UNITED
          STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
        D.C. 20549
  FORM
        10-KSB
  x
              **Annual
                  Report of Small Business Issuers under Section 13 or 15(d) of the
                  Securities Exchange Act of
                  1934**
 For
        the
        fiscal year ended June 30, 2007
 
 or
 
  ̈
              **Transition
                  Report of Small Business Issuers under Section 13 or 15(d) of the
                  Securities Exchange Act of
                  1934**
 For
        the
        transition period from __________ to ____________
 
 Commission
        File No. 001-33407
  **ISORAY,
        INC.**
 (Exact
        name of registrant as specified in its charter)
  Minnesota
              
              41-1458152(State
                  of incorporation)
              
              (I.R.S.
                  Employer Identification No.)350
                  Hills St., Suite 106
                Richland,
                  Washington 99354
              
              (509)
                  375-1202(Address
                  of principal executive offices)
              
              (Registrant’s
                  telephone number)Issuer's
                  telephone number, including area code:(509)
                  375-1202Securities
                  registered under Section 12 (b) of the Exchange Act –
                  Common
                  Stock – $0.001 par value
                (American
                  Stock Exchange)
                
                Securities
                  registered under Section 12(g) of the Exchange Act – Series C Preferred
                  Share PurchaseRightsNumber
                  of shares outstanding of each of the issuer's classes of common
                  equity:
  Class
              
              Outstanding
                  as of September 12, 2007Common
                  stock, $0.001 par value
              
              23,033,108
 
 Check
        whether the issuer is not required to file reports pursuant to Section 13
        or
        15(d) of the Exchange Act. o
  Check
        whether the issuer has (1) filed all reports required to be filed by Section
        13
        or 15(d) of the Exchange Act during the past 12 months (or for such shorter
        period the Company was required to file such reports), and (2) has been subject
        to such filing requirements for the past 90 days. Yes x No o
  Check
        if
        there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-B contained in this form, and no disclosure will be contained,
        to
        the best of Company's knowledge, in definitive proxy or information statements
        incorporated by reference in Part III of this Form 10-KSB or any amendment
        to
        this Form 10-KSB. o
  Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act):  Yes o No x
  State
        issuer’s revenues for its most recent fiscal year – $5,738,033.
  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
        sold, or the average bid and asked prices of such common equity, as of a
        specified date within the past 60 days - $77,633,857 as of September 12,
        2007.
  Documents
        incorporated by reference – none.
  Transitional
        Small Business Disclosure Format: Yes o No x
  
  **ISORAY,
        INC.**
 
 **Table
        of Contents**
  PagePART
                    IITEM
                    1 – DESCRIPTION OF BUSINESS
                
                1ITEM
                    2 – DESCRIPTION OF PROPERTY
                
                28ITEM
                    3 – LEGAL PROCEEDINGS
                
                29ITEM
                    4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
                
                29PART
                    IIITEM
                    5 – MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
                    MATTERS
                
                29ITEM
                    6 – MANAGEMENT’S DISCUSSION AND ANALYSIS
                
                31ITEM
                    7 – FINANCIAL STATEMENTS
                
                44ITEM
                    8 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                    FINANCIAL DISCLOSURE
                
                44ITEM
                    8A – CONTROLS AND PROCEDURES
                
                45ITEM
                    8B – OTHER INFORMATION
                
                46PART
                    IIIITEM
                    9 – DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND
                    CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
                    ACT
                
                46ITEM
                    10 – EXECUTIVE COMPENSATION
                
                50ITEM
                    11 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                    MANAGEMENT
                
                54ITEM
                    12 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                    INDEPENDENCE
                
                56ITEM
                    13 – EXHIBITS AND REPORTS ON FORM 8-K
                
                57ITEM
                    14 – PRINCIPAL ACCOUNTANT FEES AND SERVICES
                
                62SIGNATURES
                
                63
  
  **Caution
        Regarding Forward-Looking Information**
 
 *In
        addition to historical information, this Form 10-KSB 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-KSB, other than statements of historical
        facts, that address future activities, events or developments are
        forward-looking statements, including, but not limited to, statements containing
        the words "believe," "expect," "anticipate," "intends," "estimate," "forecast,"
        "project," and similar expressions. All statements other than statements
        of
        historical fact are statements that could be deemed forward-looking statements,
        including any statements of the plans, strategies and objectives of management
        for future operations; any statements concerning proposed new products,
        services, developments or industry rankings; any statements regarding future
        revenue, economic conditions or performance; any statements of belief; and
        any
        statements of assumptions underlying any of the foregoing. These statements
        are
        based on certain assumptions and analyses made by us in light of our experience
        and our assessment of historical trends, current conditions and expected
        future
        developments as well as other factors we believe are appropriate under the
        circumstances. However, whether actual results will conform to the expectations
        and predictions of management is subject to a number of risks and uncertainties
        described under “Risk Factors” beginning on page 21 below that may cause actual
        results to differ materially.*
 
 *Consequently,
        all of the forward-looking statements made in this Form 10-KSB 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-KSB, unless the context requires otherwise, “we” or “us” or the
“Company” means IsoRay, Inc. and its subsidiary.
 
 **ITEM
        1**–**DESCRIPTION OF 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 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.
  1
  **Available
        Information**
 
 The
        Company electronically files its annual reports on Form 10-KSB, quarterly
        reports on Form 10-QSB, 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
        is
        utilizing its patented radioisotope technology, experienced chemists and
        engineers, and management team to produce a major therapeutic medical isotope
        with a goal of providing improved patient outcomes in the treatment of prostate
        cancer and other malignant disease. IsoRay began production and sales of
        Proxcelan Cesium-131 (Cs-131) brachytherapy seed, in October 2004 for the
        treatment of prostate cancer after clearance of its premarket notification
        (510(k)), by the Food and Drug Administration (FDA). Cs-131 could also enable
        meaningful market penetration for other solid tumor applications such as
        breast,
        lung, liver, brain and pancreatic cancer, expanding the total available market
        opportunity for brachytherapy. Management believes this technology will allow
        it
        to capture a leadership position in an expanded 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, if not more so
        than,
        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 direct
        to the
        tumor than is possible with external beam radiation. Each seed contains a
        radioisotope sealed within a welded titanium capsule. Approximately 70 to
        120
        seeds are permanently implanted in the prostate in an outpatient procedure
        lasting less than one hour. 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 external beam radiation
        therapy or 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
  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. Early studies demonstrate that Cs-131 is well
        tolerated with minimal to moderate urinary symptoms that resolve relatively
        rapidly, within approximately 4-8 weeks. (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.)
 
 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.)
 
 IsoRay
        and its predecessor companies have accomplished the following key milestones
        (listed in reverse chronological order):
 §
              Opened
                  a new manufacturing and production facility at the Applied Process
                  Engineering Laboratory to replace thePEcoS-IsoRay
                  Radioisotope Laboratory (PIRL)
                  facility (September 2007);
 §
              Treated
                  over 1,600 patients with Proxcelan Cs-131 seeds (October 2004 to
                  September
                  2007);
 §
              Deployed
                  and grew the direct sales force to 11 people in the market (July
                  2007);
 §
              Branded
                  Cs-131 seeds as Proxcelan Cesium-131 brachytherapy seeds (July
                  2007);
 §
              Developed
                  a dual therapy treatment protocol with 9 centers participating
                  (June
                  2007);
 §
              Raised
                  over $42 million in debt and equity funding (September 2003 - June
                  2007);
 §
              Filed
                  additional patent applications for the production of purified Cs-131
                  (November 2003 – February 2007);
 §
              Completed
                  the monotherapy treatment protocol for prostate cancer (February
                  2007);
 §
              Obtained
                  FDA 510(k) clearance to market preloaded brachytherapy seeds (preloaded
                  Mick cartridges, strands, and needles) (November
                  2006);
 §
              Opened
                  a manufacturing and production facility at PIRL (October
                  2005);
 §
              Treated
                  the first patient with Cs-131 seeds (October
                  2004);
 §
              Commenced
                  production of the Cs-131 seed (August
                  2004);
 §
              Obtained
                  a Nuclear Regulatory Commission Sealed Source and Device Registration
                  required by the Washington State Department of Health and the FDA
                  (September 2004);
 §
              Received
                  a Radioactive Materials License from the Washington State Department
                  of
                  Health (July 2004);
 §
              Signed
                  a Commercial Work for Others Agreement between Battelle (manager
                  of the
                  Pacific Northwest National Laboratory or PNNL) and IsoRay, allowing
                  initial production of seeds through 2006 at PNNL (April
                  2004);
 §
              Obtained
                  Medicare reimbursement codes for the Cs-131 brachytherapy seed
                  (November
                  2003);
 §
              Obtained
                  FDA 510(k) clearance to market the first product: the Cs-131 brachytherapy
                  seed (March 2003);
   3
  §
              Implemented
                  a quality management system and production operating procedures
                  that are
                  compliant with the FDA’s Quality System Regulation (QSR) (January
                  2003);
 §
              Completed
                  prototype radioactive seed production, design verification, computer
                  modeling of the radiation profile, and actual dosimetric data compiled
                  by
                  the National Institute of Standards and Technology and PNNL (October
                  2002); and
 §
              Obtained
                  the initial patent for Cs-131 isotope separation and purification
                  (May
                  2000).
  **Industry
        Information**
 
 *Incidence
        of Prostate Cancer*
 
 According
        to the American Cancer Society, prostate cancer 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 218,890
        new
        cases of prostate cancer diagnosed and an estimated 27,050 deaths associated
        with the disease in the United States in 2007. Because of early detection
        techniques (e.g., screening for prostate specific antigen, or PSA) approximately
        70% (153,200) of these cases are potentially treatable with seed brachytherapy,
        when the cancers are still locally confined within the prostate.
 
 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 man in six will be diagnosed with
        prostate cancer during his lifetime.
 
 The
        American Cancer Society lists the following factors that can increase the
        risk
        of developing prostate cancer:
 §
              Age
                  – about 2 out of every 3 prostate cancers are found in men over the
                  age of
                  65;
 §
              Race
                  – prostate cancer is more prevalent in African-American men who are
                  also
                  twice as likely to die of the
                  disease;
 §
              Nationality
                  – prostate cancer is most common in North America and northwestern
                  Europe;
 §
              Family
                  history – men are more likely to have prostate cancer if a close relative
                  had the disease and especially if the relatives were young at the
                  time of
                  diagnosis;
 §
              Diet
                  – men who eat more red meat or high-fat dairy products seem to have
                  a
                  greater chance of getting prostate cancer;
                  and
 §
              Exercise
                  – men over the age of 65 who exercised vigorously had a lower rate
                  of
                  prostate cancer.
 
 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. Currently, one out of every six men is at lifetime risk
        of
        developing prostate cancer. At the age of 70, the chance of having prostate
        cancer is 12 times greater than at age 50. According to the American Cancer
        Society, prostate cancer incidence rates increased between 1988 and 1992
        due to
        earlier diagnosis in men who otherwise had no sign of symptoms. Early screening
        has fostered a decline in the prostate cancer death rate since
        1990.
 
 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.
  4
  *Brachytherapy*
 
 There
        is
        a large and growing potential market for the Company’s products.  Several
        significant clinical and market factors are contributing to the increasing
        popularity of the brachytherapy procedure.
 
 Management
        believes that brachytherapy in Europe is growing aggressively each year,
        with
        the use of I-125 growing by approximately 30% in 2006. Management expects
        that
        market growth in the U.S. will increase at the rate of 5% per year through
        2011.
 
 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
        2006 it was estimated that over 60,000 brachytherapy procedures were performed
        to treat prostate cancer.
 
 Management
        believes that brachytherapy as a treatment is now more common than radical
        prostatectomy and has become the treatment of choice for early-stage prostate
        cancer.  Considerable attention is now being given to higher risk and
        faster growing prostate cancers as well.  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).
 
 *Treatment
        Options and Protocol*
 
 In
        addition to brachytherapy, localized prostate cancer can be treated with
        radical
        prostatectomy (RP), 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.
 
 *Radical
        Prostatectomy.* 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 radical prostatectomy 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
        is generally more expensive than other common treatment modalities.
 
 *External
        Beam Radiation Therapy.*  EBRT
        involves directing a beam of radiation from outside the body at the prostate
        gland in order to destroy cancerous tissue. EBRT treatments are received
        on an
        outpatient basis 5 days a week usually over a period of 8 or 9 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 5 to
        6
        years after EBRT is comparable to that for surgery.
 
 *Intensity
        Modulated Radiation Therapy.* IMRT
        is a
        relatively new treatment modality and 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. The 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.
  5
  *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.
 
 *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 seed implant brachytherapy.
 
 *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 are 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, and that Cs-131 appears to offer improved clinical outcomes over
        I-125
        and Pd-103, given its shorter half-life and higher energy.
  6
  *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.
 
 §
              In
                  September 2006, a 5-year prospective study to assess the impact
                  of
                  interstitial brachytherapy on the quality of life of patients with
                  localized prostate cancer was published. The results of the study
                  confirm
                  the low impact of interstitial brachytherapy on the patients’ quality of
                  life despite its transient negative effects on some functions (Caffo,
                  O.,
                  et al.*International
                  Journal of Radiation Oncology; Volume 66; 1;31-37)*.
 
 §
              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 and demonstrated excellent long-term biochemical
                  control.
                  Fifteen-year biochemical relapse free survival (BRFS) for the entire
                  treatment group was 74%. BRFS using the Memorial Sloan-Kettering
                  risk
                  cohort analysis (95% confidence interval) were as follows: low
                  risk 88%,
                  intermediate risk 80%, and high risk 53% (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.).
 
 §
              A
                  study of 367 patients with localized prostate cancer treated using
                  real-time intraoperative planning technique with median follow
                  up of 63
                  months demonstrated this technique consistently achieved optimal
                  coverage
                  of the prostate with concomitant low doses delivered to the urethra
                  and
                  rectum. Biochemical control outcomes were excellent at 5 years
                  (Zelefsky
                  M, et al. “Five-year outcome of intraoperative conformal permanent I-125
                  interstitial implantation for patient with clinically localized
                  prostate
                  cancer’, Int. J. Rad. Onc. Biol., Vol. 67, 2007,
                  65-70.).
 
 §
              A
                  1700 patient case review over 12 years was conducted by J. Sharkey
                  and
                  published in the August 2004 edition of Brachytherapy. The review
                  of
                  patients diagnosed with T1 or T2 adenocarcinoma of the prostate
                  and
                  treated with either radical prostatectomy or brachytherapy showed
                  superiority of brachytherapy over prostatectomy. Low risk brachytherapy
                  resulted in 99% freedom from PSA failure while surgery showed results
                  of
                  97% (Sharkey J, et al. “Pd-103 brachytherapy versus radical prostatectomy
                  in patient with clinically localized prostate cancer: a 12-year
                  experience
                  from a single group practice”. Brachytherapy, 4,
                  2005.).
 
 *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.
 
 *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 12 months was very encouraging,
                  i.e. low levels with no failures per the nadir definition. (Prestidge
                  BR,
                  Bice WS, “Clinical
                  outcomesofa
                  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-131prostate brachytherapy:
                  Anearly experience”.*Brachytherapy*,*Volume
                  6, Issue 2*,*April-June
                  2007*, Page
                  80).
   7
  §
              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
        IPSS and patient long-term survival data.
 
 A
        second
        prospective randomized monotherapy trial is underway at The Chicago Prostate
        Cancer Center. Headed by Dr. Brian Moran, this trial directly compares Cs-131
        and I-125 treatment related morbidities such as sexual dysfunction and
        incontinence following brachytherapy for localized carcinoma of the prostate
        in
        low to intermediate risk patients.
 
 A
        third
        ongoing study first presented at the American Association of Physicists in
        Medicine (AAPM) meeting in July 2007 compared the dosimetry of Cesium-131
        and
        Palladium-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.)
 
 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.
 
