issue Costs in the Statement of Cash Flows* .
      The
      value of the shares issued was the estimated market price of the shares as
      of
      the date of issuance. Amortization of deferred financing costs, totaling $30,504
      and $178,633 for the years ended June 30, 2008 and 2007, respectively, is
      included in financing expense on the statements of operations.





F-8
 *Table
          of Contents*




Licenses





Amortization
      of licenses is computed using the straight-line method over the estimated
      economic useful lives of the assets. In fiscal year 2006, the Company entered
      into an agreement with IBt, SA, a Belgian company (IBt) to use IBt’s proprietary
“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 $225,000 and $275,000 during fiscal years 2008 and 2006, respectively,
      and is amortizing the license over the 15-year term of the license
      agreement.





In
      the
      fourth quarter of fiscal year 2008, the Company reviewed the carrying values
      of
      licenses. Although the Company has not currently integrated this technology
      into
      its products, management will reevaluate the potential of this technology during
      fiscal year 2009 after the Company has further improved its current processes.
      Therefore, the Company did not believe that any impairment had occurred to
      this
      intangible asset.




Amortization
      of licenses was $43,452 and $23,426 for the years ended June 30, 2008 and 2007,
      respectively. Based on the licenses recorded at June 30, 2008, and assuming
      no
      subsequent impairment of the underlying assets, the annual amortization expense
      for each fiscal year ending June 30 is expected to be as follows: $47,670 for
      2009, $35,354 for 2010, $35,208 for 2011, $35,208 for 2012, $35,208 for 2013,
      and $266,998 thereafter.





Other
      Assets





Other
      assets, which include deferred charges and patents, are stated at cost, less
      accumulated amortization. Amortization of patents is computed using the
      straight-line method over the estimated economic useful lives of the assets.
      The
      Company periodically reviews the carrying values of patents and any impairments
      are recognized when the expected future operating cash flows to be derived
      from
      such assets are less than their carrying value.





Based
      on
      the patents and other intangible assets recorded in other assets at June 30,
      2008, and assuming no subsequent impairment of the underlying assets, the annual
      amortization expense for each fiscal year ending June 30 is expected to be
      as
      follows: $7,798 for 2009, $4,353 for 2010, $2,632 for 2011, $2,632 for 2012,
      $2,632 for 2013, and $9,560 thereafter.





Asset
      Retirement Obligation





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 is discounted using the Company’s
      credit-adjusted risk free-rate and is reviewed periodically for changes in
      the
      estimated future costs underlying the obligation. The Company amortizes the
      initial amount capitalized to property and equipment and recognizes accretion
      expense in connection with the discounted liability over the estimated remaining
      useful life of the leased assets.





In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represented the discounted cost of cleanup that the Company
      anticipated it would have to incur at the end of its equipment and property
      leases in its old production facility. This amount was determined based on
      discussions with qualified production personnel and on historical evidence.
      During fiscal year 2007, the Company reevaluated its obligations based on
      discussions with the Washington Department of Health and determined that the
      initial asset retirement obligation should be increased by an additional
      $56,120. During the second quarter of fiscal year 2008, the Company removed
      all
      radioactive residuals and tenant improvements from its old production facility
      and returned the facility to the lessor. The Company had an asset retirement
      obligation of $135,120 accrued for this facility but total costs incurred to
      decommission the facility were $274,163 resulting in an additional expense
      of
      $139,043 that is included in cost of products sold. The additional expense
      was
      mainly due to unanticipated construction costs to return the facility to its
      previous state. The Company originally believed that the lessor would retain
      many of the leasehold improvements in the building, but the lessor instead
      required their removal.




F-9
 *Table
          of Contents*




In
      September 2007, another asset retirement obligation of $473,096 was established
      representing the discounted cost of the Company’s estimate of the obligations to
      remove any residual radioactive materials and all leasehold improvements at
      the
      end of the lease term at its new production facility. The estimate was developed
      by qualified production personnel and the general contractor of the new
      facility. The Company has reviewed the estimate again based on its experience
      with decommissioning its old facility and believes that the original estimate
      continues to be applicable.





During
      the years ended June 30, 2008 and 2007, the asset retirement obligations changed
      as follows:





2008
            
            2007Beginning
                balance
            
            $
            131,142
            
            $
            67,425New
                obligation
            
            
            473,096
            
            
            —Settlement
                of existing obligation
            
            
            (135,120
            )
            
            —Changes
                in estimates of existing obligation
            
            
            —
            
            
            56,120Accretion
                of discount
            
            
            36,887
            
            
            7,597Ending
                balance
            
            $
            506,005
            
            $
            131,142




Because
      the Company does not expect to incur any expenses related to its asset
      retirement obligations in fiscal year 2009, the entire balance as of June 30,
      2008 is classified as a noncurrent liability.





Financial
      Instruments





The
      Company discloses the fair value of financial instruments, both assets and
      liabilities, recognized and not recognized in the balance sheet, for which
      it is
      practicable to estimate the fair value. The fair value of a financial instrument
      is the amount at which the instrument could be exchanged in a current
      transaction between willing parties, other than a forced liquidation
      sale.





The
      carrying amounts of financial instruments, including cash and cash equivalents,
      short-term investments, accounts receivable, accounts payable, notes payable,
      and capital lease obligations, approximated their fair values at June 30, 2008
      and 2007.





Revenue
      Recognition





The
      Company applies the provisions of SEC Staff Accounting Bulletin (SAB)
      No. 104, *Revenue
      Recognition* .
      SAB
      No. 104, which supersedes SAB No. 101, *Revenue
      Recognition in Financial Statements* ,
      provides guidance on the recognition, presentation and disclosure of revenue
      in
      financial statements. SAB No. 104 outlines the basic criteria that must be
      met to recognize revenue and provides guidance for the disclosure of revenue
      recognition policies. The Company recognizes revenue related to product sales
      when (i) persuasive evidence of an arrangement exists, (ii) shipment
      has occurred, (iii) the fee is fixed or determinable, and
      (iv) collectability is reasonably assured.




Revenue
      for the fiscal years ended June 30, 2008 and 2007 was derived solely from sales
      of the Proxcelan Cs-131 brachytherapy seed, which is used in the treatment
      of
      cancer. The Company recognizes revenue once the product has been shipped to
      the
      customer. Prepayments, if any, received from customers prior to the time that
      products are shipped are recorded as deferred revenue. In these cases, when
      the
      related products are shipped, the amount recorded as deferred revenue is then
      recognized as revenue. The Company accrues for sales returns and other
      allowances at the time of shipment. Although the Company does not have an
      extensive operating history upon which to develop sales returns estimates,
      we
      have used the expertise of our management team, particularly those with
      extensive industry experience and knowledge, to develop a proper
      methodology.




F-10
 *Table
          of Contents*




Stock-Based
      Compensation





The
      Company measures and recognizes expense for all share-based payments at fair
      value in accordance with SFAS No. 123 (Revised 2004), *Share-Based
      Payment* (SFAS
      No. 123R). The Company uses the Black-Scholes option valuation model to estimate
      fair value for all stock options on the date of grant. For stock options that
      vest over time, the Company recognizes compensation cost on a straight-line
      basis over the requisite service period for the entire award.