 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 2008 include:
 
 §
              *Continue
                  to introduce the Proxcelan Cs-131 brachytherapy seed into the U.S.
                  market*.
                  Utilizing our direct sales organization and selected channel partners,
                  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.
  8
  §
              *Move
                  our state-of-the-art manufacturing process to a new
                  facility*.
                  IsoRay has completed construction of a new manufacturing facility
                  in
                  Richland, Washington in its recently leased facility at the Applied
                  Process Engineering Laboratory (APEL facility). This facility replaces
                  our
                  currently leased production facility (PIRL facility). The new facility
                  is
                  four times larger than the size of our former facility and will
                  allow
                  production to expand as sales orders
                  increase.
 
 §
              *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*.
                  IsoRay intends to partner with other companies to develop the appropriate
                  technologies and therapeutic delivery systems for treatment of
                  other solid
                  tumors such as breast, lung, liver, ocular, pancreas, neck, and
                  brain
                  cancers. IsoRay’s management believes that the first major opportunities
                  may be for the use of Cs-131 for ocular melanoma and as adjunct
                  therapy
                  for lung cancer (treating the surgical
                  margins).
 
 §
              *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.
 
 §
              *Diversify
                  our supply of Cs-131.*Currently, the Company relies heavily on Cs-131 from its primary
                  Russian
                  supplier. This supplier has significant capacity for producing
                  Cs-131 with
                  higher quality than currently available from other sources. The
                  Company is
                  actively developing the capability to produce multi-curie quantities
                  of
                  Cs-131 from several reactor sources located both abroad and
                  domestically.
 
 §
              *Introduce
                  Proxcelan Cesium-131 brachytherapy seeds to the European and Russian
                  markets.*The Company is currently working to obtain the European CE Mark
                  and
                  certification to ISO 13485 to enable the sale of our product in
                  the
                  European Union. If the proposed strategic alliance with IBt, SA,
                  a Belgian
                  company, is ultimately consummated, it will allow the Company to
                  obtain
                  access to various foreign countries through IBt distribution channels
                  and
                  leverage IBt's international regulatory
                  expertise.
 
 Management
        believes there is a large and growing addressable market for IsoRay’s products.
        Several factors appear to contribute to the increasing popularity of the
        brachytherapy procedure. Long-term survival data are now available for
        brachytherapy (other than with respect to treatment from Proxcelan Cs-131
        seeds). Brachytherapy has become the treatment of choice for not only
        early-stage prostate cancer but is now being considered for treatment of
        fast
        growing, aggressive tumors. Seed brachytherapy has significant advantages
        over
        competing treatments including lower cost, fewer side effects, a faster recovery
        time and the convenience of an outpatient procedure that generally lasts
        45
        minutes. Over 60,000 procedures were forecasted to occur in the U.S. in 2006.
        (At the June 30, 2007 average Proxcelan seed price of $72, this represents
        a
        potential market of over $300 million for seeds that is forecast to grow
        substantially by 2009 according to a 2004 market survey performed by Frost
&
Sullivan, a nationally recognized market research firm.) 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.
  9
  **Products**
 
 IsoRay
        markets the Proxcelan Cesium-131  brachytherapy
        seed for the treatment of prostate cancer 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*
 
 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 and ocular melanoma.
 
 **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. 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 1 cm. Pd-103 seeds emit radiation
        that
        does not penetrate as far in tissue (up to 40% lower than Cs-131). To compensate
        for this more Pd-103 seeds are required to attain the equivalent dose as
        if
        Proxcelan seeds were used. This increase in the number of seeds implanted
        increases the time and cost required to perform Pd-103-based procedures.
        The
        lower energy from Pd-103 seeds may also result in lesser homogeneity of the
        implant dose as dose rates near the surface of each seed must be higher to
        compensate for lower doses at greater distances from each seed. The higher
        energy of Cs-131 can result in radiation toxicity if the dosage is not properly
        calculated by the implanting physician and staff but the higher energy of
        Cs-131
        does make the isotope more “forgiving” for treatment planning
        purposes.
 
 *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 indicated 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
  *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. IsoRay has conducted
        extensive computer modeling of the 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**
 
 *Overview.* Cs-131
        is a radioactive isotope that can be produced by the neutron bombardment
        of
        Barium-130 (Ba-130). When Ba-130 is put into a nuclear reactor and is exposed
        to
        a flux of neutrons it 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). 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 exclusive agreements in place with three
        suppliers of irradiated Ba-131 or Cs-131. During fiscal year 2007, the Company
        obtained approximately 80% of its isotope from the Institute of Nuclear
        Materials (INM) located in Russia. The Company has an exclusive supply agreement
        with INM that originally commenced August 25, 2005 and was amended on September
        3, 2006 and February 2, 2007. The agreement has a ten-year term but is not
        an
        obligation to purchase any given quantity of the isotope; however, if the
        Company does not purchase certain minimum levels, then INM is no longer bound
        by
        the exclusivity portion of the agreement. Even if INM were to become the
        sole
        supplier, INM has sufficient irradiation capacity to meet the Company’s Cs-131
        anticipated demand through fiscal year 2009 without the use of enriched barium.
        However, the Company is actively seeking other suppliers in order to diversify
        its supply of Cs-131.
 
 During
        fiscal year 2007, the Company also obtained irradiated barium from the
        University of Missouri under an agreement originally signed on August 9,
        2005.
        The Company also has an exclusive agreement in place with the Russian Institute
        of Atomic Reactors (RIAR) for supply of Cs-131. The production development
        activities at RIAR are under way and the Company currently anticipates accepting
        deliveries of Cs-131 within the next six months, but there is no assurance
        as to
        this delivery schedule.
 
 To
        produce the Proxcelan seed, the purified Cs-131 isotope is absorbed 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.
 
 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.
  11
  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 from us than from existing seed suppliers 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 (at our facilities), 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 but wish 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 in order to be able to fulfill
        all customer orders. Consequently, some portion of the isotope is written
        off to
        current period costs as it decays and is not used in an end
        product.
 
 *Automated
        Manufacturing Process*
 
 Based
        on
        evaluations of automation options by management, IsoRay has elected to automate
        its current manufacturing process in phases. Management believes that current
        production rates with the Company’s semi-automated seed welding equipment exceed
        those attainable with fully automated lines that the Company has evaluated.
        Phased implementation of automation is expected to be less costly than fully
        automated production lines and will benefit IsoRay by reducing labor costs
        and
        helping to ensure 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 the manufacturing facility located at PEcoS-IsoRay
        Radioisotope Laboratory (PIRL) with a
        new 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
        19,000
        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 6 below. The Company now plans
        to
        decommission the PIRL facility and return it to the landlord by the end of
        calendar year 2007. 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.
 
 The
        Company has used Pacific Northwest National Laboratory (PNNL) to provide
        third-party assay of its products but has otherwise vacated PNNL facilities.
        Management is currently setting up facilities to move the independent assay
        of
        its products to its new production facility and will utilize in-house resources
        which will reduce isotope depletion and also minimize assay
        expenditures.
  12
  The
        Company intends to establish a new facility in Russia to produce Proxcelan
        Cesium-131 brachytherapy seeds. This new facility is part of the Company’s
        strategy to expand into the Russian and European markets. The Company has
        not
        entered into any agreements concerning this facility and has not begun any
        negotiations with any third-parties.
 
 The
        Company is also considering another state as a location for a future facility
        as
        a secondary production facility. No agreements have been reached for any
        possible facilities outside of Washington.
 
 *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 use toward the cost of testing at
        the
        ATR.  During July 2006, several capsules were irradiated and shipped to
        IsoRay’s PIRL facility for analysis.  The results of the analyses indicate
        the capsule performed as designed and that a planned capsule shuttle system
        will
        provide adequate conditions for Cs-131 production that will enhance IsoRay’s
        overall production capacity. ATR has now obtained the funding to design and
        implement the necessary capsule shuttle system and IsoRay has collaborated
        with
        ATR on its design and testing. The Company is seeking to enter into a contract
        with ATR in fiscal year 2008 to produce irradiated barium but 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 with 3 to 5 seeds and
                  spacers)
 §
              *Strands
                  of seeds*(consists of seeds and spacers in a biocompatible “shrink wrap”)
 §
              *Pre-loaded
                  Mick cartridges*(fits the Mick applicator)
 
 No
        single
        package configuration dominates the market at this point. In 2007, the Millenium
        Research Group reported that the estimated market shares for each of the
        four
        packaging types are: loose seeds (9.5%), Mick cartridges (29.1%), pre-loaded
        needles (19.4%) and all strand configurations (42.0%). 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
        who, 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 our loose seeds. This creates additional loss of our
        isotope due to decay and is prohibitive on a long-term basis. However, to
        increase sales in the near-term we are using these services until our own
        custom
        preloading operation comes fully on-line in our new APEL facility. Once our
        custom preloading operation comes fully on-line, we anticipate completing
        most
        of the assay, preload, and sterilization in-house rather than relying on
        independent radiopharmacies.
  13
  The
          Company currently loads most Mick cartridges in our own facility which
          in recent
          months accounted for more than 65% of total seed orders.  Currently,
          PNNL provides independent third-party assay of seeds for customers who
          request
          this service. The Company expects to begin offering a 100% confirmation
          assay in
          Q2 of FY2008 performed by in-house analytical services. Providing the assay and preloading services in-house allows the Company
          to
          reduce the time to process an order by two to four days as the additional
          shipping and third-party handling time are eliminated. This reduction in
          order
          processing time eliminates 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 in the future both
          as a
          backup to our own preloading operation and to handle periodic increases
          in
          demand.
  Independent
          radiopharmacies usually provide the final packaging of the product delivered
          to
          the end user. This eliminates the opportunity for reinforcing the "branding"
          of
          our seed product. By providing its own repackaging service, the Company
          preserves the product branding opportunity and eliminates any concerns
          related
          to the handling of its product by a third party prior to delivery to the
          end
          user.
  Providing
          different packaging configurations adds significant value to the product
          while
          providing an additional revenue stream and incremental margins to the Company
          through the pricing premiums that can be charged. 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 load and sterilize
          seeds and needles, and eliminating the expense of additional assaying of
          the
          seeds.
  *Barium
        Enrichment Device*
 
 Ba-130
        is
        the original source material for Cs-131. When Ba-130 is put into a nuclear
        reactor it becomes Ba-131 which is the radioactive material that is the parent
        isotope of Cs-131. Natural barium contains only 0.1% of Ba-130 with six other
        isotopes making up the other 99.9%. The Company is currently developing 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. In June 2007, the Company purchased
        approximately 6 grams of Ba-130 (metal equivalent) that will be used in future
        production of Cs-131. The enriched barium is being stored in Russia and is
        included in raw materials at June 30, 2007.
 
 **Marketing
        and Sales**
 
 *Marketing
        Strategy*
 
 The
        Company has worked to position 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 a patient would experience from the use of Cs-131
        for their brachytherapy seed treatment. The potential negative effects of
        the
        prolonged radiation times associated with the long half-life of I-125 make
        this
        isotope less attractive than Cs-131. The low energy of Pd-103 creates potential
        cold or hot areas in the treatment plan and requires more seeds to optimize
        the
        implant.
 
 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 competing isotopes
        as our
        principal competition rather than the various manufacturers and distributors
        of
        these isotopes. In this way, the choice of brachytherapy isotopes will 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.
  14
  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),
 §
              American
                  Urological Association (AUA),
 §
              Association
                  of American Physicists in Medicine (AAPM),
                  and
 §
              various
                  other professional society
                  meetings.
 
 In
        today’s U.S. health care market, patients are more informed and involved in the
        management of their health and any treatments required. 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 market factor, we also promote our products directly to the general
        population. The audience targeted will be the prostate cancer patient, his
        spouse, family and care givers. The marketing message to this segment of
        the
        market emphasizes the specific advantages of the Proxcelan Cesium-131
        brachytherapy seed, including fewer side effects, less total radiation, and
        a
        shorter period of radiation exposure. The Company is targeting this market
        through its websites (located at www.isoray.com, www.cesium.com, and
        www.proxcelan.com), advertising in magazines read by prostate cancer patients
        and their care givers, through patient advocacy efforts, informational patient
        brochures and DVDs with patient testimonials, and advertisements in specific
        markets supporting brachytherapy, etc.
 
 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.
 
 During
        fiscal year 2007, the first abstracts were published on the results of clinical
        studies of Cs-131 treatments. In fiscal year 2008, the Company will continue
        its
        collaboration with leading physicians to develop clinical data on the efficacy
        of Cs-131 seeds including the dual therapy protocol and the prospective
        randomized trial. In addition, the Company continues to consult with noted
        contributors from the medical physics community and will have articles submitted
        to professional journals such as *Medical
        Physics* and the *International
        Journal of Radiation*  *Oncology,
        Biology, and Physics* regarding the benefits of and clinical trials involving Cs-131.
 
 At
        ASTRO
        2007 to be held in Los Angeles on October 28 th through
        November 1 st ,
        the
        following abstracts related to Cs-131 have been accepted:
 1.
              Urinary
                  Morbidity Following Cs-131 Brachytherapy for Localized Prostate
                  Cancer
 (Brian
        Moran, M.D., Chicago Prostate Cancer Center, Chicago, IL)
 2.
              Results
                  of a Multi-Institutional Trial Using Cesium-131 Permanent Prostate
                  Brachytherapy
 (Brad
        Prestidge, M.D., Texas Cancer Clinic, San Antonio, TX)
 3.
              BED
                  as a Predictive Tool for the Outcome of a Permanent Prostate Brachytherapy
                  Trial Using Cesium-131 as
                  Monotherapy
 (William
        Bice, PhD, Texas Cancer Clinic, San Antonio, TX)
 4.
              Dosimetric
                  Comparison of Cesium-131 and Palladium-103 for Permanent Prostate
                  Brachytherapy
 (J.
        S.
        Musmacher, North Shore Medical Accelerator, Smithtown, NY)
  15
  *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. During 2007 IsoRay
        expanded its sales force to eleven sales people. These sales people include
        those experienced in the brachytherapy market and the medical device
        market.
 
 The
        initial response to our new isotope from prominent radiation oncologists,
        medical physicists and urologists in the US has been very positive and the
        number of surgical centers and clinics using the Proxcelan seed continues
        to
        increase.
 
 The
        Company expects to expand its customer base in fiscal year 2008. 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.
 
 *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 70% 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 reviews and adjusts
        outpatient reimbursement on a periodic basis and is currently reviewing the
        reimbursement rates that will be effective beginning January 1, 2008. CMS
        has
        proposed that a fixed price per seed be reimbursed and the Company is working
        to
        ensure that the proposed amounts are adequate to reimburse hospitals or clinics
        for the full amount of the seeds. The US House of Representatives has passed
        a
        bill that would continue the pass-through reimbursement of brachytherapy
        seeds
        during 2008. However, the US Senate version of the bill did not contain the
        same
        provisions. The Company believes that the final calendar year 2008 reimbursement
        rates will not be known until November or December 2007. 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, 2007 include:
  16
  Community
                Hospital of Los Gatos
              Los
                Gatos, CA
              24.5%
                of revenueChicago
                Prostate Cancer Center
              Westmont,
                IL
              13.2%
                of revenue
  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.
 
 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. 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 2007 and 2006, the Company recorded royalty expense of
        $2,161 and $0, respectively.
 
 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 license agreement was transferred to IsoRay through a series
        of
        mergers and the reverse acquisition.
 
 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, the Company participated in
        nonbinding mediation and no settlement was reached. The parties have agreed
        to
        extend mediation discussions until early October, 2007. If no settlement
        is
        reached, the parties may demand binding arbitration.
  17
  *Research
        and Development*
 
 During
        the three-year period ended June 30, 2007, IsoRay and its predecessor companies
        incurred more than $1.8 million in costs related to research and development
        activities. The Company expects to continue to devote employees to ongoing
        research and development activities for the foreseeable future.
 
 The
        Company anticipates finishing its major research and development project
        to
        develop a proprietary separation process to manufacture enriched barium and
        thereby increase isotope production efficiency during fiscal year 2008. The
        remaining project costs are anticipated to be approximately
        $400,000.
 
 *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. IsoRay'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.
 