Research
      and Development Costs





Research
      and development costs, including salaries, research materials, administrative
      expenses and contractor fees, are charged to operations as incurred. The cost
      of
      equipment used in research and development activities which has alternative
      uses
      is capitalized as part of fixed assets and not treated as an expense in the
      period acquired. Depreciation of capitalized equipment used to perform research
      and development is classified as research and development expense in the year
      recognized.





Advertising
      and Marketing Costs





Advertising
      costs are expensed as incurred except for the cost of tradeshows and related
      marketing materials which are deferred until the tradeshow occurs. Advertising
      and marketing costs expensed (including tradeshows) were $598,663 and $441,196
      for the years ended June 30, 2008 and 2007, respectively. Marketing costs of
      $15,800 were included in prepaid expenses at June 30, 2008.





Legal
      Contingencies





In
      the
      ordinary course of business, the Company is involved in legal proceedings
      involving contractual and employment relationships, product liability claims,
      patent rights, environmental matters, and a variety of other matters. The
      Company is also 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 and has recorded an asset retirement obligation for
      these expenses.





The
      Company records contingent liabilities resulting from asserted and unasserted
      claims against it, when it is probable that a liability has been incurred and
      the amount of the loss is reasonably estimable. Estimating probable losses
      requires analysis of multiple factors, in some cases including judgments about
      the potential actions of third-party claimants and courts. Therefore, actual
      losses in any future period are inherently uncertain. Currently, the Company
      does not believe any probable legal proceedings or claims will have a material
      adverse effect on its financial position or results of operations. However,
      if
      actual or estimated probable future losses exceed the Company’s recorded
      liability for such claims, it would record additional charges as other expense
      during the period in which the actual loss or change in estimate
      occurred.





Income
      Taxes





Income
      taxes are accounted for under the liability method. Under this method, the
      Company provides deferred income taxes for temporary differences that will
      result in taxable or deductible amounts in future years based on the reporting
      of certain costs in different periods for financial statement and income tax
      purposes. This method also requires the recognition of future tax benefits
      such
      as net operating loss carryforwards, to the extent that realization of such
      benefits is more likely than not. Deferred tax assets and liabilities are
      measured using enacted tax rates expected to apply to taxable income in the
      years in which those temporary differences are expected to be recovered or
      settled. The effect on deferred tax assets and liabilities of a change in tax
      rates is recognized in operations in the period that includes the enactment
      of
      the change.




F-11
 *Table
          of Contents*




On
      July
      1, 2007, the Company adopted Financial Accounting Standards Board Interpretation
      No. 48, *Accounting
      for Uncertainty in Income Taxes* (FIN No.
      48). 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 are subject to examination of
      their income tax filings in the United States and state jurisdictions for the
      2004 through 2007 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 year ended
      June 30, 2008 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.





Income
      (Loss) Per Common Share





The
      Company accounts for its income (loss) per common share according to SFAS No.
      128, *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 and options to
      purchase the Company's common stock, are excluded from the calculations when
      their effect is antidilutive. At June 30, 2008 and 2007, 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 antidilutive due to the Company’s net loss position.





Securities
      that could be dilutive in the future as of June 30, 2008 and 2007 are as
      follows:


2008
              
              2007Preferred
                  stock
              
              
              59,065
              
              
              59,065Common
                  stock warrants
              
              
              3,245,082
              
              
              3,627,764Common
                  stock options
              
              
              2,803,393
              
              
              3,683,439Total
                  potential dilutive securities
              
              
              6,107,540
              
              
              7,370,268




Use
      of
      Estimates





The
      preparation of financial statements in accordance with accounting principles
      generally accepted in the United States of America requires management of the
      Company to make estimates and assumptions that affect the amounts reported
      in
      the financial statements and accompanying notes. Accordingly, actual results
      could differ from those estimates and affect the amounts reported in the
      financial statements.





Reclassifications





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




F-12
 *Table
          of Contents*


Impact
      of Recently Issued Accounting Pronouncements





In
      December 2007, FASB issued SFAS No. 141(R), *Business
      Combinations* (“SFAS 141R”), which replaces SFAS No. 141, *Business
      Combinations* (“SFAS 141”).
      SFAS 141R applies to all transactions and other events in which one entity
      obtains control over one or more other businesses. The standard requires the
      fair value of the purchase price, including the issuance of equity securities,
      to be determined on the acquisition date. SFAS 141R requires an acquirer to
      recognize the assets acquired, the liabilities assumed, and any noncontrolling
      interests in the acquiree at the acquisition date, measured at their fair values
      as of that date, with limited exceptions specified in the statement.
      SFAS 141R requires acquisition costs to be expensed as incurred and
      restructuring costs to be expensed in periods after the acquisition date.
      Earn-outs and other forms of contingent consideration are to be recorded at
      fair
      value on the acquisition date. Changes in accounting for deferred tax asset
      valuation allowances and acquired income tax uncertainties after the measurement
      period will be recognized in earnings rather than as an adjustment to the cost
      of the acquisition. SFAS 141R generally applies prospectively to business
      combinations for which the acquisition date is on or after the beginning of
      the
      first annual reporting period beginning on or after December 15, 2008 with
      early adoption prohibited. The implementation of this standard did not have
      a
      material impact on the Company’s consolidated financial position or results of
      operations.





In
      December 2007, the FASB issued statement No. 160, *Noncontrolling
      Interests in Consolidated Financial Statements – an amendment of ARB No.
      51* (SFAS
      160). The statement requires noncontrolling interests or minority interests
      to
      be treated as a separate component of equity, not as a liability or other item
      outside of permanent equity. Upon a loss of control, the interest sold, as
      well
      as any interest retained, is required to be measured at fair value, with any
      gain or loss recognized in earnings. Based on SFAS 160, assets and liablities
      will not change for subsequent purchase of sales transactions with
      noncontrolling interests as long as control is maintained. Differences between
      the fair value of consideration paid or received and the carrying value of
      noncontrolling interests are to be recognized as an adjustment to the parent
      interest’s equity. SFAS 160 is effective for fiscal years beginning on or after
      December 15, 2008 and earlier adoption is prohibited. The Company is currently
      evaluating the impact that the implementation of SFAS 160 will have with respect
      to the Company’s interest in UralDial.





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 No.
      159 will have a material effect on its consolidated financial
      statements.





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





**3.**  **Short-Term
      Investments**





The
      Company’s short-term investments consisted of the following at June 30, 2008 and
      2007:


2008
              
              2007Municipal
                  debt securities
              
              $
              3,726,000
              
              $
              3,000,000Corporate
                  debt securities
              
              
              —
              
              
              6,942,840$
              3,726,000
              
              $
              9,942,840




F-13
 *Table
          of Contents*




The
      Company’s municipal debt securities consist of auction rate securities (ARS)
      that are generally long-term debt instruments that provide liquidity through
      a
      modified Dutch auction process that resets the applicable interest rate at
      predetermined intervals, usually every 28 days. ARS generally trade at par
      and
      are callable at par on any interest payment date at the option of the issuer.
      Interest received during a given period is based upon the interest rate
      determined through the auction process. Although these securities are issued
      and
      rated as long-term bonds, they are priced and traded as short-term instruments
      because of the liquidity provided through the interest rate reset. This
      mechanism generally allows existing investors to roll over their holdings and
      continue to own their respective securities or liquidate their holdings by
      selling their securities at par value. The Company generally invests in these
      securities for short periods of time as part of its cash management
      program.





However,
      the uncertainties in the credit markets that began in February 2008 have
      prevented the Company and other investors from liquidating their holdings by
      selling their securities at par value as the amount of securities submitted
      for
      sale at recent ARS auctions has exceeded the market demand. These securities
      continue to pay interest according to their stated terms. For those securities
      that failed to auction, the Company continues to hold these securities and
      accrues interest at a higher rate than similar securities for which auctions
      have cleared. The Company's ARS are all AAA/Aaa rated investments and consist
      of
      various student loan portfolios with the vast majority of the student loans
      guaranteed by the U.S. Government under the Federal Family Education Loan
      Program. These securities were valued using a model that takes into
      consideration the financial conditions of the issuer and the bond insurers
      as
      well as the current illiquidity of the securities. If the credit ratings of
      the
      issuers deteriorate, the Company may adjust the carrying value of these
      investments. The Company is uncertain as to when the liquidity issues relating
      to these investments will improve.





None
      of
      the ARS investments in our portfolio were backed by sub-prime mortgage
      loans.





Although
      insufficient demand for certain ARS may continue, we anticipate, based on
      discussions with our investment advisors, that liquidity may possibly be
      realized through the emergence of secondary markets in the near term,
      particularly considering the high default interest rates, high credit ratings,
      the backing of the Federal Family Education Loan Program, and the historically
      low default rates of these securities. As such, we believe that the primary
      impact of the failed auctions is reduced liquidity rather than impairment of
      principal. In the event that we are unable to sell the investments at or above
      our carrying value, these securities may not provide us with a liquid source
      of
      cash.





Unrealized
      gains and temporary unrealized losses on these securities are recorded in other
      comprehensive income/loss within Shareholders' Equity. Declines in fair value
      that are considered other than temporary are recorded in the Consolidated
      Statements of Operations in loss on short-term investments. The Company has
      recognized the decline in fair value of the ARS as other than temporary and
      recorded the loss in the statement of operations rather than in other
      comprehensive income as the Company may need access to these funds before the
      uncertainties in the credit markets are fully resolved.





**4.**  **Inventory**





Inventory
      consisted of the following at June 30, 2008 and 2007:


2008
              
              2007Raw
                  materials
              
              $
              696,958
              
              $
              682,327Work
                  in process
              
              
              191,684
              
              
              120,242Finished
                  goods
              
              
              11,322
              
              
              78,265$
              899,964
              
              $
              880,834





The
      cost
      of materials and production costs contained in inventory that are not useable
      due to the passage of time, and resulting loss of bio-effectiveness, are written
      off to cost of product sales at the time it is determined that the product
      is
      not useable.




F-14
 *Table
          of Contents*




In
      June
      2007, the Company purchased $469,758 of enriched barium that will be used in
      future production of our isotope. The enriched barium is held by a Russian
      vendor and is included in raw materials at June 30, 2008 and
      2007.





**5.**  **Prepaid
      Expenses**





Prepaid
      expenses consisted of the following at June 30, 2008 and 2007:





2008
            
            2007Prepaid
                contract work
            
            $
            60,107
            
            $
            —Prepaid
                insurance
            
            
            38,059
            
            
            37,001Prepaid
                rent
            
            
            24,199
            
            
            26,693Other
                prepaid expenses
            
            
            106,960
            
            
            249,184Other
                current assets
            
            
            37,676
            
            
            145,245$
            267,001
            
            $
            458,123





**6.**  **Fixed
      Assets**





Fixed
      assets consisted of the following at June 30, 2008 and 2007:





2008
            
            2007Production
                equipment
            
            $
            2,786,748
            
            $
            807,838Office
                equipment
            
            
            153,215
            
            
            111,218Furniture
                and fixtures
            
            
            148,265
            
            
            118,227Leasehold
                improvements (a)
            
            
            4,622,136
            
            
            522,951Capital
                lease assets (b)
            
            
            222,911
            
            
            655,858Construction
                in progress
            
            
            64,219
            
            
            2,217,3727,997,494
            
            
            4,433,464Less
                accumulated depreciation
            
            
            (1,956,853
            )
            
            (767,913
            )$
            6,040,641
            
            $
            3,665,551





(a)  Balance
      includes asset retirement addition of $473,096 as of June 30, 2008.


(b)  Balance
      includes asset retirement addition of $119,160 as of June 30, 2007.





Depreciation
      and amortization expense related to fixed assets totaled $1,103,940 and $491,643
      for 2008 and 2007, respectively. Accumulated amortization of capital lease
      assets totaled $166,328 and $198,171 at June 30, 2008 and 2007,
      respectively.





The
      Company recorded an impairment charge of $85,000 in fiscal year 2008 for a
      hot
      cell that is not currently in use. This impairment charge is included in cost
      of
      product sales on the Consolidated Statement of Operations. The Company estimated
      its fair market value based on values for similar assets.





**7.**  **Restricted
      Cash**





The
      Washington Department of Health, effective October 2007, has required the
      Company to provide collateral for the decommissioning of its facility. To
      satisfy this requirement, the Company funded two certificates of deposits (CDs)
      totaling $172,500 in separate banks. The CDs both have original maturities
      of
      three months but are classified as long-term as the Company does not anticipate
      decommissioning the facility until the end of the current lease plus the lease
      option periods. Interest earned on the CDs is rolled-over at the maturity of
      each CD and becomes part of the restricted cash balance. Interest earned and
      added to restricted cash during the fiscal year ended June 30, 2008 was $3,352.
      These funds will be used to settle a portion of the Company’s remaining asset
      retirement obligations (Note 2).




F-15
 *Table
          of Contents*


**8.**  **Other
      Assets**





Other
      assets, net of accumulated amortization, consisted of the following at June
      30,
      2008 and 2007:





2008
            
            2007Deferred
                charges
            
            $
            322,319
            
            $
            297,008Patents
                and trademarks, net of accumulated amortization of $19,094 and
                $16,463
            
            
            22,721
            
            
            25,352$
            345,040
            
            $
            322,360





Deferred
      charges consist of prepaid legal fees for patents which have not yet been
      obtained, and prepayments and deposits on fixed assets and contracts.
      Amortization of patents and trademarks was $2,631 and $2,632 for the years
      ended
      June 30, 2008 and 2007, respectively.