 Specifically,
        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,
        prevent
        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. We are prohibited from marketing the modified product
        until the 510(k) notice is cleared by the FDA.
  18
  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 other countries such
        as Europe, Canada, as well as other foreign markets, we have initiated a
        project
        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). Compliance with the MDD 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
        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, including PNNL, as it prohibits additional mixed
        radioactive and hazardous waste from being brought to sites, such as PNNL,
        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. However, the State of Washington has appealed
        the decision. If this decision is overturned and Initiative 297 is enforced
        it
        could impact our ability to manufacture our seeds, whether at PNNL or elsewhere
        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.
  19


*Employees*





As
      of
      September 4, 2007, IsoRay employed 66 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 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
      support 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 30 additional employees
      by the end of fiscal year 2008.





*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, radical prostatectomy
      and external beam radiation therapy which includes intensity modulated radiation
      therapy, as well as competing permanent brachytherapy devices. RP has
      historically represented the most common medical treatment for early-stage,
      localized prostate cancer but has 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 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, Oncura currently claims about 35% of the market with
      the
      original I-125 seed. Theragenics Corp., which introduced the original Pd-103
      seed, currently claims (through CR Bard and direct distribution) over 50% of
      the
      Pd-103 market share. The Company believes it may obtain a similar and
      significant advantage by being the first to introduce a Cs-131
      seed.





The
      Company’s patented Cs-131 separation process is likely to provide us a
      sustainable competitive advantage in this area. 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., Oncura (part of GE Healthcare), Theragenics Corp., North American
      Scientific, Inc., Mentor Corp., and Best Medical International, Inc. The top
      three - CR Bard, Inc., Oncura and Theragenics - currently garner over 80% of
      annual sales.





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 10
      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.





20




*Additional
      Growth Opportunities*





The
      Cs-131 isotope has the performance characteristics to be a technological
      platform for sustained long-term growth. The most immediate opportunities are
      introducing Cs-131 for prostate brachytherapy to Russia, Europe, Canada, and
      other international markets, introducing Cs-131-based therapies for other
      indications such as lung cancer and ocular melanoma, and through the marketing
      of other radioactive isotopes. These growth initiatives appear to be significant
      incremental opportunities.





The
      Company plans to introduce Cs-131 for prostate brachytherapy initially into
      Europe and later into other international markets through partnerships and
      strategic alliances with channel partners for manufacturing and distribution.
      Another advantage of the Cs-131 isotope is its potential applicability to other
      cancers and other diseases. 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
      had discussions with prominent physicians and is looking at treatment of lung,
      pancreatic and brain cancer. There is the opportunity to develop and market
      other radioactive isotopes to the US market, and to market the 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.





**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, Europe,
      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 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 One Type Of Cancer.*  Currently, the Proxcelan Cs-131 seed is used exclusively for the treatment
      of
      prostate cancer. We believe the Proxcelan Cs-131 seed will be used to treat
      cancers of other sites as well, 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 net operating losses. However, in March 2007, we completed
        a
        public equity offering and a warrant call that raised gross proceeds of
        approximately $20 million.  Due to raising this additional capital,
        management believes cash and cash equivalents on hand at June 30, 2007 will
        be sufficient to meet our anticipated cash requirements for operations, debt
        service, and capital expenditure requirements through at least the next twelve
        months. While we are generating significantly more revenue, if operating
        costs
        expand proportionately with revenue increases, other applications are pursued
        for seed usage outside the prostate market, if protocols are expanded supporting
        the integrity of our product, and marketing expenses increased, management
        believes approximately $2 million in monthly revenue will be needed to reach
        break-even. 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.




21




*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. Over eighty percent (80%) of our cesium is now supplied
      through the Institute of Nuclear Materials (INM) located in Russia. This
      percentage will continue to increase as demand for our products increases.
      Management expects that we will be able to supplement our supply of cesium
      with
      deliveries under our recent contract with the Russian Research Institute of
      Atomic Reactors (RIAR). Although deliveries have not yet begun under this
      contract, production capabilities at RIAR are well under development. With
      the
      development of barium enrichment capabilities, the Company plans to expand
      Cs-131 manufacturing capability at the MURR reactor and create production
      capabilities at Idaho’s Advanced Test Reactor (ATR). This strategy will reduce
      the risk associated with concentrating isotope production at a single reactor
      facility. Failure to obtain deliveries of cesium from these sources could have
      a
      material adverse effect on seed production and there may be a delay before
      we
      could locate alternative suppliers. We may not be able to locate 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 a single supplier. We do not have formal written agreements with
      either this key supplier or 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 contract with INM 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 the INM and the 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 of initial quantities of the isotope from RIAR is
      expected to begin within the next six months. 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 now 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
      and if sufficient supplies are attained, we will need to increase our
      manufacturing staff. 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. 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




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.
      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
      September 1, 2007, the Proxcelan Cs-131 seed has been implanted in over
      1,600 **** patients
      and research papers are beginning to be 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, indicating that, at least for these initial
      patients, 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




*The
      Passage Of Initiative 297 In Washington May Result In The Relocation Of Our
      Manufacturing Operations.*  Washington voters approved Initiative 297 in late 2004, which may impose
      restrictions on sites at which mixed radioactive and hazardous wastes are
      generated and stored. IsoRay has been assured by the Attorney General’s office
      of the State of Washington that medical isotopes are not included in Initiative
      297 and that manufacturing in IsoRay’s production facility will not be
      interrupted, but there is no assurance that this interpretation of Initiative
      297 by the Attorney General’s Office will continue to exclude medical isotopes.
      In June 2006, a U.S. District court judge ruled that Initiative 297 was
      unconstitutional in its entirety. However, the State of Washington has appealed
      this 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.





Management
      believes that we will be able to continue our manufacturing operations in the
      State of Washington for the foreseeable future. In the event Initiative 297
      is
      enforced against us, management may consider establishing an alternate
      manufacturing facility outside of Washington, and we may consider moving all
      or
      part of our operations to another state even if Initiative 297 is not enforced
      against us.





*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 established 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.





*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.





24




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.





*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. Although not anticipated, 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.





25




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.





*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 and key scientific personnel.
      If we
      lose the services of several officers 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 Europe and Asia. 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; 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. If the
      strategic alliance with IBt is ultimately consummated, it will allow the Company
      to obtain access to various foreign countries through IBt distribution channels
      and customer relationships and leverage IBt's international regulatory
      expertise.





26




*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.





*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. The Company will no longer
      qualify as a small business issuer under the federal securities laws for fiscal
      year 2008 and will therefore need to implement additional provisions of the
      Sarbanes Oxley Act during the next fiscal year. 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, 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; 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 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, 2007, we had 22,789,324 outstanding shares of common
      stock, and the following additional shares were reserved for issuance: 3,683,439
      shares upon exercise of outstanding options, 3,627,764 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
      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 an approximate additional 7,300,000 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.





27




*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 law and other factors our Board deems relevant.





*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
      2 - DESCRIPTION OF PROPERTY**





The
      Company’s executive offices are located at 350 Hills Street, Suite 106,
      Richland, WA 99354, (509) 375-1202, where IsoRay currently leases approximately
      19,330 square feet of office and laboratory space for approximately $26,700
      per
      month plus monthly janitorial expenses of approximately $700 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. Additional office space will be needed as other general and
      administrative employees are hired and will be secured in the Richland
      area.





In
      February 2005, the Company entered into a lease agreement for leased space
      at
      the PEcoS-IsoRay
      Radioisotope Laboratory ( PIRL)
      in
      which it established production facilities. The lease was for 4,400 total square
      feet and the term commenced on regulatory licensing approval, which was obtained
      in October 2005. The lease had a base term of one year with a one year renewal
      option. The first year of rent was paid by issuing 24,000 shares of the
      Company’s common stock. The Company has agreed to rent of $5,000 per month for
      the renewal term. However, if the Company fails to decommission this site and
      complete the required regulatory “clean-up” by January 1, 2008, the Company will
      face stiff fines and penalties for holding over. The Company is not affiliated
      with the lessor.





28




In
      September 2007, the Company moved all manufacturing operations to the APEL
      facility after completing the necessary improvements and installing the required
      equipment and will vacate its leased space at PIRL. The
      APEL
      facility has over 19,000 square feet and includes space for isotope separation,
      seed production, order dispensing, a clean room for preloading seeds into
      strands, needles, and cartridges, 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 6 below. The Company believes that the APEL
      facility will be used through April 2016 which is the end of the original lease
      term plus the two three-year renewal options. Other facilities could be
      necessary to produce additional Cs-131 products for the prostate and other
      organ
      cancer markets in other regions of the country or the world if demand continues
      to grow.





The
      Company has used Pacific Northwest National Laboratory (PNNL) to provide
      third-party assay of its products but has otherwise vacated PNNL facilities.





The
      Company intends to establish a new facility in Russia to produce Cs-131
      brachytherapy seeds. This new facility is part of the Company’s strategy to
      expand into the Russian and European markets. The Company has not entered into
      any agreements concerning this facility and has not started negotiations with
      any third-parties.





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.





**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 COMMON EQUITY AND RELATED STOCKHOLDERS’
MATTERS**





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 4, 2007, we had 23,033,108 outstanding shares of Common
      Stock and 59,065 outstanding shares of Preferred Stock.





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 now obtained our AMEX listing, at times 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,
      the OTC Bulletin Board, and the Pink Sheets. The OTC Bulletin Board and Pink
      Sheet 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.





29





**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
 
 **Year
                  ended June 30, 2006**
              
              **High**
              ****
              **Low**First
                  quarter
              
              $
              5.95
              
              $
              1.00Second
                  quarter
              
              
              8.25
              
              
              4.50Third
                  quarter
              
              
              7.25
              
              
              6.20Fourth
                  quarter
              
              
              6.40
              
              
              3.25




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.





As
      of
      September 4, 2007, we had approximately 880 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.





As
      of
      June 30, 2007, the following options had been granted under the option
      plans.





**Plan
                Category**
            
            Number
                ofsecurities tobe issued onexercise
                ofoutstandingoptions,warrantsand rights
              #
            
            Weighted-averageexerciseprice
                ofoutstandingoptions,warrants,and rights
              $
            
            Number
                ofsecuritiesremainingavailable
                forfutureissuanceunder
                equitycompensationplansEquity
                compensation plans approved by shareholders
            
            
            N/A
            
            
            N/A
            
            
            N/AEquity
                compensation plans not approved by shareholders
            
            
            3,683,439
            
            $
            2.86
            
            
            259,778Total
            
            
            3,683,439
            
            $
            2.86
            
            
            259,778





30




Sales
      of Unregistered Securities





All
      sales
      of unregistered securities were previously reported.





**ITEM
      6 - MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION**





**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 disclosure of contingent
      liabilities. On an on-going basis, management evaluates past judgments and
      estimates, including those related to bad debts, inventories, accrued
      liabilities, and contingencies. Management bases its estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances, the results of which form the basis for making
      judgments about the carrying values of assets and liabilities that are not
      readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions.





The
      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 losses included
      in
      shareholders’ equity.





The
      Company’s short-term investments consisted of the following at June 30, 2007 and
      2006:




2007
              
              2006Municipal
                  debt securities
              
              $
              3,000,000
              
              $
              –Corporate
                  debt securities
              
              
              6,942.840
              
              
              –$
              9,942,840
              
              $
              –





At
      June
      30, 2007, all of the Company’s corporate debt securities mature within fiscal
      year 2008. All municipal debt consists of auction rate securities that may
      have
      maturity dates exceeding 5 years, however, they reset each month. Based on
      the
      frequency of the auction reset periods, the fair market value approximates
      cost.





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.





31




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 had minimal gross margin throughout the
      past
      fiscal years, inventories have generally been recorded at market or net
      realizable value.





Fixed
      Assets





Fixed
      assets are carried at the lower of cost or net realizable value. Production
      equipment with a cost of $2,500 or greater and other fixed assets with a cost
      of
      $1,500 or greater are capitalized. Major betterments that extend the useful
      lives of assets are also capitalized. 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 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 in accordance with
      APB 21 and EITF Issue 95-13. 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 $178,633 and $296,608 for the years ended June 30,
      2007 and 2006, respectively, is included in financing expense on the statements
      of operations.





32




The
      Company’s deferred financing costs consisted of the following at June 30, 2007
      and 2006:


2007
              
              2006Value
                  of shares issued to guarantors:Benton-Franklin
                  Economic Development District (83,640 shares)
              
              $
              138,006
              
              $
              138,006Columbia
                  River Bank line of credit (127,500 shares)
              
              
              –
              
              
              210,375Benton-Franklin
                  Economic DevelopmentDistrict
                  loan fees
              
              
              3,450
              
              
              3,450Columbia
                  River Bank line of credit loan fees
              
              
              –
              
              
              500Convertible
                  debentures issuance costs
              
              
              –
              
              
              30,047Hanford
                    Area Economic Investment Fund Committee loan fees
              
              
              22,128
              
              
              22,128Less
                  amortization
              
              
              (67,859
              )
              
              (130,148
              )$
              95,725
              
              $
              274,358




In
      June
      2007, the Company elected not to renew its line of credit with Columbia River
      Bank due to the Company’s current cash position. The Company wrote off the
      remaining net deferred financing charges of $98,409 relating to this line of
      credit.





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 Cs-131. The Company paid license fees of
      $275,000 during fiscal year 2006 and another payment of $225,000 was to be
      made
      in August 2006 pursuant to the license agreement. Royalty payments based on
      net
      sales revenue incorporating the technology are also required, with minimum
      quarterly royalties ranging from $100,000 to $200,000 and minimum annual
      royalties ranging from $400,000 to $800,000 over the term of the agreement.
      The
      IBt license is being amortized over the 15-year term of the license
      agreement.





In
      the
      fourth quarter of fiscal year 2007, the Company reviewed the carrying values
      of
      licenses. As of the date of this report, the August 2006 payment has not been
      made as the Company has been in continued negotiations with IBt concerning
      the
      license agreement and other business arrangements.




Amortization
      of licenses was $23,426 and $20,530 for the years ended June 30, 2007 and 2006,
      respectively. Based on the licenses recorded at June 30, 2007, 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: $30,795
      for
      2008, $18,770 for 2009, $18,481 for 2010, $18,333 for 2011, $18,333 for 2012,
      and $157,363 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,
      2007, 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: $30,155 for 2008, $2,632 for 2009, $2,632 for 2010, $2,632 for 2011,
      $2,632 for 2012, and $12,192 thereafter.





33




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





In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represents the discounted cost of cleanup that the Company
      anticipates it will have to incur at the end of its equipment and property
      leases. This amount was determined based on discussions with qualified
      production personnel and on historical evidence. During fiscal year 2007, the
      Company reevaluated its obligations based on discussions with the Washington
      Department of Health and determined that the initial asset retirement obligation
      should be increased by an additional $56,120. The Company anticipates spending
      most of the amounts represented by this accrual in fiscal year 2008. In
      addition, another asset retirement obligation will be established in the first
      quarter of fiscal year 2008 representing obligations at its new production
      facility. This new asset retirement obligation will be for obligations to remove
      any residual radioactive materials and to remove any unwanted leasehold
      improvements.





During
      the years ended June 30, 2007 and 2006, the asset retirement obligation changed
      as follows:


2007
              
              2006Beginning
                  balance
              
              $
              67,425
              
              $
              –New
                  obligations
              
              
              –
              
              
              63,040Changes
                  in estimates of existing obligations
              
              
              56,120
              
              
              –Accretion
                  of discount
              
              
              7,597
              
              
              4,385Ending
                  balance
              
              $
              131,142
              
              $
              67,425




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;
      capital lease obligations; and convertible debentures payable, approximated
      their fair values at June 30, 2007 and 2006.





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* ,
      that
      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.




34




Revenue
      for the fiscal years ended June 30, 2007 and 2006 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 an order has been received and
      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
      for
      estimating returns.





Stock-Based
      Compensation





Prior
      to
      July 1, 2006, the Company accounted for share-based employee compensation,
      including stock options, using the method prescribed in Accounting Principles
      Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* and
      related interpretations (APB 25). Under APB 25, for stock options granted at
      market price, no compensation cost was recognized and a disclosure was made
      regarding the pro forma effect on net earnings assuming compensation cost had
      been recognized in accordance with SFAS No. 123, *Accounting
      for Stock-Based Compensation* (SFAS
      123). On December 16, 2004, the Financial Accounting Standards Board issued
      SFAS
      No. 123 (Revised 2004), *Share
      Based Payment* (SFAS
      123R), which requires companies to measure and recognize expense for all
      share-based payments at fair value. SFAS 123R eliminates the ability to account
      for share-based compensation transactions using APB 25 and generally requires
      that such transactions be accounted for using prescribed fair-value-based
      methods. SFAS 123R permits public companies to adopt its requirements using
      one
      of two methods: (a) a “modified prospective” method in which compensation
      costs are recognized beginning with the effective date based on the requirements
      of SFAS No. 123R for all share-based payments granted or modified after the
      effective date, and based on the requirements of SFAS No. 123 for all awards
      granted to employees prior to the effective date of SFAS No. 123R that remain
      unvested on the effective date or (b) a “modified retrospective” method
      which includes the requirements of the modified prospective method described
      above, but also permits companies to restate based on the amounts previously
      recognized under SFAS No. 123 for purposes of pro forma disclosures either
      for
      all periods presented or for prior interim periods of the year of adoption.
      Effective July 1, 2006, the Company adopted SFAS 123R using the modified
      prospective method. No share-based employee compensation cost was reflected
      in
      the statement of operations prior to the adoption of SFAS No. 123R. Results
      for
      prior periods have not been restated.





The
      following table presents the share-based compensation expense recognized in
      accordance with SFAS 123R during the year ended June 30, 2007 and in accordance
      with APB 25 during the year ended June 30, 2006:




Year
                  ended June 30,2007
              
              2006Cost
                  of product sales
              
              $
              120,710
              
              $
              –Research
                  and development
              
              
              41,481
              
              
              –Sales
                  and marketing
              
              
              216,432
              
              
              –General
                  and administrative
              
              
              1,449,491
              
              
              –Total
                  share-based compensation
              
              $
              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, 2007, total unrecognized
      compensation cost related to stock-based options and awards was $1,707,843
      and
      the related weighted-average period over which it is expected to be recognized
      is approximately 1.23 years.





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 that 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
      computed.





35




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 when it
      relocates its 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. The Company discloses contingent
      liabilities when there is a reasonable possibility that the ultimate loss will
      exceed the recorded liability. 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 impact 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.





Income
      (Loss) Per Common Share





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





36




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




2007
              
              2006Preferred
                  stock
              
              
              59,065
              
              
              144,759Preferred
                  stock warrants
              
              
              –
              
              
              179,512Common
                  stock warrants
              
              
              3,627,764
              
              
              2,502,769Common
                  stock options
              
              
              3,683,439
              
              
              3,129,692Convertible
                  debentures
              
              
              –
              
              
              109,639Total
                  potential dilutive securities
              
              
              7,370,268
              
              
              6,066,371




**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, 2007 and
      2006. This discussion and analysis should be read in conjunction with our
      consolidated financial statements appearing elsewhere in this Annual Report
      on
      Form 10-KSB. 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 1 — Risk Factors” of this Annual Report on
      Form 10-KSB.





Year
      ended June 30, 2007 compared to year ended June 30, 2006





**Product
      sales.** Revenues
      for the year ended June 30, 2007 were $5,738,033 compared to revenues of
      $1,994,306 for the year ended June 30, 2006. The increase of $3,743,727 or
      188%
      is due to increased sales volume of the Company’s Proxcelan (Cs-131) seed. All
      of the Company’s revenues were generated through sales of its Proxcelan (Cs-131)
      seeds for the treatment of prostate cancer. The number of medical centers that
      purchased Proxcelan seeds during the fiscal year ended June 30, 2007 has grown
      to 59 as compared to 26 medical centers that ordered seeds in the fiscal year
      ended June 30, 2006.





**Cost
      of product sales.** Cost of
      product sales was $5,792,630 for the year ended June 30, 2007 compared to cost
      of product sales of $3,815,122 for the year ended June 30, 2006. The increase
      of
      $1,977,508 or 52% was mainly due to higher production levels during the year
      ended June 30, 2007 which were related to the increase in sales volume over
      the
      corresponding period from 2006. The major components of the increase were wages,
      benefits and related taxes, materials, depreciation, preload expenses, and
      share-based compensation. Wages, benefits, and related taxes increased about
      $753,000 for the year ended June 30, 2007 due to the hiring of additional
      production employees to support the higher production levels. Materials costs
      increased about $201,000 due to increased sales volume. Depreciation and
      amortization expense increased about $245,000 due to the addition of equipment
      that was placed in service in fiscal year 2006 or 2007. Preload expenses
      increased about $301,000 due to higher sales volumes. Share-based compensation
      expense was about $121,000 in fiscal year 2007 as the Company implemented SFAS
      No. 123R on July 1, 2006. These increases were partially offset by a decrease
      in
      payments to Pacific Northwest National Laboratory (PNNL). During part of fiscal
      year 2006, the Company used PNNL for manufacturing and other ancillary services.
      The Company stopped using PNNL to produce the seeds during fiscal year 2006
      but
      continues to use PNNL for certain analytical support functions.





**Gross
      loss.** Gross
      loss for the year ended June 30, 2007 was $54,597 compared to gross loss of
      $1,820,816 for the year ended June 30, 2006. The decrease of $1,766,219 or
      97%
      was due to higher revenues offsetting fixed production costs and increased
      production efficiency.





37


**Research
      and development.** Research
      and development expenses for the year ended June 30, 2007 were $1,345,163 which
      represents an increase of $894,738 or 199% over the research and development
      expenses of $450,425 for the corresponding period of 2006. The major components
      of the increase were wages, benefits and related taxes, consulting, legal
      expenses, share-based compensation, and protocol expenses. Wages, benefits
      and
      related taxes were approximately $294,000 and $77,000 for the years ended June
      30, 2007 and 2006, respectively as the Company hired research scientists and
      associated personnel. Consulting expenses increased during 2007 due to a project
      to increase the efficiency of isotope production. The Company incurred
      approximately $245,000 of legal expense related to patents and trademarks that
      were expensed. Share-based compensation expense was approximately $41,000 and
      $0
      for the years ended June 30, 2007 and 2006, respectively, as the Company
      implemented SFAS No. 123R on July 1, 2006. Clinical study protocol expenses
      were
      approximately $227,000 and $116,000 for the years ended June 30, 2007 and 2006,
      respectively, due to payments to clinics for participation in the Company’s
      protocols.





**Sales
      and marketing expenses.** Sales
      and marketing expenses were $3,384,472 for the year ended June 30, 2007. This
      represents an increase of $1,963,972 or 138% compared to the year ended June
      30,
      2006 sales and marketing expenses of $1,420,500. Wages, benefits, payroll taxes,
      travel, and office and other support expenses on behalf of our sales, marketing,
      and customer service staff increased about $1,100,000 due to the hiring of
      additional sales and marketing personnel. Conventions and tradeshows increased
      by about $217,000 due to the Company’s continued and expanding presence at these
      events in an effort to expand its market share. Marketing and advertising
      expenses increased about $149,000 as the Company has created and distributed
      brochures, videos, and other promotional literature designed to promote the
      benefits of our product. Consulting expenses increased about $151,000 due to
      consultants hired to assist with protocols, develop a branding strategy, and
      increase brand awareness. Share-based compensation expense was about $216,000
      in
      fiscal year 2007 as the Company implemented SFAS No. 123R on July 1,
      2006.





**General
      and administrative expenses.** General
      and administrative expenses for the year ended June 30, 2007 were $4,915,598
      compared to general and administrative expenses of $3,503,522 for the
      corresponding period of 2006. The increase of $1,412,076 or 40% is primarily
      due
      to approximately $1,449,000 of share-based compensation expense related to
      the
      implementation of SFAS No. 123R on July 1, 2006, approximately $440,000 of
      increased payroll costs due to a higher headcount, and approximately $243,000
      relating to investor relations and other public company expenses. These
      increased expenses were partially offset by a reduction in consulting fees
      of
      approximately $455,000 including $330,000 which represented merger consulting
      fees incurred in the three months ended September 30, 2005. Other consulting
      fees were reduced as the Company used less external resources. Legal expenses
      and audit fees decreased approximately $160,000 as the Company had more
      regulatory and other filings in fiscal year 2006 due to the merger, private
      placements, and registration statement filings.





**Operating
      loss.** Due to
      our rapid structural growth and related need to capture additional market share,
      product revenues not covering production costs, and significant research and
      development expenditures, we have not been profitable, and have generated
      operating losses since our inception. In the year ended June 30, 2007, the
      Company had an operating loss of $9,699,830 which is an increase of $2,504,567
      or 35% over the operating loss of $7,195,263 for the year ended June 30, 2006.
      Included in the operating loss for the year ended June 30, 2007 is share-based
      compensation of $1,828,114 due to the implementation of SFAS No. 123R on July
      1,
      2006. Without the share-based compensation expense, our operating loss would
      have only increased by $676,453 or 9%.





**Interest
      income.** Interest
      income was $406,921 for the year ended June 30, 2007 compared to interest income
      of $51,744 for the year ended June 30, 2006. Interest income is mainly derived
      from excess funds held in money market and investment accounts. The increase
      of
      $355,177 or 686% was due to the additional cash and investment balances held
      by
      the Company due to the additional capital raised throughout the year ended
      June
      30, 2007.





38


**Financing
      expense.** Financing expense for the year ended June 30, 2007 was $312,246 or a decrease
      of
      $376,854 or 55% from financing expense of $689,100 for the corresponding period
      in 2006. Included in financing expense is interest expense of approximately
      $134,000 and $332,493 for the years ended June 30, 2007 and 2006, respectively.
      The decrease in interest expense is due to the conversion of debentures to
      common stock during the fiscal year ended June 30, 2006 partially offset by
      interest expense related to the Hanford Area Economic Investment Fund Committee
      (HAEIFC) loan that was entered into in June 2006. The remaining balance of
      financing expense represents the amortization of deferred financing costs which
      decreased due to the write-off in fiscal year 2006 of the deferred financing
      costs relating to the debentures that were converted to common stock, partially
      offset by the amortization of the HAEIFC deferred financing costs and the
      write-off in fiscal year 2007 of the deferred financing costs relating to the
      Columbia River Bank line of credit that the Company elected not to
      renew.





**Debt
      conversion expense.** Debt
      conversion expense for the year ended June 30, 2006 relates to the one-time
      recognition of $385,511 expense in short-term inducement to convert
      debentures.





**Liquidity
      and capital resources.** We have
      historically financed our operations through cash investments from shareholders.
      During fiscal year 2007 our primary source of cash was an institutional round
      of
      financing (August 2006), a public direct equity offering (March 2007), and
      the
      exercise of common stock warrants and options and preferred stock
      warrants.





*Cash
      flows from operating activities*





Cash
      used
      in operating activities was $7.3 million in fiscal year 2007 compared to $7.0
      million in fiscal year 2006, an increase of approximately $300,000. Cash used
      by
      operating activities is net loss adjusted for non-cash items and changes in
      operating assets and liabilities. The increase is mainly related to an increase
      in net loss of approximately $600,000. The large increase due to the higher
      accounts payable balance is partially offset by the large decrease related
      to
      higher inventory levels and mainly results from the accrual of approximately
      $470,000 for the purchase of enriched barium in June 2007. This invoice was
      paid
      in July 2007. The remaining increase in accounts payable is due to higher
      production and operating levels.





*Cash
      flows from investing activities*





In
      2007,
      the Company invested its excess cash generated from shareholder investments.
      During 2007, the Company purchased $10.9 million of various short-term
      investments (mainly commercial paper and municipal auction rate securities).
      One
      of these investments valued at approximately $1.0 million matured and was
      subsequently reinvested. As of June 30, 2007, short-term investments held by
      the
      Company amounted to $9.9 million.





Cash
      expenditures for fixed assets were $2.4 million in fiscal 2007 and $475,000
      in
      fiscal 2006. The large increase is mainly due to construction of our new
      facility and equipment purchases for the new facility. The Company expects
      to
      spend approximately $4.0 to $5.0 million during fiscal year 2008 for capital
      expenditures to complete the construction of our new facility and purchase
      other
      equipment.





*Cash
      flows from financing activities*





In
      August
      2006, the Company completed an institutional round of financing. Pursuant to
      the
      round of institutional financing the Company issued 2,063,000 shares of common
      stock at a price of $2.50 per share and 2,269,300 common stock warrants
      (including broker warrant commissions) with an exercise price of $3.00 per
      share. The common stock issued provided approximately $4.7 million, net of
      offering costs. All of the warrants were exercised prior to the call date of
      March 26, 2007 which provided an additional $6.8 million of cash.





39




In
      March
      2007, the Company issued 4,130,500 shares of common stock at a price of $4.00
      per share, 826,100 common stock warrants with an exercise price of $5.00 per
      share, and 206,526 common stock warrants representing placement agent warrants
      with an exercise price of $4.40 per share. This public direct equity offering
      provided approximately $15.1 million, net of offering costs.





Additionally,
      the Company issued 781,705 shares of common stock pursuant to the exercise
      of
      common stock options and warrants (excluding the warrants issued pursuant to
      the
      round of institutional financing) and preferred stock warrants, which were
      exchanged for common stock immediately upon exercise. The Company received
      approximately $900,000 in cash pursuant to these exercises.





*Projected
      2008 Liquidity and Capital Resources*





At
      June
      30, 2007, cash and cash equivalents amounted to $9,335,730 and short-term
      investments amounted to $9,942,840 compared to $2,207,452 of cash and cash
      equivalents at June 30, 2006.





The
      Company had approximately $6.9 million of cash and $10.1 million of short-term
      investments as of September 4, 2007. As of that date management believes that
      the Company’s monthly required cash operating expenditures were approximately
      $600,000. Management believes that approximately $4.0 to $5.0 million will
      be
      spent on capital expenditures during fiscal year 2008.





The
      Company anticipates finishing its major research and development project to
      develop a proprietary separation process to manufacture enriched barium and
      thereby increase isotope production efficiency during fiscal year 2008. The
      remaining project costs are anticipated to be approximately
      $400,000.





During
      fiscal year 2008, the Company intends to continue its existing protocol studies
      as well as initiate new protocols for additional therapies. Due to this, the
      cost of protocols is currently budgeted to be about $800,000 in fiscal year
      2008.





Sales
      and
      marketing and general and administrative expenses are anticipated to increase
      about $1.0 million during fiscal year 2008 mainly due to additional sales
      personnel and sales related activities.





Assuming
      operating costs expand proportionately with revenue increases, other
      applications are pursued for seed usage outside the prostate market, protocols
      are expanded supporting the integrity of our product and marketing expenses
      are
      increased, management believes the Company will reach breakeven with revenues
      of
      approximately $2 million per month. Based on the foregoing assumptions,
      management believes cash, cash equivalents, and short-term investments on hand
      at June 30, 2007 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, developing additional therapies, and maintaining cost
      control. However, there can be no assurance that the Company will attain
      profitability or that the Company will be able to attain its aggressive revenue
      targets. If 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, solicitation to warrant holders to exercise their warrants, and
      possibly strategic collaborations or debt financing or through other sources
      that may be dilutive to existing shareholders. If the Company needs to raise
      additional money to fund its operations, funding may not be available to it
      on
      acceptable terms, or at all. If the Company is unable to raise additional funds
      when needed, it may not be able to market its products as planned or continue
      development and regulatory approval of its future products. If the Company
      raises additional funds through equity sales, these sales may be dilutive to
      existing investors.





40




*Long-Term
      Debt and Capital Lease Agreements*





IsoRay
      has two loan facilities in place as of June 30, 2007. The first loan is from
      the
      Benton-Franklin Economic Development District (BFEDD) in an original principal
      amount of $230,000 and was funded in December 2004. It bears interest at eight
      percent and has a sixty month term with a final balloon payment. As of June
      30,
      2007, the principal balance owed was $185,848. This loan is secured by certain
      equipment, materials and inventory of IsoRay, and also required personal
      guarantees, for which the guarantors were issued approximately 70,455 shares
      of
      common stock. The second loan is from the Hanford Area Economic Investment
      Fund
      Committee and was originated in June 2006. The loan has a total facility of
      $1,400,000 and bears interest at nine percent. As of June 30, 2007, the Company
      has taken only a partial draw of $418,670 on the facility and the remaining
      facility of $981,330 is available to purchase equipment. The principal balance
      owed on the loan as of June 30, 2007 was $391,610. This loan is secured by
      receivables, equipment, materials and inventory, and certain life insurance
      policies and also required personal guarantees.