**9.**  **Notes
      Payable**





Notes
      payable consisted of the following at June 30, 2008 and 2007:





2008
            
            2007Benton-Franklin
                Economic Development District (BFEDD) note payable (a)
            
            $
            145,745
            
            $
            185,848Hanford
                Area Economic Investment Fund Committee (HAEIFC) note payable
                (b)
            
            
            263,639
            
            
            391,610409,384
            
            
            577,458Less
                amounts due within one year
            
            
            (64,486
            )
            
            (49,212
            )Amounts
                due after one year
            
            $
            344,898
            
            $
            528,246





(a)
            The
                note payable to BFEDD, which is collateralized by substantially all
                of the
                Company’s assets, and guaranteed by certain shareholders, was executed
                pursuant to a Development Loan Agreement. The note contains certain
                restrictive covenants relating to: working capital; levels of long-term
                debt to equity; incurrence of additional indebtedness; payment of
                compensation to officers and directors; and payment of dividends.
                The note
                is payable in monthly installments including interest at 8.0% per
                annum
                with a final balloon payment due in October 2009. At June 30, 2008,
                the
                Company was not in compliance with certain of the covenants. The
                Company
                has obtained a waiver from BFEDD, relating to these covenants, through
                June 30, 2009.


(b)
            In
                June 2006, the Company entered into a note payable with HAEIFC, which
                is
                collateralized by receivables, inventory, equipment, and certain
                life
                insurance policies. 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 note contains certain restrictive covenants
                relating
                to: financial ratios; payment of compensation to officers and directors;
                and payment of dividends. The note accrues interest at 9% and is
                payable
                in monthly installments with the final installment due in July 2016.
                At
                June 30, 2008, the Company was not in compliance with certain of
                the
                covenants. The Company has obtained a waiver from HAEIFC, relating
                to
                these covenants, through June 30,
                2009.




F-16
 *Table
          of Contents*


Principal
      maturities on notes payable as of June 30, 2008 are as follows:





Year
                ending June 30,2009
            
            $
            64,4862010
            
            
            168,0082011
            
            
            49,7362012
            
            
            54,3792013
            
            
            59,503Thereafter
            
            
            13,272$
            409,384





**10.**  **Capital
      Lease Obligations**





The
      Company leases certain equipment under long-term agreements that represent
      capital leases. Future minimum lease payments under capital lease obligations
      are as follows:





Year
                ending June 30, 2009
            
            $
            27,627Total
                future minimum lease payments
            
            
            27,627Less
                amounts representing interest
            
            
            (2,067
            )Present
                value of net minimum lease payments
            
            
            25,560Less
                amounts due within one year
            
            
            (25,560
            )Amounts
                due after one year
            
            $
            —





**11.**  **Share-Based
      Compensation**





The
      following table presents the share-based compensation expense recognized in
      accordance with SFAS 123R during the years ended June 30, 2008 and
      2007:





Year
                ended June 30,2008
            
            2007Cost
                of product sales
            
            $
            109,578
            
            $
            120,710Research
                and development
            
            
            43,885
            
            
            41,481Sales
                and marketing expenses
            
            
            238,230
            
            
            216,432General
                and administrative expenses
            
            
            205,361
            
            
            1,449,491Total
                share-based compensation
            
            $
            597,054
            
            $
            1,828,114





The
      total
      value of the stock options awards is expensed ratably over the service period
      of
      the employees receiving the awards. As of June 30, 2008, total unrecognized
      compensation cost related to stock-based options and awards was $496,868 and
      the
      related weighted-average period over which it is expected to be recognized
      is
      approximately 0.75 years.





The
      Company currently provides share-based compensation under three equity incentive
      plans approved by the Board of Directors: the Amended and Restated 2005 Stock
      Option Plan (the Option Plan), the Amended and Restated 2005 Employee Stock
      Option Plan (the Employee Plan), and the 2006 Director Stock Option Plan (the
      Director Plan). The Option Plan allows the Board of Directors to grant options
      to purchase up to 1,800,000 shares of common stock to directors, officers,
      key
      employees and service providers of the Company. The Employee Plan allows the
      Board of Directors to grant options to purchase up to 2,000,000 shares of common
      stock to officers and key employees of the Company. The Director Plan allows
      the
      Board of Directors to grant options to purchase up to 1,000,000 shares of common
      stock to directors of the Company. Options granted under all 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.




F-17
 *Table
          of Contents*


On
      January 8, 2008, the Board of Directors unanimously adopted, subject to
      shareholder approval, the 2008 Employee Stock Option Plan (2008 Option Plan).
      The 2008 Option Plan would have allowed the Board of Directors to grant options
      to purchase up to 2,000,000 shares of common stock to selected employees,
      consultants, and advisors of the Company. Shareholder approval was not obtained
      for the 2008 Plan at the Company’s annual meeting held on February 20, 2008, and
      thus no grants have been or will be made under the 2008 Option
      Plan.





On
      June
      1, 2007, the Company issued an option grant to employees and directors. The
      options had an exercise price of $4.14 which was the closing market price of
      the
      Company’s stock on the grant date. The options issued to the employees vest over
      three years while the options granted to the non-employee directors were
      immediately vested.





The
      Company’s former CEO, who also served as Chairman of the Board, was granted
      150,000 options, and the former Executive Vice President Operations
      (EVP–Operations), who also served as a director, was granted 100,000 options,
      and all non-employee directors were granted 50,000 options each. On July 25,
      2007, the Board discussed the issue of director compensation and each director
      (including the employee directors) elected to cancel 50,000 of their options
      from the June 1, 2007 grant. After the cancellation, the former CEO and former
      EVP–Operations had 100,000 and 50,000 options, respectively, and the
      non-employee directors had no options from the June 1, 2007 grant. The terms
      of
      these remaining options for the former CEO and former EVP–Operations were not
      changed as part of the cancellation.





In
      accordance with SFAS 123R, all of the options that were cancelled have been
      accounted for as cancellation of options with no consideration. No additional
      compensation cost associated with the former CEO’s and EVP–Operations’ options
      will be recognized after the cancellation date of July 25, 2007. Cancelled
      options that had been granted to non-employee directors were immediately vested
      on the date of grant; therefore all related compensation cost was recognized
      in
      fiscal year 2007. Under SFAS 123R, the value of the cancelled options to each
      non-employee director was $128,500.





All
      of
      these subsequently cancelled options are included in the options granted and
      outstanding as of June 30, 2007 and are included in the options cancelled in
      fiscal year 2008.





A
      summary
      of stock option activity within the Company’s share-based compensation plans for
      the year ended June 30, 2008 is as follows:





Shares
            
            Price (a)
            
            Life (b)
            
            Value (c)Outstanding
                at June 30, 2008
            
            
            2,803,393
            
            $
            2.62
            
            
            7.63
            
            $
            25,000Vested
                and expected to vest atJune
                30, 2008
            
            
            2,768,607
            
            $
            2.60
            
            
            7.63
            
            $
            25,000Vested
                and exercisable atJune
                30, 2008
            
            
            2,442,001
            
            $
            2.42
            
            
            7.53
            
            $
            25,000





(a)
            Weighted
                average exercise price per share.


(b)
            Weighted
                average remaining contractual life.


(c)
            Aggregate
                intrinsic value.





The
      aggregate intrinsic value of options exercised during the years ended June
      30,
      2008 and 2007 was $25,300 and $2,286,370, respectively. The Company’s current
      policy is to issue new shares to satisfy option exercises.




F-18
 *Table
          of Contents*


The
      weighted average fair value of stock option awards granted and the key
      assumptions used in the Black-Scholes valuation model to calculate the fair
      value are as follows for the year ended June 30, 2008 and 2007:




Years
                ended June 30,2008
            
            2007Weighted
                average fair value of options granted
            
            $
            0.70
            
            $
            2.29Key
                assumptions used in determining fair value:Weighted
                average risk-free interest rate
            
            
            3.17
            %
            
            4.86
            %Weighted
                average life of the option (in years)
            
            
            6.00
            
            
            5.58Weighted
                average historical stock price volatility
            
            
            141.67
            %
            
            69.87
            %Expected
                dividend yield
            
            
            0.00
            %
            
            0.00
            %





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





**12.**  **Shareholders’
      Equity**





The
      authorized capital structure of the Company consists of $.001 par value
      preferred stock and $.001 par value common stock.





Preferred
      Stock





The
      Company's Certificate of Incorporation authorizes 6,000,000 shares of $0.001
      par
      value preferred stock available for issuance with such rights and preferences,
      including liquidation, dividend, conversion, and voting rights, as described
      below.





Series
      A





Series
      A
      preferred shares are entitled to a 10% dividend annually on the stated par
      value
      per share. These shares are convertible into shares of common stock at the
      rate
      of one share of common stock for each share of Series A preferred stock, and
      are
      subject to automatic conversion into common stock upon the closing of an
      underwritten public offering pursuant to an effective registration statement
      under the Securities Act of 1933 covering the offer and sale of common stock
      in
      which the gross proceeds to the Company are at least $4 million. Series A
      preferred shareholders have voting rights equal to the voting rights of common
      stock, except that the vote or written consent of a majority of the outstanding
      preferred shares is required for any changes to the Company’s Certificate of
      Incorporation, Bylaws or Certificate of Designation, or for any bankruptcy,
      insolvency, dissolution or liquidation of the Company. Upon liquidation of
      the
      Company, the Company’s assets are first distributed ratably to the Series A
      preferred shareholders. At June 30, 2008, there were no Series A preferred
      shares outstanding.





Series
      B





Series
      B
      preferred shares are entitled to a cumulative 15% dividend annually on the
      stated par value per share. These shares are convertible into shares of common
      stock at the rate of one share of common stock for each share of Series B
      preferred stock, and are subject to automatic conversion into common stock
      upon
      the closing of an underwritten public offering pursuant to an effective
      registration statement under the Securities Act of 1933 covering the offer
      and
      sale of common stock in which the gross proceeds to the Company are at least
      $4
      million. Series B preferred shareholders have voting rights equal to the voting
      rights of common stock, except that the vote or written consent of a majority
      of
      the outstanding preferred shares is required for any changes to the Company’s
      Certificate of Incorporation, Bylaws or Certificate of Designation, or for
      any
      bankruptcy, insolvency, dissolution or liquidation of the Company. Upon
      liquidation of the Company, the Company’s assets are first distributed ratably
      to the Series A preferred shareholders, then to the Series B preferred
      shareholders.




F-19
 *Table
          of Contents*




On
      February 1, 2007, the Board of Directors declared a dividend on the Series
      B
      Preferred Stock of all outstanding and cumulative dividends through December
      31,
      2006. The total dividends of $38,458 were paid on February 15, 2007. The Company
      does not anticipate paying any cash dividends on the Series B Preferred Stock
      in
      the foreseeable future. At June 30, 2008, there were 59,065 Series B preferred
      shares outstanding and cumulative dividends in arrears were
      $15,933.





In
      addition to the previously outstanding shares of common stock and Series B
      preferred stock, the Company had the following transactions that affected
      shareholders’ equity during the years ended June 30, 2008 and 2007.


Cancellation
        of Common Shares
 
 In
        March
        2008, the Company cancelled 148,112 shares of common stock held by Roger
        Girard,
        the Company’s former CEO, due to the release of Mr. Girard from certain personal
        guarantees of Company debt and due to Mr. Girard’s resignation as Chairman,
        President, and CEO.  The shares were originally issued in connection with
        Mr. Girard’s personal guarantee of Company debt or were contingent on his
        employment through August 2008.




March
      2007 Public Equity Offering





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





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





The
      warrants issued in the March 2007 Purchase Agreements were not accounted for
      as
      derivatives in accordance SFAS 133 paragraph 11(a), SFAS 150, and EITF
      00-19.





March
      2007 Warrant Call





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





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




F-20
 *Table
          of Contents*


August
      2006 Stock Purchase Agreement





On
      August
      17, 2006, the Company sold certain shares of its common stock and warrants
      to
      purchase common stock pursuant to a Common Stock and Warrant Purchase Agreement
      (the August 2006 Purchase Agreement) dated August 9, 2006. The securities were
      issued to 25 accredited investors pursuant to the exemption from registration
      provided by Section 4(2) of the Securities Act of 1933, as amended.
      MicroCapital, LLC acted as the lead investor for the transaction. Net proceeds
      of $4.7 million were received by the Company in exchange for the issuance of
      2,063,000 shares of common stock and warrants to purchase 2,063,000 shares
      of
      common stock. In addition, brokers assisting the Company with the capital raise
      were issued warrants to purchase 206,300 shares of common stock on identical
      terms as the warrants issued to investors.





Pursuant
      to the August 2006 Purchase Agreement, the purchase price per share of the
      Company’s common stock was $2.50, and the accompanying warrants were issued with
      an exercise price of $3.00 per share. The warrants and the August 2006 Purchase
      Agreement contained anti-dilution provisions, including one providing that,
      if
      the Company issues stock or rights to acquire stock at a price less than $2.00
      (excluding certain issuances such as options to employees, directors and certain
      consultants and shares issued in connection with licensing or leasing
      transactions), the Company is required to issue to each investor additional
      shares equal to 25% of what such investor purchased in the original transaction.
      The warrants were exercisable by the holder (subject to anti-dilution and
      adjustment provisions) for a period of five years from the date of issuance.
      The
      warrants were callable by the Company for 45 days after a period of 60 trading
      days in which the price of the underlying stock exceeds $4.50 per share for
      30
      of the 60 days, and only if a registration statement covering the underlying
      shares is effective.





In
      connection with the August 2006 Purchase Agreement, the Company also entered
      into a Registration Rights Agreement whereby the Company agreed to file a
      registration statement to cover the re-sale of the shares of common stock sold
      and issuable upon exercise of the warrants. Under the Registration Rights
      Agreement, the Company agreed to file the registration statement within 60
      days
      of the closing, cure any defect causing the registration statement to fail
      to be
      effective within ten business days, and cause suspension periods for the
      registration statement to not exceed 60 days in any 360 day period. A Form
      SB-2
      Registration Statement to register these shares was filed with the SEC on
      October 16, 2006 and declared effective on December 5, 2006.