The
      BFEDD
      has granted IsoRay 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, 2008 and also excuses 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. Management believes that if the BFEDD
      accelerates repayment that it has sufficient cash resources to satisfy this
      obligation.





The
      Company had a line of credit from Columbia River Bank, which provided credit
      in
      the amount of $375,000. This line expired on March 1, 2007. Although the bank
      offered to extend this credit line, the Company elected to not extend the line
      of credit as part of its overall review of its banking and cash management
      relationships.





The
      Company has certain capital leases for production and office equipment that
      expire at various times from March 2008 to April 2009. These leases currently
      call for total monthly payments of $19,361. The total of all capital lease
      obligations at June 30, 2007 was $220,415.





Principal
      maturities on notes payable are due as follows:


Year
                  ending June 30,2008
              
              $
              49,2122009
              
              
              53,6092010
              
              
              182,5662011
              
              
              38,4362012
              
              
              41,983Thereafter
              
              
              211,652$
              577,458




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




Year
                  ending June 30,2008
              
              $
              214,2692009
              
              
              27,626Total
                  future minimum lease payments
              
              
              241,895Less
                  amounts representing interest
              
              
              (21,480
              )Present
                  value of net minimum lease payments
              
              
              220,415Less
                  amounts due in one year
              
              
              (194,855
              )Amounts
                  due after one year
              
              $
              25,560


41





*Other
      Commitments and Contingencies*





As
      of
      September 1, 2007, the Company had issued purchase orders for approximately
      $681,000 of production and office equipment and inventory materials that were
      not yet received. The Company anticipates financing most of these purchases
      through its cash reserves.





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 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.





The
      Company’s lease agreement with PEcoS IsoRay Radioisotope Laboratory (PIRL) is
      scheduled to expire in October 2007 but has been extended through December
      2007
      at a monthly rent of $5,000.





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




Year
                ending June 30,2008
            
            $
            372,1182009
            
            
            338,4962010
            
            
            338,3542011
            
            
            337,9252012
            
            
            328,749Thereafter
            
            
            1,260,206$
            2,975,848


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





In
      September 2007, the Company entered into a letter of intent with IBt to enter
      into a Global Strategic Alliance incorporating various cooperative initiatives
      which will be the subject of a number of subsequent agreements and transactions.
      The proposed initiatives, each of which are subject to Board approval by each
      respective party, include:


§
            An
                amendment to IsoRay’s license agreement with IBt for use of its polymer
                seed technology whereby IsoRay would pay the remaining $225,000 license
                fee but would not be subject to ongoing royalty payments. IsoRay
                would
                purchase polymer seed components at cost plus a profit margin to
                be
                determined.


§
            The
                Company would grant IBt an exclusive license to distribute Cs-131
                brachytherapy seeds in certain markets outside of North and South
                America,
                including the European Union.


§
            The
                Company would receive the exclusive right to manufacture and distribute
                polymer I-125 brachytherapy seeds in North and South
                America.


§
            The
                Company would also receive IBt’s US subsidiary’s customer list and the
                right to offer employment to certain IBt US
                employees.




42




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 when it
      relocates its current production facilities then certain decommissioning
      expenses will be incurred. Therefore, the Company established in fiscal year
      2006 an initial asset retirement obligation of $63,040 which represents the
      discounted cost of cleanup that the Company anticipates it will have to incur
      at
      the end of its equipment and property leases. This amount was determined based
      on discussions with qualified production personnel and on historical evidence.
      During fiscal year 2007, the Company reevaluated its obligations based on
      discussions with the Washington Department of Health and determined that the
      initial asset retirement obligation should be increased by an additional
      $56,120. The Company anticipates spending most of the amounts represented by
      this accrual in fiscal year 2008. In addition, another asset retirement
      obligation will be established in the first quarter of fiscal year 2008
      representing obligations at its new production facility. This new asset
      retirement obligation will be for obligations to remove any residual radioactive
      materials and to remove any unwanted 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.





*Related
      Party Transactions*





The
      Company received legal services from a law firm in which Stephen Boatwright,
      a
      member of the Board of Directors, is one of the firm’s partners. The total
      amounts paid in 2007 and 2006 to the law firm were $458,534 and $390,000,
      respectively. The 2007 amount includes approximately $18,000 accrued in accounts
      payable as of June 30, 2007.





**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.




43




**New
      Accounting Standards**





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





In
      September 2006, the FASB issued statement No. 157, Fair Value Measurements,
      (SFAS 157). SFAS 157 defines fair value, establishes a framework for
      measuring fair value in accordance with accounting principles generally accepted
      in the United States, and expands disclosures about fair value measurements.
      SFAS 157 is effective for fiscal years beginning after November 15,
      2007, with earlier application encouraged. Any amounts recognized upon adoption
      as a cumulative effect adjustment will be recorded to the opening balance of
      retained earnings in the year of adoption. The Company is currently evaluating
      the impact this statement will have on its financial statements.





In
      February 2007, the FASB issued statement No. 159, The Fair Value Option for
      Financial Assets and Financial Liabilities Including an Amendment of FASB
      Statement No. 115 (SFAS 159). The statement allows entities to value financial
      instruments and certain other items at fair value. The statement provides
      guidance over the election of the fair value option, including the timing of
      the
      election and specific items eligible for the fair value accounting. Changes
      in
      fair values would be recorded in earnings. The statement is effective for fiscal
      years beginning after November 15, 2007. The Company is currently
      evaluating the impact this statement will have on its financial
      statements.





**ITEM
      7 –
      FINANCIAL STATEMENTS**




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




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





The
      Company’s Board of Directors engaged DeCoria, Maichel & Teague, P.S., then
      the independent auditor for the Company's wholly-owned subsidiary, to be its
      new
      independent auditor effective November 15, 2005, which was also the effective
      date of S.W. Hatfield, CPA’s dismissal as the Company’s certifying accountant by
      the Board.





Except
      for an expression of doubt about our ability to continue as a going concern,
      S.W. Hatfield, CPA's audit reports on the Company’s financial statements as of
      June 30, 2005 and September 30, 2004 did not contain an adverse opinion or
      disclaimer of opinion, nor were they qualified or modified as to uncertainty,
      audit scope or accounting principles.





During
      the two fiscal years ended June 30, 2005 and September 30, 2004, and through
      November 15, 2005 there were no disagreements with S.W. Hatfield, CPA on any
      matter of accounting principles or practices, financial statement disclosure,
      or
      auditing scope or procedures, which disagreements, if not resolved to the
      satisfaction of S.W. Hatfield, CPA would have caused it to make a reference
      to
      the subject matter of the disagreements in connection with its report; and
      there
      were no reportable events as described in Item 304(a)(1)(iv)(B) of Regulation
      S-B promulgated by the Securities and Exchange Commission (the SEC) pursuant
      to
      the Securities Exchange Act of 1934, as amended.





During
      the Company’s two most prior fiscal years and through November 15, 2005, the
      Company did not consult DeCoria, Maichel & Teague, P.S. with respect to the
      application of accounting principles to a specified transaction, either
      completed or proposed, or the type of audit opinion that might be rendered
      on
      the Company’s financial statements, or any other matters or reportable events
      listed in Item 304(a)(2) of Regulation S-B. However, IsoRay Medical, Inc.,
      the
      Company's wholly-owned subsidiary, has consulted with DeCoria, Maichel &
Teague, P.S., its independent auditor, during these time periods solely in
      connection with IsoRay Medical, Inc.'s financial statements.




44




**ITEM
      8A – CONTROLS AND PROCEDURES**





(a)
      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, 2007. Based on that evaluation, our principal executive
      officer and our principal financial officer concluded that the design and
      operation of our disclosure controls and procedures were effective in timely
      alerting them to material information required to be included in the Company's
      periodic reports filed with the SEC under the Exchange Act. The design of any
      system of controls is based in part upon certain assumptions about the
      likelihood of future events, and there can be no assurance that any design
      will
      succeed in achieving its stated goals under all potential future conditions,
      regardless of how remote. However, management believes that our system of
      disclosure controls and procedure is designed to provide a reasonable level
      of
      assurance that the objectives of the system will be met.





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





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





***Lack
      of segregation of duties***


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


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


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


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





***Financial
      reporting procedures***


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


§
            Established
                and implemented various accounting policies and procedures;
                and


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





Based
      on
      the evaluation completed in the fourth quarter of fiscal year 2007, the
      Company has concluded that these control improvements are properly designed
      and
      operating effectively as of June 30, 2007, and the two significant
      deficiencies that previously existed have been substantially
      remediated.




45




**ITEM
      8B – 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, 2007 that have not been already
      disclosed on a Form 8-K filed with the SEC.





**PART
      III**




**ITEM
      9 – DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS, AND
      CORPORATE GOVERANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
      ACT**





Effective
      as of July 28, 2005 (the closing date of the Merger), Roger Girard and David
      Swanberg were appointed as directors by the resigning Board, and, also effective
      as of July 28, 2005, they appointed Robert Kauffman, Thomas LaVoy and Stephen
      Boatwright to fill the remaining three vacant Board positions. On March 31,
      2006, the number of directors was increased to seven and Dwight Babcock and
      Albert Smith were appointed to fill the newly created positions.





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





*Audit
      Committee*





The
      Audit
      Committee Charter was established on December 8, 2006. 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 401 of Regulation S-B
      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, 2007 were
      as
      follows:


Name
              
              Age
              
              Position
                  Held
              
              Term*Roger
                  Girard
              
              64
              
              Chairman,
                  President, CEO
              
              AnnualJonathan
                  Hunt
              
              40
              
              Chief
                  Financial Officer –
                  TreasurerDavid
                  Swanberg
              
              51
              
              Executive
                  Vice President – Operations and Corporate Secretary,
                  Director
              
              AnnualLori
                  Woods
              
              45
              
              Vice
                  PresidentDwight
                  Babcock
              
              59
              
              Director
              
              AnnualStephen
                  Boatwright
              
              43
              
              Director
              
              AnnualRobert
                  Kauffman
              
              66
              
              Director
              
              AnnualThomas
                  LaVoy
              
              47
              
              Director
              
              AnnualAlbert
                  Smith
              
              63
              
              Director
              
              Annual





*
      For
      directors only




46




Roger
      Girard –
      In addition to serving as President, Chairman and CEO for the Company, Mr.
      Girard is also the CEO, President and Chairman of the Board of IsoRay Medical,
      Inc., and has served in these positions since the formation of IsoRay Medical,
      Inc. Mr. Girard was CEO and Chairman of IsoRay's predecessor company from August
      of 2003 until October 1, 2004. Mr. Girard has been actively involved in the
      management and the development of the management team at IsoRay, and his
      experienced leadership has helped drive IsoRay's development to date. From
      June
      1998 until August of 2003, Mr. Girard served as President of Strategic Financial
      Services, a business consulting company based in Seattle, Washington designed
      to
      help wealthy individuals and companies with strategic planning and financial
      strategy. Strategic Financial Services previously provided its services to
      another medical device company. Mr. Girard served as its sole employee. Mr.
      Girard also served as the managing partner for the Northwest office of Capital
      Consortium, another business consulting company based in Seattle, during this
      time. Capital Consortium employed four people and analyzed business market
      potential for start-ups and early stage companies. Mr. Girard has knowledge,
      experience and connections to private, institutional and public
      sources of capital and is experienced in managing and designing capital
      structures for business organizations as well as organizing and
      managing the manufacturing process, distribution, sales, and marketing,
      based on his 35 years of experience.





Jonathan
      Hunt – Mr. Hunt has over 10 years of finance and accounting experience,
      including financial reporting, SEC knowledge, and operational analysis. Before
      joining IsoRay, 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.





David
      Swanberg **-** Mr.
      Swanberg has more than 22 years experience in engineering and materials science,
      nuclear waste and chemical processing, aerospace materials and processes, and
      environmental technology development and environmental compliance. Beginning
      in
      November 1995 and until January 2004, Mr. Swanberg was employed full time as
      Sr.
      Chemical/Environmental Engineer for Science Applications International
      Corporation working on a variety of projects including nuclear waste research
      and development. Mr. Swanberg joined IsoRay's predecessor company in March
      of
      1999 on a part-time basis and has held management positions in the IsoRay
      companies since 2000. Mr. Swanberg began full-time employment with IsoRay in
      February 2004. He has been instrumental in development of IsoRay's initial
      product, the Cs-131 brachytherapy seed, including interfaces with technical,
      regulatory, and quality assurance requirements. With IsoRay and its predecessor
      companies, he has managed the development and production of radioactive seeds
      to
      support testing to meet NRC and FDA requirements, provided technical guidance
      for characterization of the IsoRay seed to meet AAPM Task Group 43 protocols,
      and coordinated production and testing of non-radioactive seeds to conform
      to
      ISO standards for brachytherapy devices. He is President of the Nuclear Medicine
      Research Council. He holds an MS in Chemical Engineering, is a licensed Chemical
      Engineer, and a certified Level II Radiation Worker.





Lori
      Woods – Ms. Woods joined the Company in July 2006 and 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.




47




Dwight
      Babcock – 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.





Stephen
      Boatwright – Mr. Boatwright has been a member of Keller Rohrback, PLC
      in Phoenix, Arizona since 2005. From 1997 through 2005, Mr. Boatwright was
      a partner at Gammage & Burnham, PLC, also in Phoenix, Arizona. Throughout
      his career, he has provided legal counsel to both private and public companies
      in many diverse industries. In recent years, Mr. Boatwright’s legal
      practice has focused on representing technology, biotechnology, life science
      and
      medical device companies for their securities, corporate and intellectual
      property licensing needs. Mr. Boatwright earned both a J.D. and an M.B.A.
      from the University of Texas at Austin, and holds a B.A. in Philosophy from
      Wheaton College.





Robert
      Kauffman – 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.





Thomas
      LaVoy – 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 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, LLC a private video conferencing company in Scottsdale,
      Arizona in December 2005 where he presently serves as CEO and President. Mr.
      Smith presently serves as a director for Center for Arizona Policy (Scottsdale)
      and Doulos Ministries (Denver). 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.




48




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
            
            59
            
            VP,
                Regulatory Affairs and Quality AssuranceLane
                Bray
            
            79
            
            ChemistOleg
                Egorov
            
            37
            
            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.





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 9 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 recently 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.


49





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, 2006
      except as follows: David Swanberg (two Form 4s). We believe all of these forms
      have been filed as of the date of this Report.





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-B 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
      10 – 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 are set by the Compensation Committee
      of the Board of Directors.


50




**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 ($)Roger
                  Girard, Chairman and CEO (2)
              
              2007
              
              
              298,042
              
              
              -
              
              
              -
              
              
              600,500
              
              
              -
              
              
              -
              
              
              -
              
              
              898,5422006
              
              
              199,231
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              199,231David
                  Swanberg, Executive Vice President - Operations (2) (3)
              
              2007
              
              
              161,539
              
              
              -
              
              
              -
              
              
              372,228
              
              
              -
              
              
              -
              
              
              -
              
              
              533,7672006
              
              
              120,000
              
              
              25,000
              
              
              -
              
              
              79,500
              
              
              -
              
              
              -
              
              
              -
              
              
              224,500Lori
                  Woods, Vice President (4)
              
              2007
              
              
              155,692
              
              
              -
              
              
              -
              
              
              327,150
              
              
              -
              
              
              -
              
              
              -
              
              
              482,8422006
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Jonathan
                  Hunt, Chief Financial Officer (5)
              
              2007
              
              
              120,000
              
              
              -
              
              
              -
              
              
              205,650
              
              
              -
              
              
              -
              
              
              24,266
              
              
              349,9162006
              
              
              60,000
              
              
              -
              
              
              -
              
              
              58,512
              
              
              -
              
              
              -
              
              
              -
              
              
              118,512Michael
                  Dunlop, former Chief Financial Officer (6)
              
              2007
              
              
              30,660
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              288,000
              
              
              318,6602006
              
              
              80,167
              
              
              -
              
              
              -
              
              
              79,500
              
              
              -
              
              
              -
              
              
              -
              
              
              159,667





(1)
            Amounts
                represent the FAS 123R valuation for the fiscal year ended June 30,
                2007
                and 2006, respectively. All such options were awarded under one of
                the
                Company’s stock option plans. All options awarded (with the exception of
                Mr. Swanberg’s and Mr. Dunlop’s fiscal year 2006 stock option grants that
                were 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.
                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 3 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.