The
      warrants issued in the August 2006 Purchase Agreement were not accounted for
      as
      derivatives in accordance SFAS 133 paragraph 11(a), SFAS 150, and EITF
      00-19.





Warrants
      to Purchase Series B Preferred Stock





Pursuant
      to a private placement of debt units during 2003 and 2004, a predecessor company
      issued $365,000 of notes payable to investors and granted warrants for the
      purchase of 227,750 of its Class A member shares. Through a series of mergers,
      these warrants were exchanged for warrants to purchase 323,830 Series B
      preferred shares. The warrants activity is summarized as follows:




F-21
 *Table
          of Contents*




2008
            
            2007Warrants
            
            Price
                (a)
            
            Warrants
            
            Price
                (a)Beginning
                balance outstanding
            
            
            –
            
            $
            –
            
            
            179,512
            
            $
            0.79Converted
                to common warrants (b)
            
            
            –
            
            
            –
            
            
            (142,190
            )
            
            0.70Exercised
            
            
            –
            
            
            –
            
            
            (37,322
            )
            
            1.12Ending
                balance outstanding
            
            
            –
            
            $
            –
            
            
            –
            
            $
            –





(a)
            Weighted
                average exercise price per share.


(b)
            During
                fiscal year 2007, one preferred warrant holder requested the Board
                of
                Directors to extend the expiration date of his warrants and to convert
                them to common warrants. The Board granted this request and set new
                expiration dates as noted below. The exercise price was not changed.
                The
                change in expiration date and the conversion to common warrants was
                a
                modification of the original warrant based on market conditions and
                was
                accounted for as a financing transaction similar to a modification
                of the
                offering price of shares in a stock sale. Therefore there was no
                effect on
                the statement of operations as the Company had previously determined
                that
                under SFAS 133 and EITF 00-19 these warrants were equity instruments
                rather than derivatives. These converted common warrants are summarized
                as
                follows:





Number of Warrants
            
            Price
            
            New Expiration Date
            
            Old Expiration Date56,876
            
            $
            0.70
            
            
            October
                30, 2007
            
            
            October
                30, 200628,438
            
            
            0.70
            
            
            January
                31, 2009
            
            
            January
                31, 200756,876
            
            
            0.70
            
            
            March
                30, 2010
            
            
            March
                30, 2007142,190





Warrants
      to Purchase Common Stock





In
      connection with the various common stock offerings and at other times the
      Company has issued warrants for the purchase of common stock. The warrants
      activity is summarized as follows:





2008
            
            2007Warrants
            
            Price
                (a)
            
            Warrants
            
            Price
                (a)Beginning
                balance outstanding
            
            
            3,627,764
            
            $
            5.31
            
            
            2,502,769
            
            $
            5.73Warrants
                issued
            
            
            –
            
            
            –
            
            
            3,301,926
            
            
            3.59Converted
                from preferred (b)
            
            
            –
            
            
            –
            
            
            142,190
            
            
            0.70Cancelled/expired
            
            
            (91,806
            )
            
            4.18
            
            
            (23,615
            )
            
            2.54Exercised
            
            
            (290,876
            )
            
            3.48
            
            
            (2,295,506
            )
            
            2.99Ending
                balance outstanding
            
            
            3,245,082
            
            $
            5.50
            
            
            3,627,764
            
            $
            5.31





(a)
            Weighted
                average exercise price per share.


(b)
            During
                fiscal year 2007, one preferred warrant holder requested the Board
                of
                Directors to extend the expiration date of his warrants and to convert
                them to common warrants. The Board granted this request and set new
                expiration dates as noted in the Warrants to Purchase Series B Preferred
                Stock section of this footnote.





On
      January 8, 2008, the Board of Directors retroactively extended the expiration
      dates of warrants issued pursuant to the Company’s private placement memorandums
      dated October 17, 2005 and February 1, 2006 for an additional one-year period.
      These warrants began expiring in October 2007. Based on the extension, the
      warrants will now expire between October 2008 and February 2009. No other terms
      or conditions of the warrants were changed. The change in expiration dates
      affected outstanding warrants to purchase 2,102,142 shares of common stock.
      Of
      these outstanding warrants, there were warrants to purchase 18,000 common shares
      held by two directors of the Company. Prior to the extension, warrants to
      purchase 1,186,219 shares of common stock had passed their original expiration
      dates.




F-22
 *Table
          of Contents*




The
      change in expiration date was a modification of the original warrant based
      on
      market conditions and was accounted for as a financing transaction similar
      to an
      extension of time in the offering of shares in a stock sale. Therefore there
      was
      no effect on the statement of operations as the Company had previously
      determined that under SFAS 133 and EITF 00-19 these warrants were equity
      instruments rather than derivatives.





The
      following table summarizes additional information about the Company’s common
      warrants outstanding as of June 30, 2008:





Number of Warrants
            
            Range of Exercise Prices
            
            Expiration Date53,000
            
            $
            6.00
            
            
            October
                2008162,500
            
            $
            6.00
            
            
            November
                2008909,469
            
            $
            6.00
            
            
            December
                200828,438
            
            $
            0.70
            
            
            January
                2009700,250
            
            $
            6.00
            
            
            January
                2009276,923
            
            $
            6.00
                to $6.50
            
            
            February
                200956,876
            
            $
            0.70
            
            
            March
                2010826,100
            
            $
            5.00
            
            
            March
                2011206,526
            
            $
            4.40
            
            
            March
                201225,000
            
            $
            2.00
            
            
            July
                20153,245,082





Common
      Stock Options





A
      summary
      of the Company’s stock option activity and related information for the years
      ended June 30, 2008 and 2007 is as follows:





2008
            
            2007Shares
            
            Price
                (a)
            
            Shares
            
            Price
                (a)Beginning
                balance outstanding
            
            
            3,683,439
            
            $
            2.86
            
            
            3,129,692
            
            $
            2.05Granted
                (b) (c)
            
            
            100,000
            
            
            0.75
            
            
            1,488,700
            
            
            3.67Cancelled
                (c)
            
            
            (970,046
            )
            
            3.35
            
            
            (179,454
            )
            
            2.68Exercised
            
            
            (10,000
            )
            
            1.19
            
            
            (755,499
            )
            
            1.16Ending
                balance outstanding
            
            
            2,803,393
            
            $
            2.62
            
            
            3,683,439
            
            $
            2.86Exercisable
                at end of year
            
            
            2,442,001
            
            $
            2.42
            
            
            2,528,172
            
            $
            2.45





(a)
            Weighted
                average exercise price per share.


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


(c)
            Included
                in options granted in fiscal year 2007 are 350,000 options granted
                with an
                exercise price of $4.14 to members of the Board of Directors that
                were
                subsequently cancelled on July 25, 2007. 100,000 of these options
                were
                granted to the Company’s former CEO and former EVP–Operations
                and were to vest over three years. The remaining 250,000 options
                were
                granted to non-employee Directors and were immediately vested. These
                options are included in the options cancelled in fiscal year 2008.
                See
                Note 11 for a further discussion of these cancelled
                options.




F-23
 *Table
          of Contents*


The
      following table summarizes additional information about the Company’s stock
      options outstanding as of June 30, 2008:





Options Outstanding
            
            Options ExercisableRange of Exercise Prices
            
            Shares
            
            Price (a)
            
            Life (b)
            
            Shares
            
            Price (a)$0.75
                to $1.19
            
            
            887,184
            
            $
            1.11
            
            
            7.36
                yrs
            
            
            887,184
            
            $
            1.11$1.96
                to $2.00
            
            
            653,791
            
            
            1.98
            
            
            7.09
                yrs
            
            
            653,791
            
            
            1.98$3.10
                to $3.11
            
            
            512,666
            
            
            3.11
            
            
            8.17
                yrs
            
            
            414,862
            
            
            3.11$3.50
                to $3.85
            
            
            200,000
            
            
            3.74
            
            
            8.00
                yrs
            
            
            149,999
            
            
            3.78$4.14
                to $4.15
            
            
            244,702
            
            
            4.14
            
            
            8.26
                yrs
            
            
            120,737
            
            
            4.14$4.40
            
            
            83,800
            
            
            4.40
            
            
            8.68
                yrs
            
            
            27,928
            
            
            4.40$5.50
                to $6.50
            
            
            221,250
            
            
            6.06
            
            
            7.65
                yrs
            
            
            187,500
            
            
            6.11Total
                options
            
            
            2,803,393
            
            
            
            
            
            
            
            
            2,442,001





(a)
            Weighted
                average exercise price.


(b)
            Weighted
                average remaining contractual life.





**13.**  **Treasury
      Stock**





In
      June
      2008, the Board of Directors of IsoRay authorized the repurchase of up to
      1,000,000 shares of the Company’s common stock. During June 2008, the Company
      repurchased 5,000 shares of its common stock for $3,655.





**14.**  **Income
      Taxes**





The
      Company recorded no income tax provision or benefit for the years ended June
      30,
      2008 and 2007.





The
      Company had a net deferred tax asset of approximately $9.3 and $6.7 million
      as
      of June 30, 2008 and 2007, respectively. The deferred tax asset has arisen
      principally from net operating loss carryforwards, share-based compensation,
      depreciation and amortization, and accrued compensation. The deferred tax asset
      was calculated based on the currently enacted 34% statutory income tax rate.
      Since management of the Company cannot determine if it is more likely than
      not
      that the Company will realize the benefit of its net deferred tax asset, a
      valuation allowance equal to the full amount of the net deferred tax asset
      at
      June 30, 2008 and 2007 has been established.





At
      June
      30, 2008, the Company had tax basis net operating loss carryforwards of
      approximately $27 million available to offset future regular taxable income.
      These net operating loss carryforwards expire through 2028.





**15.**  **401(k)
      and Profit Sharing Plan**





The
      Company has a 401(k) plan, which commenced in fiscal year 2007, covering all
      eligible full-time employees of the Company. Contributions to the 401(k) plan
      are made by the participants to their individual accounts through payroll
      withholding. The 401(k) plan also allows the Company to make contributions
      at
      the discretion of management. To date, the Company has not made any
      contributions to the 401(k) plan.





**16.**  **Related
      Party Transactions**





The
      Company received various legal services for assistance with the common stock
      and
      warrant offerings, lease and contract review, and other general counsel support
      from a law firm in which one of the firm’s partners was formerly a member of the
      Company’s Board of Directors (until his resignation in February 2008). The total
      amounts paid in 2008 and 2007 to the law firm were $426,430 and $458,534,
      respectively. The 2008 amount includes approximately $10,000 accrued in accounts
      payable as of June 30, 2008.




F-24
 *Table
          of Contents*


**17.**  **UralDial,
      LLC**





On
      January 23, 2008, the Company, through its subsidiary IsoRay International
      LLC,
      became a 30% owner in a Russian limited liability company, UralDial, LLC
      (UralDial), a new company based in Yekaterinburg, Russia. The Company is
      currently working on a distribution agreement with UralDial through which the
      Company will sell its Proxcelan Cs-131 brachytherapy seeds to UralDial for
      distribution to medical centers in Russia. From its formation through June
      30,
      2008, UralDial did not have any significant activity and does not have any
      significant asset or liabilities.





**18.**  **Commitments
      and Contingencies**





Royalty
      Agreement for Invention and Patent Application





A
      shareholder of the Company previously assigned his rights, title and interest
      in
      an invention to IsoRay Products LLC (a predecessor company) in exchange for
      a
      royalty equal to 1% of the Gross Profit, as defined, from the sale of “seeds”
incorporating the technology. The patent and associated royalty obligations
      were
      transferred to the Company in connection with the merger transaction (see Note
      1).





The
      Company must also pay a royalty of 2% of Gross Sales, as defined, for any
      sub-assignments of the aforesaid patented process to any third parties. The
      royalty agreement will remain in force until the expiration of the patents
      on
      the assigned technology, unless earlier terminated in accordance with the terms
      of the underlying agreement.





During
      fiscal years 2008 and 2007, the Company recorded royalty expenses of $21,219
      and
      $2,161, respectively.





Patent
      and Know-How Royalty License Agreement





IsoRay
      Products LLC was the holder of an exclusive license with Donald Lawrence to
      use
      certain “know-how.” This license was transferred to Medical and subsequently to
      the Company in connection with the merger transaction (see Note 1). The terms
      of
      the original license agreement required 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, 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.





The
      licensor of the Lawrence “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.





Battelle
      Memorial Institute Production Agreement





In
      April
      2004, IsoRay Products LLC entered into an agreement with Battelle Memorial
      Institute, Pacific Northwest Division (Battelle), the operator of the Pacific
      Northwest National Laboratory, for certain production-related services and
      facilities. This agreement was assumed by Medical and subsequently by the
      Company following the merger transaction (see Note 1). In accordance with the
      terms of the agreement, the Company is required to make advance payments, which
      are then applied against billings by Battelle as services are provided. During
      the years ended June 30, 2008 and 2007, the Company incurred $142,991 and
      $151,065, respectively, of costs for production-related services and facilities
      provided by Battelle. At June 30, 2008, prepaid expenses included $60,107
      related to this agreement. The agreement, which expires December 31, 2008,
      may
      be terminated at any time by either party, upon giving a 60-day written notice
      to the other party.




F-25
 *Table
          of Contents*




Operating
      Lease Agreements





The
      Company leases office and laboratory space and production and office equipment
      under noncancelable operating leases. The lease agreements require monthly
      lease
      payments and expire on various dates through April 2016 (including renewal
      dates). The Company’s significant lease is described below.