(3)
            The
                value of Mr. Swanberg’s options includes $7,728 relating to options
                granted to his wife who is also an employee of the
                Company.


(4)
            Ms.
                Woods became an employee of the Company on July 5,
                2006.


(5)
            Mr.
                Hunt became an employee of the Company on May 1, 2006. The Company
                reimbursed Mr. Hunt for certain of his relocation costs and this
                amount is
                included in the “All other compensation” column for fiscal year
                2007.


(6)
            Mr.
                Dunlop left the Company in September 2006. As part of his employment
                agreement, Mr. Dunlop was entitled to a severance payment of $288,000
                and
                this amount is included in the “All other compensation”
                column.





Mr.
      Girard and Ms. Woods, have employment contracts with the Company. Mr. Swanberg
      had an employment agreement with the Company’s subsidiary that expired on
      September 1, 2007. The Company and Mr. Swanberg are negotiating terms for a
      new
      employment agreement as of the date of this report.


51





Mr.
      Girard’s employment agreement is dated October 6, 2005 and expires on October 6,
      2009. The agreement will be automatically extended at the end of the fourth
      year
      for one year on each anniversary date unless the agreement is modified at least
      90 days prior to the anniversary date. Effective July 1, 2006, the agreement
      calls for an annual salary of $300,000 with increases as determined by the
      Compensation Committee of the Board and a bonus plan as determined by the Board.
      Under the terms of the agreement, if Mr. Girard is terminated without cause
      or
      he terminates his employment for good reason then he is entitled to receive
      his
      continued salary and benefits for a one year period. Good reason is defined
      in
      the agreement to mean a reduction of salary or benefits, a change in Mr.
      Girard’s title, position, authority, or responsibilities, or any breach by the
      Company of this agreement. In the event of disability, Mr. Girard is entitled
      to
      his continued salary and benefits for a one year period. The agreement also
      includes certain restrictive covenants that prohibit Mr. Girard from providing
      services to a competing business for the period of this agreement plus one
      year.





Mr.
      Swanberg’s employment agreement was with IsoRay Medical, Inc. and was dated
      September 1, 2004. The agreement had a term of three years and expired on
      September 1, 2007. Mr. Swanberg is due $50,000 under this agreement as a bonus
      from August 2007.





Ms.
      Woods’ employment agreement dated February 14, 2007, 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.




52


**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
                dateRoger
                  Girard, Chief Executive Officer (Principal Executive
                  Officer)
              
              
              513,840
              
              
              -
              
              
              -
              
              
              1.19
              
              
              8/1/2015**-**
              
              
              100,000
              (1)
              
              -
              
              
              3.11
              
              
              8/15/2016**-**
              
              
              150,000
              (2)
              
              -
              
              
              4.14
              
              
              6/1/2017David
                  Swanberg, Executive Vice President - Operations
              
              
              150,000
              
              
              -
              
              
              -
              
              
              1.00
              
              
              8/18/2015**-**
              
              
              50,000
              (1)
              
              -
              
              
              3.11
              
              
              8/15/2016**-**
              
              
              100,000
              (2)
              
              -
              
              
              4.14
              
              
              6/1/2017Lori
                  Woods, Vice President
              
              
              -
              
              
              50,000
              (3)
              
              -
              
              
              3.50
              
              
              7/5/2016**-**
              
              
              50,000
              (4)
              
              -
              
              
              3.10
              
              
              10/17/2016**-**
              
              
              15,000
              (5)
              
              -
              
              
              4.40
              
              
              3/2/2017**-**
              
              
              20,000
              (6)
              
              -
              
              
              4.14
              
              
              6/1/2017Jonathan
                  Hunt, Chief Financial Officer
              
              
              10,000
              
              
              20,000
              (7)
              
              -
              
              
              5.50
              
              
              5/1/2016**-**
              
              
              50,000
              (4)
              
              -
              
              
              3.10
              
              
              10/17/2016**-**
              
              
              15,000
              (5)
              
              -
              
              
              4.40
              
              
              3/2/2017**-**
              
              
              20,000
              (6)
              
              -
              
              
              4.14
              
              
              6/1/2017Michael
                  Dunlop, former Chief Financial Officer
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -


(1)
            Represents
                the August 15, 2006 grant, one-third of which became exercisable
                on August
                15, 2007, one-third of which will become exercisable on August 15,
                2008,
                and the final third will become exercisable on August 15,
                2009.


(2)
            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 3 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 was not changed as part of the cancellation.
                These
                cancelled options have been included in the table above as they were
                outstanding on June 30, 2007.


(3)
            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.


(4)
            Represents
                the October 17, 2006 grant, one-third of which will become 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.


(5)
            Represents
                the March 2, 2007 grant, one-third of which will become 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.


(6)
            Represents
                the June 1, 2007 grant, one-third of which will become 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.


53


(7)
            Represents
                the final two-thirds vesting of a May 1, 2006 grant, half of which
                will
                become exercisable on May 1, 2008 and the other half will become
                exercisable on May 1, 2009.





The
      Company has a 401(k) plan that commenced in fiscal year 2007. The 401(k) plan
      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.




**Non-Employee
        Director Compensation**





Name
              
              Fees
                earned or
                paid in
                cash ($)
                (1)
              
              Stock
                awards ($)
              
              Option
                awards ($)
                (2) (3)
              
              Non-equity
                incentive
                plan
                compensation
                ($)
              
              Non-qualified
                deferred
                compensation
                earnings
                ($)
              
              All other
                compensation
                ($)
              
              Total ($)Dwight
                  Babcock
              
              
              8,000
              
              
              -
              
              
              236,000
              
              
              -
              
              
              -
              
              
              -
              
              
              244,000Stephen
                  Boatwright
              
              
              8,000
              
              
              -
              
              
              236,000
              
              
              -
              
              
              -
              
              
              -
              
              
              244,000Robert
                  Kauffman
              
              
              8,000
              
              
              -
              
              
              236,000
              
              
              -
              
              
              -
              
              
              -
              
              
              244,000Thomas
                  LaVoy
              
              
              7,000
              
              
              -
              
              
              236,000
              
              
              -
              
              
              -
              
              
              -
              
              
              243,000Albert
                  Smith
              
              
              7,000
              
              
              -
              
              
              236,000
              
              
              -
              
              
              -
              
              
              -
              
              
              243,000


(1)
            In
                fiscal year 2007, each non-employee director received cash compensation
                of
                $1,000 per meeting attended. Beginning in fiscal year 2008, each
                non-employee director will receive cash compensation of $3,000 per
                month,
                except for Mr. Boatwright who will receive $1,000 per month. In addition,
                each non-employee director will receive $1,000 per Board meeting
                attended
                in person or $500 per Board meeting attended via telephone and $500
                per
                committee meeting attended.


(2)
            This
                represents the value determined in accordance with FAS 123R for the
                option
                grant of August 15, 2006. Each non-employee director also received
                a grant
                of 50,000 options with an exercise price of $4.14 per share on June
                1,
                2007. After a discussion of director compensation with the entire
                Board,
                each Board member elected to cancel their June 1, 2007 option grant
                on
                July 25, 2007 in exchange for the additional cash compensation discussed
                in (1) above. Under FAS 123R, these options were valued at $128,500
                per
                director. The value of these options has been included in the table
                above
                and in the financial statements as they were fully vested on the
                day of
                grant.


(3)
            Each
                director had stock options to purchase 200,000 shares of the Company’s
                common stock outstanding as of June 30, 2007 including the June 1,
                2007
                grant (for 50,000 shares per director) that was subsequently cancelled
                on
                July 25, 2007.





**ITEM
      11 – 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 12,
      2007 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
      12, 2007, the Company had 23,033,108 shares of common stock and 59,065 shares
      of
      preferred stock outstanding.


54





**Common
                Stock Share Ownership**Name of Beneficial Owner
            
            Common Shares
              Owned
            
            Common Stock
              Options
              Exercisable
              Within 60 Days
            
            Common
              Warrants
            
            Percent of
              Class (1)Roger
                Girard
            
            
            368,534
            
            
            547,173
            
            
            -
            
            
            3.98
            %David
                Swanberg (2)
            
            
            324,327
            
            
            179,999
            
            
            5,500
            
            
            2.21
            %Lori
                Woods
            
            
            3,000
            
            
            33,332
            
            
            -
            
            
            —
            %Jonathan
                Hunt
            
            
            -
            
            
            26,666
            
            
            -
            
            
            —
            %Michael
                Dunlop
            
            
            195,050
            
            
            -
            
            
            -
            
            
            —
            %Dwight
                Babcock (3)
            
            
            61,002
            
            
            150,000
            
            
            12,500
            
            
            —
            %Stephen
                Boatwright (4)
            
            
            60,000
            
            
            150,000
            
            
            -
            
            
            —
            %Robert
                Kauffman
            
            
            43,802
            
            
            150,000
            
            
            -
            
            
            —
            %Thomas
                LaVoy
            
            
            8,423
            
            
            150,000
            
            
            -
            
            
            —
            %Albert
                Smith
            
            
            108,947
            
            
            150,000
            
            
            12,500
            
            
            1.18
            %Directors
                and Executive Officers as a group
            
            
            1,173,085
            
            
            1,537,170
            
            
            30,500
            
            
            11.90
            %




(1)
              Percentage
                  ownership is based on 23,033,108 shares of Common Stock outstanding
                  on
                  September 12, 2007. Shares of Common Stock subject to stock options
                  which
                  are currently exercisable or will become exercisable within 60
                  days after
                  September 12, 2007 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.
                  Swanberg’s options include 13,333 options granted to his
                  spouse.(3)
              Mr.
                  Babcock’s common shares owned include 2,695 shares owned by his
                  spouse.(4)
              Mr.
                  Boatwright’s common shares owned are held by an entity controlled by Mr.
                  Boatwright.


**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 12, 2007.(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.


55


**ITEM
      12 – 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
      $2,161 for fiscal year 2007 related to these payments.





On
      January 16, 2005, in addition to certain other shareholders, the following
      current and former officers and directors of the Company were awarded shares
      of
      common stock for guaranteeing a loan with the Benton Franklin Economic
      Development District (BFEDD) in the amount of $230,000, which was funded in
      December 2004, and a line of credit with Columbia River Bank in the amount
      of
      $395,000: Michael Dunlop guaranteed $15,000 of the BFEDD loan and $30,000 of
      the
      Columbia River Bank line of credit, for which he received 12,888 post-merger
      shares; Roger Girard guaranteed $20,000 of the BFEDD loan, for which he received
      5,728 post-merger shares; John Hrobsky guaranteed $15,000 of the Columbia River
      Bank line of credit, for which he received 4,296 post merger shares; and David
      Swanberg guaranteed $30,000 of the Columbia River Bank line of credit, for
      which
      he received 8,592 post-merger shares. During fiscal year 2006, certain original
      guarantors, including John Hrobsky, declined to continue guaranteeing the loans
      and forfeited the shares which had been granted to them. Due to this the
      following officers agreed to increase the amount of their guarantees as follows:
      Michael Dunlop guaranteed an additional $5,000 of the Columbia River Bank line
      of credit, for which he received an additional 1,432 common shares; and Roger
      Girard guaranteed an additional $105,000 of the Columbia River Bank line of
      credit, for which he received an additional 30,072 common shares.





Mr. Stephen
      Boatwright, a 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, 2007 and 2006,
      the
      Company paid Keller Rohrback, PLC approximately $459,000 and $390,000,
      respectively, for legal services. In addition, the Company had accrued at June
      30, 2007 approximately $18,000 in legal fees to be paid.





Certain
      members of management, including Roger Girard and David Swanberg, personally
      guaranteed a loan from HAEIFC, in exchange for which they have a contractual
      right to receive their pro rata portion of the 70,455 shares that will be issued
      to the guarantors of this loan.





On
      May
      27, 2005, the Company, Century Park Transitory Subsidiary, Inc., a Delaware
      corporation, Thomas Scallen and Anthony Silverman (shareholders of the Company),
      and IsoRay Medical, Inc., a Delaware corporation, entered into a Merger
      Agreement. Pursuant to the Merger Agreement, Century Park Transitory Subsidiary,
      Inc. was merged with and into IsoRay Medical, Inc. and IsoRay Medical, Inc.
      became a wholly-owned subsidiary of the Company. The Merger Agreement was
      subject to the satisfaction of certain conditions, including the granting of
      certain "piggy-back" and demand registration rights to the purchasers of certain
      convertible debentures of IsoRay Medical, Inc., Anthony Silverman and certain
      other affiliates of the Company; the agreements of the officers and directors
      of
      IsoRay Medical, Inc. to lock-up the shares of common stock of the Company they
      received in the merger for a period of one year from the closing of the merger;
      the agreements of Thomas Scallen and Anthony Silverman to escrow certain shares
      of common stock of the Company; and the receipt by IsoRay Medical, Inc. from
      Anthony Silverman or his associates of one million dollars as the purchase
      price
      of certain securities of IsoRay Medical, Inc. before the closing. These
      conditions were satisfied prior to the closing of the merger, which occurred
      on
      July 28, 2005.


56


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, the Company participated in
      nonbinding mediation and no settlement was reached. The parties have agreed
      to
      extend mediation discussions until early October, 2007. If no settlement is
      reached, the parties may demand binding arbitration. .





Director
      Independence




Using
      the
      standards of the American Stock Exchange, the Company's Board has
      determined that Mr. Babcock, Mr. Kauffman, Mr. LaVoy, and
      Mr. Smith each qualify under such standards as an independent
      director. Mr. Kauffman and Mr. LaVoy each meet the American Stock Exchange
      listing standards for independence both as a director and as a member of the
      Audit Committee, and Mr. Babcock 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.




**ITEM
      13 – 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,
                  2007.4.2
              
              Form
                  of Lock-Up Agreement for Certain IsoRay Medical, Inc. Shareholders
                  incorporated by reference to the Form 8-K filed on August 3,
                  2005.4.3
              
              Form
                  of Lock-Up Agreement for Anthony Silverman incorporated by reference
                  to
                  the Form 8-K filed on August 3, 2005.4.4
              
              Form
                  of Registration Rights Agreement among IsoRay Medical, Inc., Century
                  Park
                  Pictures Corporation and the other signatories thereto incorporated
                  by
                  reference to the Form 8-K filed on August 3, 2005.4.5
              
              Form
                  of Escrow Agreement among Century Park Pictures Corporation, IsoRay
                  Medical, Inc. and Anthony Silverman incorporated by reference to
                  the Form
                  8-K filed on August 3, 2005.
  57
  4.6
              
              Form
                  of Escrow Agreement among Century Park Pictures Corporation, IsoRay
                  Medical, Inc. and Thomas Scallen incorporated by reference to the
                  Form 8-K
                  filed on August 3, 2005.4.7
              
              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,
                  2007.10.2
              
              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
              
              Tri-City
                  Industrial Development Council Promissory Note, dated July 22,
                  2002,
                  incorporated by reference to the Form SB-2/A2 filed on April 27,
                  2006.10.5
              
              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
              
              Applied
                  Process Engineering Laboratory APEL Tenant Lease Agreement, dated
                  April
                  23, 2001 between Energy Northwest and IsoRay, LLC, incorporated
                  by
                  reference to the Form SB-2/A2 filed on April 27, 2006.10.8
              
              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.
  58
  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
              
              Lease
                  Agreement, Rev. 2, dated November 1, 2005 between Pacific EcoSolutions,
                  Inc. and IsoRay Medical, Inc., incorporated by reference to the
                  Form
                  SB-2/A2 filed on April 27, 2006.10.16
              
              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
              
              Girard
                  Employment Agreement, dated October 6, 2005 between Roger E. Girard
                  and
                  IsoRay, Inc., incorporated by reference to the Form 10-QSB filed
                  on
                  November 21, 2005.10.21
              
              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
              
              SICAV
                  ONE Securities Purchase Agreement, dated December 7, 2005, by and
                  between
                  IsoRay, Inc. and Mercatus & Partners, Ltd., incorporated by reference
                  to the Form 8-K filed on December 12, 2005.10.24
              
              SICAV
                  TWO Securities Purchase Agreement, dated December 7, 2005, by and
                  between
                  IsoRay, Inc. and Mercatus & Partners, Ltd., incorporated by reference
                  to the Form 8-K filed on December 12, 2005.10.25
              
              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
              
              Benton
                  Franklin Economic Development District Loan Covenant Waiver Letter,
                  dated
                  as of March 31, 2005, incorporated by reference to the Form SB-2/A3
                  filed
                  on May 12, 2006.10.28
              
              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
              
              Business
                  Loan Agreement between IsoRay Medical, Inc. and Columbia River
                  Bank, dated
                  March 1, 2006, incorporated by reference to the Form SB-2/A4 filed
                  on May
                  26, 2006.10.30
              
              Letter
                  from HAEIFC to IsoRay Medical, Inc. dated April 26, 2006, incorporated
                  by
                  reference to the Form SB-2/A5 filed on June 6,
                  2006.
  59
  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, 2006.10.34
              
              Benton
                  Franklin Economic Development District Loan Covenant Waiver Letter,
                  dated
                  September 26, 2006, filed herewith.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
              
              APEL
                  - Tenant Lease Agreement Revision No. 11 dated as of May 2, 2007
                  with an
                  effective date of May 1, 2007 between Energy Northwest and IsoRay
                  Medical,
                  Inc., incorporated by reference to the Form 8-K filed on May 8,
                  2007.10.43
              
              Loan
                  Covenant Waiver Letter dated September 24, 2007 from the Hanford
                  Area
                  Economic Investment Fund Committee, filed herewith.10.44
              
              Loan
                  Covenant Waiver Letter dated September 26, 2007 from the Benton-Franklin
                  Economic Development District, filed herewith.16.1
              
              Letter
                  from S.W. Hatfield, CPA to the SEC dated December 13, 2005, incorporated
                  by reference to the Form 8-K filed on December 14,
                  2005.21.1
              
              Subsidiaries
                  of the Company, incorporated by reference to the Form 10-KSB filed
                  on
                  October 11, 2005.23.1
              
              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
      April
      4, 2007, the Company filed a Current Report on Form 8-K announcing that as
      a
      result of its warrant call on March 26, 2007, the Company received $4,989,000
      of
      capital from warrant exercises.


60


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




61


**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. and to its
      previous principal accountant, S. W. Hatfield, CPA:





Year ended
              June 30,
              2007
            
            Year ended
              June 30,
              20061.Audit
                fees(1)
            
            $
            41,016
            
            $
            72,2922.Audit-related
                fees
            
            
            1,800
            
            
            1,1503.Tax
                fees
            
            
            4,250
            
            
            2,7504.All
                other fees
            
            
            -
            
            
            -Totals
            
            $
            47,066
            
            $
            76,192




(1)
            Fees
                for the year ended June 30, 2006 were as follows: $49,125 paid to
                DeCoria,
                Maichel & Teague, P.S. and $23,167 paid to S. W. Hatfield,
                CPA.





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.




62


**IsoRay,
      Inc.**


**Index
      to Financial Statements**





PageReport
                of Independent Registered Public Accounting Firm
            
            F-2Financial
                Statements:Consolidated
                Balance Sheets as of June 30, 2007 and 2006
            
            F-3Consolidated
                Statements of Operations for the years ended June 30, 2007 and 2006
            
            F-4Consolidated
                Statement of Changes in Shareholders’ Equity for the years ended
                June 30, 2007 and 2006
            
            F-5Consolidated
                Statements of Cash Flows for the years ended June 30, 2007 and 2006
            
            F-6Notes
                to Consolidated Financial Statements
            
            F-7




F-1


**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
      Subsidiary (“the Company”) (see Note 1) as of June 30, 2007 and 2006, 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
      Subsidiary as of June 30, 2007 and 2006, 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
      28, 2007


F-2


**IsoRay,
        Inc. and Subsidiary**
 **Consolidated
        Balance Sheets**
 
 **June 30,****2007**
              
              **2006****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              9,355,730
              
              $
              2,207,452Short-term
                  investments
              
              
              9,942,840
              
              
              -Accounts
                  receivable, net of allowance for doubtful accounts of $99,789 and
                  $85,183,
                  respectively
              
              
              1,092,925
              
              
              596,447Inventory
              
              
              880,834
              
              
              161,381Prepaid
                  expenses and other current assets
              
              
              458,123
              
              
              161,546Total
                  current assets
              
              
              21,730,452
              
              
              3,126,826Fixed
                  assets, net of accumulated depreciation
              
              
              3,665,551
              
              
              1,642,293Deferred
                  financing costs, net of accumulated amortization
              
              
              95,725
              
              
              274,358Licenses,
                  net of accumulated amortization
              
              
              262,074
              
              
              273,475Other
                  assets, net of accumulated amortization
              
              
              322,360
              
              
              338,987Total
                  assets
              
              $
              26,076,162
              
              $
              5,655,939**LIABILITIES
                  AND SHAREHOLDERS' EQUITY**Current
                  liabilities:Accounts
                  payable and accrued expenses
              
              $
              1,946,042
              
              $
              584,296Accrued
                  payroll and related taxes
              
              
              459,068
              
              
              614,645Accrued
                  interest payable
              
              
              1,938
              
              
              11,986Deferred
                  revenue
              
              
              23,874
              
              
              -Notes
                  payable, due within one year
              
              
              49,212
              
              
              51,351Capital
                  lease obligations, due within one year
              
              
              194,855
              
              
              183,554Convertible
                  debentures payable, due within one year
              
              
              -
              
              
              455,000Asset
                  retirement obligation, current portion
              
              
              131,142
              
              
              -Total
                  current liabilities
              
              
              2,806,131
              
              
              1,900,832Notes
                  payable, due after one year
              
              
              528,246
              
              
              581,557Capital
                  lease obligations, due after one year
              
              
              25,560
              
              
              220,415Asset
                  retirement obligation
              
              
              -
              
              
              67,425Total
                  liabilities
              
              
              3,359,937
              
              
              2,770,229Commitments
                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 and 144,759 shares issued
                  and
                  outstanding
              
              
              59
              
              
              145Common
                  stock, $.001 par value; 194,000,000 shares authorized; 22,789,324
                  and
                  15,157,901 shares issued and outstanding
              
              
              22,789
              
              
              15,158Subscriptions
                  receivable
              
              
              -
              
              
              (6,122,007
              )Additional
                  paid-in capital
              
              
              45,844,793
              
              
              22,538,675Accumulated
                  deficit
              
              
              (23,151,416
              )
              
              (13,546,261
              )Total
                  shareholders' equity
              
              
              22,716,225
              
              
              2,885,710Total
                  liabilities and shareholders' equity
              
              $
              26,076,162
              
              $
              5,655,939
  The
          accompanying notes are an integral part of these financial
          statements.
  F-3
 **IsoRay,
        Inc. and Subsidiary**
 **Consolidated
        Statements of Operations**
 
 **Year
                  ended June 30,****2007**
              
              **2006**Product
                  sales
              
              $
              5,738,033
              
              $
              1,994,306Cost
                  of product sales
              
              
              5,792,630
              
              
              3,815,122Gross
                  loss
              
              
              (54,597
              )
              
              (1,820,816
              )Operating
                  expenses:Research
                  and development
              
              
              1,345,163
              
              
              450,425Sales
                  and marketing expenses
              
              
              3,384,472
              
              
              1,420,500General
                  and administrative expenses
              
              
              4,915,598
              
              
              3,503,522Total
                  operating expenses
              
              
              9,645,233
              
              
              5,374,447Operating
                  loss
              
              
              (9,699,830
              )
              
              (7,195,263
              )Non-operating
                  income (expense):Interest
                  income
              
              
              406,921
              
              
              51,744Financing
                  expense
              
              
              (312,246
              )
              
              (689,100
              )Debt
                  conversion expense (Note 10)
              
              
              -
              
              
              (385,511
              )Non-operating
                  income (expense), net
              
              
              94,675
              
              
              (1,022,867
              )Net
                  loss
              
              $
              (9,605,155
              )
              $
              (8,218,130
              )Basic
                  and diluted loss per share
              
              $
              (0.54
              )
              $
              (0.68
              )Weighted
                  average shares used in computing net loss per share:Basic
                  and diluted
              
              
              17,827,522
              
              
              12,051,964
 
 The
        accompanying notes are an integral part of these financial
        statements.
  F-4
 
 **IsoRay,
        Inc. and Subsidiary**
 **Consolidated
        Statement of Changes in Shareholders' Equity (Deficit)**
 **IsoRay, Inc. (MN)**
                
                **IsoRay Medical, Inc.****Series B Preferred Stock**
                
                **Common Stock**
                
                **Series B Preferred Stock**
                
                **Common Stock****Shares**
                
                **Amount**
                
                **Shares**
                
                **Amount**
                
                **Shares**
                
                **Amount**
                
                **Shares**
                
                **Amount**
                
                **Subscriptions**
                  **Receivable**
                
                **Additional**
                  **Paid-in Capital**
                
                **Accumulated**
                  **Deficit**
                
                **Total**Balances
                    at June 30, 2005
                
                
                -
                
                $
                -
                
                
                -
                
                $
                -
                
                
                1,338,167
                
                $
                1,338
                
                
                6,163,623
                
                $
                6,164
                
                $
                -
                
                $
                3,805,773
                
                $
                (5,328,131
                )
                $
                (1,514,856
                )Merger
                    of IsoRay, Inc. (formerly Century Park Pictures Corporation)
                    and IsoRay
                    Medical, Inc., net of fractional shares paid in cash (see Note
                    1)
                
                
                1,338,132
                
                
                1,338
                
                
                6,163,518
                
                
                6,164
                
                
                (1,338,167
                )
                
                (1,338
                )
                
                (6,163,623
                )
                
                (6,164
                )
                
                
                
                
                
                
                
                
                
                
                -Common
                    stock held by shareholders of Century Park Picture Corporation
                    after the
                    reverse acquisition
                
                
                
                
                
                
                
                
                2,498,534
                
                
                2,499
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                8,733
                
                
                
                
                
                11,232Issuance
                    of common shares as payment for merger consulting services
                
                
                
                
                
                
                
                
                168,472
                
                
                169
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                329,831
                
                
                
                
                
                330,000Payments
                    to shareholders in lieu of issuing fractional shares
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (734
                )
                
                
                
                
                (734
                )Issuance
                    of preferred stock pursuant to exercise of warrants
                
                
                8,708
                
                
                8
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                6,977
                
                
                
                
                
                6,985Issuance
                    of preferred stock pursuant to exercise of warrants paid by surrending
                    a
                    partial note payable
                
                
                44,788
                
                
                45
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                48,268
                
                
                
                
                
                48,313Issuance
                    of common stock pursuant to exercise of warrants
                
                
                
                
                
                
                
                
                84,147
                
                
                84
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                49,866
                
                
                
                
                
                49,950Issuance
                    of common stock pursuant to exercise of options
                
                
                
                
                
                
                
                
                101,284
                
                
                101
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                119,476
                
                
                
                
                
                119,577Conversion
                    of preferred stock to common stock
                
                
                (1,246,869
                )
                
                (1,246
                )
                
                1,246,869
                
                
                1,246
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Exchange
                    of convertible debentures payable to common stock
                
                
                
                
                
                
                
                
                911,271
                
                
                911
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                3,681,964
                
                
                
                
                
                3,682,875Issuance
                    of warrants pursuant to short-term inducement to convert
                    debentures
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                385,511
                
                
                
                
                
                385,511Issuance
                    of warrants as inducement for note payable from shareholder (see
                    Note
                    8)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                60,000
                
                
                
                
                
                60,000Issuance
                    of common stock pursuant to the October 2005 private placement,
                    net of
                    offering costs
                
                
                
                
                
                
                
                
                1,500,000
                
                
                1,500
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                5,406,626
                
                
                
                
                
                5,408,126Issuance
                    of common stock pursuant to the February 2006 private placement,
                    net of
                    offering costs
                
                
                
                
                
                
                
                
                268,889
                
                
                269
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,107,955
                
                
                
                
                
                1,108,224Issuance
                    of common stock to Mercatus subject to a subscription receivable
                    agreement
                
                
                
                
                
                
                
                
                1,748,146
                
                
                1,748
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (6,122,007
                )
                
                6,120,259
                
                
                
                
                
                -Issuance
                    of common stock for payment of invoices
                
                
                
                
                
                
                
                
                39,007
                
                
                39
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                184,996
                
                
                
                
                
                185,035Issuance
                    of common stock pursuant to the June 2006 warrant exercise solicitation,
                    net of offering costs
                
                
                
                
                
                
                
                
                427,764
                
                
                428
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,223,174
                
                
                
                
                
                1,223,602Net
                    loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (8,218,130
                )
                
                (8,218,130
                )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
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Issuance
                    of common stock 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
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (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
                )
                $
                22,716,225
 The
          accompanying notes are an integral part of these financial
          statements.
  F-5
  **IsoRay,
        Inc. and Subsidiary**
 **Consolidated
        Statements of Cash Flows**
 
 **Year
                  ended June 30,****2007**
              
              **2006****CASH
                  FLOWS FROM OPERATING ACTIVITIES:**Net
                  loss
              
              $
              (9,605,155
              )
              $
              (8,218,130
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation
                  and amortization of fixed assets
              
              
              491,643
              
              
              271,060Amortization
                  of deferred financing costs and other assets
              
              
              223,604
              
              
              384,266Accretion
                  of asset retirement obligation
              
              
              7,597
              
              
              4,385Share-based
                  compensation (Note 11)
              
              
              1,828,114
              
              
              -Merger
                  consulting fees paid by issuance of common stock
              
              
              -
              
              
              330,000Consulting
                  and repair fees paid by issuance of common stock
              
              
              -
              
              
              39,750Rent
                  expense paid by issuance of common stock
              
              
              -
              
              
              90,026Debt
                  conversion expense (Note 10)
              
              
              -
              
              
              385,511Changes
                  in operating assets and liabilities:Accounts
                  receivable, net
              
              
              (496,478
              )
              
              (546,478
              )Inventory
              
              
              (719,453
              )
              
              (79,455
              )Prepaid
                  expenses
              
              
              (296,577
              )
              
              41,252Accounts
                  payable and accrued expenses
              
              
              1,361,746
              
              
              (132,646
              )Accrued
                  payroll and related taxes
              
              
              (10,577
              )
              
              456,721Accrued
                  interest payable
              
              
              (10,048
              )
              
              (29,339
              )Deferred
                  revenue
              
              
              23,874
              
              
              -Net
                  cash used by operating activities
              
              
              (7,201,710
              )
              
              (7,003,077
              )**CASH
                  FLOWS FROM INVESTING ACTIVITIES:**Purchases
                  of fixed assets
              
              
              (2,445,850
              )
              
              (474,795
              )Additions
                  to licenses and other assets
              
              
              (29,874
              )
              
              (395,201
              )Purchase
                  of short-term investments
              
              
              (10,931,920
              )
              
              -Proceeds
                  from the sale or maturity of short-term investments
              
              
              989,080
              
              
              -Cash
                  acquired in reverse acquisition (Note 1)
              
              
              -
              
              
              32,587Net
                  cash used by investing activities
              
              
              (12,418,564
              )
              
              (837,409
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Proceeds
                  from issuance of notes payable, net of financing costs
              
              
              -
              
              
              646,542Proceeds
                  from sales of convertible debentures payable
              
              
              -
              
              
              550,000Repayment
                  of convertible debentures payable
              
              
              (405,001
              )
              
              -Principal
                  payments on notes payable
              
              
              (55,450
              )
              
              (592,790
              )Principal
                  payments on capital lease obligations
              
              
              (183,554
              )
              
              (124,688
              )Proceeds
                  from cash sales of common shares, net of offering costs
              
              
              19,819,964
              
              
              6,516,350Proceeds
                  from cash sales of preferred stock, pursuant to exercise of
                  warrants
              
              
              41,679
              
              
              6,985Proceeds
                  from cash sales of common stock, pursuant to exercise of
                  warrants
              
              
              6,859,680
              
              
              49,950Proceeds
                  from cash sales of common stock, pursuant to exercise of
                  options
              
              
              729,692
              
              
              119,577Proceeds
                  from cash sales of common stock, pursuant to June 2006 warrant
                  exercises
              
              
              -
              
              
              1,223,602Payments
                  of dividends to preferred shareholders
              
              
              (38,458
              )
              
              -Payments
                  to common shareholders in lieu of issuing fractional
                  shares
              
              
              -
              
              
              (734
              )Net
                  cash provided by financing activities
              
              
              26,768,552
              
              
              8,394,794Net
                  increase in cash and cash equivalents
              
              
              7,148,278
              
              
              554,308Cash
                  and cash equivalents, beginning of period
              
              
              2,207,452
              
              
              1,653,144**CASH
                  AND CASH EQUIVALENTS, END OF PERIOD**
              
              $
              9,355,730
              
              $
              2,207,452Supplemental
                  disclosures of cash flow information:Cash
                  paid for interest
              
              $
              143,662
              
              $
              361,832Non-cash
                  investing and financing activities:Cashless
                  exercise of common stock options in lieu of severance pay
              
              $
              145,000
              
              $
              -Exchange
                  of convertible debentures payable for shares of common
                  stock
              
              
              49,999
              
              
              3,682,875Fixed
                  assets acquired by capital lease obligations
              
              
              -
              
              
              507,947Increase
                  in PP&E related to asset retirement obligation
              
              
              56,120
              
              
              63,040Issuance
                  of common shares as partial payment for production
                  equipment
              
              
              -
              
              
              25,248Issuance
                  of common shares as partial payment of notes payable
              
              
              -
              
              
              48,313Liabilities
                  acquired in acquisition
              
              
              -
              
              
              21,355Prepaid
                  rent paid by issuance of common stock
              
              
              -
              
              
              120,036Issuance
                  of warrants as an inducement for a note payable
              
              
              -
              
              
              60,000
 
 The
        accompanying notes are an integral part of these financial
        statements.