On
      May 2,
      2007, Medical entered into a lease for its new production facility with Energy
      Northwest, the owner of the Applied Process Engineering Laboratory (the APEL
      lease). The new lease originally provided the Company with 19,328 square feet
      of
      manufacturing and office space and the Company has moved all manufacturing
      operations to this new leased space as of September 2007 and vacated its leased
      space at the PEcoS-IsoRay Radioisotope Laboratory (PIRL). The
      APEL
      lease has a three year term expiring on April 30, 2010, plus options to renew
      for two additional three-year terms, and monthly rent of approximately $26,700,
      subject to annual increases based on the Consumer Price Index, plus monthly
      janitorial expenses of approximately $700. Due to the severe economic penalty
      associated with not exercising the two lease renewal options, the Company
      currently intends to exercise both of the three-year renewal options at the
      appropriate time in the lease. Subsequent to the initial signing of this lease,
      the Company reconfigured its space requirements and returned some lab space
      to
      Energy Northwest. This has reduced the Company’s rent to approximately $24,200
      per month plus monthly janitorial expenses of approximately $550 per
      month.





On
      October 10, 2007, the Company executed a Lease Agreement with Perma-Fix
      Northwest Richland, Inc. (Perma-Fix).  The Lease Agreement had an effective
      date of September 1, 2007, and provided for the continuation of the Company's
      lease of its PIRL facility located at 2025 Battelle Boulevard, Richland,
      Washington.  The Company originally leased this facility from Nuvotec USA,
      Inc. under a Lease Agreement dated February 9, 2005, but Nuvotec USA, Inc.
      subsequently sold the facility to Perma-Fix.  The new lease term was
      through January 31, 2008, with early termination permitted upon 45 days prior
      written notice. The Company terminated this lease in mid-December
      2007.





Future
      minimum lease payments under operating leases including the two three-year
      renewals of the APEL lease, which the Company intends to exercise, are as
      follows:





Year
                ending June 30,2009
            
            $
            315,0272010
            
            
            314,8842011
            
            
            310,7822012
            
            
            299,5402013
            
            
            297,015Thereafter
            
            
            841,541$
            2,378,789





Rental
      expense amounted to $354,202 and $207,044 for the years ended June 30, 2008
      and
      2007, respectively.





License
      Agreement with IBt





In
      February 2006, the Company signed a license agreement with International
      Brachytherapy SA (IBt), a Belgian company, covering North America and providing
      the Company with access to IBt’s Ink Jet production process and its proprietary
      polymer seed technology for use in brachytherapy procedures using Cs-131. Under
      the original agreement royalty payments were to be paid on net sales revenue
      incorporating the technology.




F-26
 *Table
          of Contents*


On
      October 12, 2007, the Company entered into Amendment No. 1 (the Amendment)
      to
      its License Agreement dated February 2, 2006 with IBt. The Company paid license
      fees of $275,000 (under the original agreement) and $225,000 (under the
      Amendment) during fiscal years 2006 and 2008, respectively. The Amendment
      eliminates the previously required royalty payments based on net sales revenue,
      and the parties intend to negotiate terms for future payments by the Company
      for
      polymer seed components to be purchased at IBt's cost plus a to-be-determined
      profit percentage. No agreement has been reached on these terms and there is
      no
      assurance that the parties will consummate an agreement pursuant to such
      terms.





**19.**  **Concentrations
      of Credit and Other Risks**





Financial
      Instruments





The
      Company’s financial instruments that are exposed to concentrations of credit
      risk consist primarily of cash and cash equivalents, short-term investments,
      and
      accounts receivable.





The
      Company’s cash and cash equivalents are maintained with high-quality financial
      institutions. The accounts are guaranteed by the Federal Deposit Insurance
      Corporation (FDIC) up to $100,000. At June 30, 2008, uninsured cash balances
      totaled approximately $4.6 million.





Short-term
      investments are held by a major, high-quality financial institution. Generally,
      these securities are traded in a highly liquid market and may be redeemed upon
      demand and bear minimal risk. As discussed in Note 3, the Company has been
      unable to liquidate its municipal debt securities due to uncertainties in the
      credit markets. The Company is uncertain as to when the liquidity issues related
      to these investments will improve.





The
      Company’s accounts receivable result from credit sales to customers. The Company
      had two customers whose sales were greater than 10% for each of the years ended
      June 30, 2008 and 2007, respectively. These customers represented a combined
      34.3% and 37.7% of the Company’s total revenues for the years ended June 30,
      2008 and 2007, respectively. These same customers accounted for a combined
      38.4%
      and 25.6% of the Company’s net accounts receivable balance at June 30, 2008
      and 2007, respectively.





The
      loss
      of any of these significant customers would have a temporary adverse effect
      on
      the Company’s revenues, which would continue until the Company located new
      customers to replace them.





The
      Company routinely assesses the financial strength of its customers and provides
      an allowance for doubtful accounts as necessary.





Inventories





Most
      components used in the Company’s product are purchased from outside sources.
      Certain components are purchased from single suppliers. The failure of any
      such
      supplier to meet its commitment on schedule could have a material adverse effect
      on the Company’s business, operating results and financial condition. If a
      sole-source supplier or a supplier of Cs-131 or irradiated barium were to go
      out
      of business or otherwise become unable to meet its supply commitments, the
      process of locating and qualifying alternate sources could require up to several
      months, during which time the Company’s production could be delayed. Such delays
      could have a material adverse effect on the Company’s business, operating
      results and financial condition.




F-27
 *Table
          of Contents*




**20.**  **Subsequent
      Events**





The
      following events and transactions have occurred subsequent to June 30,
      2008:





FDA
      Inspection





The
      Company underwent its first inspection by the Food and Drug Administration
      (FDA)
      in July 2008. The inspection covered the manufacturing and quality systems
      at
      its Richland facility. At the end of the inspection, no report of deviations
      from Good Manufacturing Practices or list of observations (form FDA 483) was
      issued to IsoRay.





Extension
      of Warrants





On
      August
      20, 2008, the Board of Directors extended the expiration dates of warrants
      issued pursuant to the Company’s private placement memorandums dated October 17,
      2005 and February 1, 2006 for an additional one-year period. These warrants
      originally began expiring in October 2007 but were retroactively extended for
      a
      one-year term on January 8, 2008 (Note 12). Based on this additional extension,
      the warrants will now expire between October 2009 and February 2010. No other
      terms or conditions of the warrants were changed. The change in expiration
      dates
      affected outstanding warrants to purchase 2,102,142 shares of common stock.
      Of
      these outstanding warrants there were warrants to purchase 12,500 shares held
      by
      the Chairman and Interim CEO of the Company.




F-28
 *Table
          of Contents*


**SIGNATURES**





In
      accordance with the requirements of Section 13 or 15(d) of the Securities
      Exchange Act of 1934, the Company caused this report to be signed on its behalf
      by the undersigned, thereunto duly authorized.





Dated:
      September 29, 2008





ISORAY,
                INC., a Minnesota corporationBy
            /s/
                Dwight BabcockDwight
                Babcock, Interim Chief Executive OfficerBy
            /s/
                Jonathan R. HuntJonathan
                R. Hunt, Chief Financial Officer








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