F-6


**IsoRay,
      Inc.**


**Notes
      to Consolidated Financial Statements**


**For
      the years ended June 30, 2007 and 2006**





**1.**
            **Organization**





Historical
      Organization





Century
      Park Pictures Corporation (Century) was organized under Minnesota law in 1983.
      Century is a public company subject to the periodic reporting requirements
      of
      the Securities Exchange Act of 1934.




Century
      had no operations since its fiscal year ended September 30, 1999 through June
      30, 2005.





Merger
      Transaction





On
      May
      27, 2005, IsoRay Medical, Inc. (Medical) entered into a merger agreement with
      Century to merge with Century’s newly-formed, wholly-owned subsidiary.





On
      July
      28, 2005, the merger transaction closed. As a result of the merger, Medical
      became a wholly-owned subsidiary of Century, which concurrently changed its
      name
      to IsoRay, Inc. (IsoRay or the Company).





IsoRay
      issued shares of its common and preferred stock to the holders of common and
      preferred stock of Medical at a rate of 0.842362 share of IsoRay’s stock for
      each share of Medical’s stock. Options and warrants to purchase common and
      preferred stock of Medical were also converted at the same rate into options
      and
      warrants to purchase common and preferred stock of IsoRay, Inc. On a
      fully-diluted basis, Medical’s shareholders owned approximately 82% of IsoRay’s
      outstanding securities following the merger.





Management
      believes the transaction was structured to qualify as a non-taxable
      reorganization under Section 368(a)(1)(A) of the Internal Revenue Code of 1986,
      as amended.





As
      part
      of the reverse merger, Medical acquired cash of $32,587 and accounts payable
      of
      $21,355.





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





Consolidation





The
      accompanying consolidated financial statements include the accounts of the
      Company and its wholly-owned subsidiary (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 losses included
      in
      shareholders’ equity.


F-7


The
      Company’s short-term investments consisted of the following at June 30, 2007 and
      2006:





2007
            
            2006Municipal
                debt securities
            
            $
            3,000,000
            
            $
            –Corporate
                debt securities
            
            
            6,942.840
            
            
            –$
            9,942,840
            
            $
            –





At
      June
      30, 2007, all of the Company’s corporate debt securities mature within fiscal
      year 2008. All municipal debt consists of auction rate securities that may
      have
      maturity dates exceeding 5 years, however, they reset each month. Based on
      the
      frequency of the auction reset periods, the fair market value approximates
      cost.





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 had minimal gross margin throughout the
      past
      fiscal years, inventories have generally been recorded at market or net
      realizable value.





Fixed
      Assets





Fixed
      assets are carried at the lower of cost or net realizable value. Production
      equipment with a cost of $2,500 or greater and other fixed assets with a cost
      of
      $1,500 or greater are capitalized. Major betterments that extend the useful
      lives of assets are also capitalized. 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 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.


F-8


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 Notes 7 and
      8) in accordance with APB 21 and EITF Issue 95-13. 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 $178,633 and $296,608 for
      the
      years ended June 30, 2007 and 2006, respectively, is included in financing
      expense on the statements of operations.





The
      Company’s deferred financing costs consisted of the following at June 30, 2007
      and 2006:





2007
            
            2006Value
                of shares issued to guarantors:Benton-Franklin
                Economic Development District (83,640 shares)
            
            $
            138,006
            
            $
            138,006Columbia
                River Bank line of credit (127,500 shares)
            
            
            –
            
            
            210,375Benton-Franklin
                Economic Development District loan fees
            
            
            3,450
            
            
            3,450Columbia
                River Bank line of credit loan fees
            
            
            –
            
            
            500Convertible
                debentures issuance costs
            
            
            –
            
            
            30,047Hanford
                Area Economic Investment Fund Committee loan fees
            
            
            22,128
            
            
            22,128Less
                amortization
            
            
            (67,859
            )
            
            (130,148
            )$
            95,725
            
            $
            274,358





In
      June
      2007, the Company elected not to renew its line of credit with Columbia River
      Bank due to the Company’s current cash position. The Company wrote off the
      remaining net deferred financing charges of $98,409 relating to this line of
      credit.





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 $275,000 during fiscal year 2006 and another payment of $225,000 was
      to
      be made in August 2006 pursuant to the license agreement. Royalty payments
      based
      on net sales revenue incorporating the technology are also required, with
      minimum quarterly royalties ranging from $100,000 to $200,000 and minimum annual
      royalties ranging from $400,000 to $800,000 over the term of the agreement.
      The
      IBt license is being amortized over the 15-year term of the license
      agreement.


F-9


In
      the
      fourth quarter of fiscal year 2007, the Company reviewed the carrying values
      of
      licenses. As of the date of this report, the August 2006 payment has not been
      made as the Company has been in continued negotiations with IBt concerning
      the
      license agreement and other business arrangements (see Note 19).




Amortization
      of licenses was $23,426 and $20,530 for the years ended June 30, 2007 and 2006,
      respectively. Based on the licenses recorded at June 30, 2007, 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: $30,795 for
      2008, $18,770 for 2009, $18,481 for 2010, $18,333 for 2011, $18,333 for 2012,
      and $157,363 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,
      2007, 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: $30,155 for 2008, $2,632 for 2009, $2,632 for 2010, $2,632 for 2011,
      $2,632 for 2012, and $12,192 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, which has been discounted using
      the
      Company’s credit-adjusted risk free-rate, will be reviewed periodically to
      reflect the passage of time and changes in the estimated future costs underlying
      the obligation. The Company amortizes the initial amount capitalized to property
      and equipment and recognizes accretion expense in connection with the discounted
      liability over the estimated remaining useful life of the leased
      assets.





In
      fiscal
      year 2006, the Company established an initial asset retirement obligation of
      $63,040 which represents the discounted cost of cleanup that the Company
      anticipates it will have to incur at the end of its equipment and property
      leases. This amount was determined based on discussions with qualified
      production personnel and on historical evidence. During fiscal year 2007, the
      Company reevaluated its obligations based on discussions with the Washington
      Department of Health and determined that the initial asset retirement obligation
      should be increased by an additional $56,120. The Company anticipates spending
      most of the amounts represented by this accrual in fiscal year 2008. In
      addition, another asset retirement obligation will be established in the first
      quarter of fiscal year 2008 representing obligations at its new production
      facility. This new asset retirement obligation will be for obligations to remove
      any residual radioactive materials and to remove any unwanted leasehold
      improvements.


F-10


During
      the years ended June 30, 2007 and 2006, the asset retirement obligation changed
      as follows:





2007
            
            2006Beginning
                balance
            
            $
            67,425
            
            $
            –New
                obligations
            
            
            –
            
            
            63,040Changes
                in estimates of existing obligations
            
            
            56,120
            
            
            –Accretion
                of discount
            
            
            7,597
            
            
            4,385Ending
                balance
            
            $
            131,142
            
            $
            67,425





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;
      capital lease obligations; and convertible debentures payable, approximated
      their fair values at June 30, 2007 and 2006.





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, 2007 and 2006 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 an order has been received and
      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





Prior
      to
      July 1, 2006, the Company accounted for share-based employee compensation,
      including stock options, using the method prescribed in Accounting Principles
      Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* and
      related interpretations (APB 25). Under APB 25, for stock options granted at
      market price, no compensation cost was recognized and a disclosure was made
      regarding the pro forma effect on net earnings assuming compensation cost had
      been recognized in accordance with SFAS No. 123, *Accounting
      for Stock-Based Compensation* (SFAS
      123). On December 16, 2004, the Financial Accounting Standards Board issued
      SFAS
      No. 123 (Revised 2004), *Share
      Based Payment* (SFAS
      123R), which requires companies to measure and recognize expense for all
      share-based payments at fair value. SFAS 123R eliminates the ability to account
      for share-based compensation transactions using APB 25 and generally requires
      that such transactions be accounted for using prescribed fair-value-based
      methods. SFAS 123R permits public companies to adopt its requirements using
      one
      of two methods: (a) a “modified prospective” method in which compensation
      costs are recognized beginning with the effective date based on the requirements
      of SFAS No. 123R for all share-based payments granted or modified after the
      effective date, and based on the requirements of SFAS No. 123 for all awards
      granted to employees prior to the effective date of SFAS No. 123R that remain
      unvested on the effective date or (b) a “modified retrospective” method
      which includes the requirements of the modified prospective method described
      above, but also permits companies to restate based on the amounts previously
      recognized under SFAS No. 123 for purposes of pro forma disclosures either
      for
      all periods presented or for prior interim periods of the year of adoption.
      Effective July 1, 2006, the Company adopted SFAS 123R using the modified
      prospective method. No share-based employee compensation cost was reflected
      in
      the statement of operations prior to the adoption of SFAS No. 123R. Results
      for
      prior periods have not been restated (see Note 11).


F-11





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
      computed.





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 $441,196 and $292,351
      for the years ended June 30, 2007 and 2006, respectively. Marketing costs of
      $162,307 are capitalized at June 30, 2007.





Shipping
      and Handling Costs





Shipping
      and handling costs are expensed as incurred and included in cost of product
      sales.





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 when 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. The Company discloses contingent
      liabilities when there is a reasonable possibility that the ultimate loss will
      exceed the recorded liability. 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 impact 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.


F-12


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.





Income
      (Loss) Per Common Share





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





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





2007
            
            2006Preferred
                stock
            
            
            59,065
            
            
            144,759Preferred
                stock warrants
            
            
            –
            
            
            179,512Common
                stock warrants
            
            
            3,627,764
            
            
            2,502,769Common
                stock options
            
            
            3,683,439
            
            
            3,129,692Convertible
                debentures
            
            
            –
            
            
            109,639Total
                potential dilutive securities
            
            
            7,370,268
            
            
            6,066,371





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.





F-13


**3.**
            **Inventory**





Inventory
      consists of the following at June 30, 2007 and 2006:





2007
            
            2006Raw
                materials
            
            $
            682,327
            
            $
            61,531Work
                in process
            
            
            120,242
            
            
            67,906Finished
                goods
            
            
            78,265
            
            
            31,944$
            880,834
            
            $
            161,381





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.





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, 2007.





**4.**
            **Prepaid
                Expenses**





Prepaid
      expenses consist of the following at June 30, 2007 and 2006:





2007
            
            2006Prepaid
                contract work
            
            $
            -
            
            $
            7,913Prepaid
                insurance
            
            
            37,001
            
            
            21,340Prepaid
                rent
            
            
            26,693
            
            
            30,009Other
                prepaid expenses
            
            
            249,184
            
            
            21,200Other
                current assets
            
            
            145,245
            
            
            81,084$
            458,123
            
            $
            161,546





**5.**
            **Fixed
                Assets**





Fixed
      assets consist of the following at June 30, 2007 and 2006:




2007
            
            2006Production
                equipment
            
            $
            807,838
            
            $
            590,908Office
                equipment
            
            
            111,218
            
            
            70,060Furniture
                and fixtures
            
            
            118,227
            
            
            100,653Leasehold
                improvements
            
            
            522,951
            
            
            652,404Capital
                lease assets (a)
            
            
            655,858
            
            
            599,738Construction
                in progress
            
            
            2,217,372
            
            
            34,2544,433,464
            
            
            2,048,017Less
                accumulated depreciation
            
            
            (767,913
            )
            
            (405,724
            )$
            3,665,551
            
            $
            1,642,293




(a)  Balance
      includes asset retirement addition of $119,160 and $63,040 as of June 30, 2007
      and 2006, respectively.


F-14


Depreciation
      and amortization expense related to fixed assets totaled $491,643 and $271,060
      for 2007 and 2006, respectively. Accumulated amortization of capital lease
      assets totaled $198,171 and $55,644 at June 30, 2007 and 2006,
      respectively.





**6.**
            **Other
                Assets**





Other
      assets, net of accumulated amortization, consist of the following at June 30,
      2007 and 2006:





2007
            
            2006Deferred
                charges
            
            $
            297,008
            
            $
            318,885Patents
                and trademarks, net of accumulated amortization of $16,463 and
                $13,831
            
            
            25,352
            
            
            20,102$
            322,360
            
            $
            338,987





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 $2,632 and $1,513 for the years
      ended
      June 30, 2007 and 2006, respectively.





**7.**
            **Bank
                Line of Credit**





The
      Company had a $375,000 revolving line of credit with Columbia River Bank that
      expired on March 1, 2007. The Company intended to renew the line of credit
      and
      received a proposal from the bank. In June 2007, the Company decided not to
      renew this line of credit as part of its overall review of its banking and
      cash
      management relationships. The Company had no borrowings under the line of credit
      during the fiscal year ended June 30, 2007.





**8.**
            **Notes
                Payable**





Notes
      payable consist of the following at June 30, 2007 and 2006:





2007
            
            2006Tri-City
                Industrial Development Council (TRIDEC) note payable (a)
            
            $
            -
            
            $
            10,000Benton-Franklin
                Economic Development District (BFEDD) note payable (b)
            
            
            185,848
            
            
            204,237Hanford
                Area Economic Investment Fund Committee (HAEIFC) note payable
                (c)
            
            
            391,610
            
            
            418,671577,458
            
            
            632,908Less
                amounts due within one year
            
            
            (49,212
            )
            
            (51,351
            )Amounts
                due after one year
            
            $
            528,246
            
            $
            581,557





(a)
            This
                is a non-interest bearing note, due in annual installments of $10,000
                that
                matured in August 2006. The note payable to TRIDEC did not bear interest,
                but was not discounted because the note was exchanged solely for
                cash.


(b)
            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, 2007,
                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, 2008.


F-15


(c)
            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 total note payable facility is for $1.4 million
                and is to be used to purchase production equipment. In June 2006,
                the
                Company requested an initial disbursement of approximately $400,000.
                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,
                2007, 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,
                2008.





On
      October 14, 2005, the Company borrowed $250,000 under a short-term note payable
      from a shareholder who was later appointed to the Board of Directors in April
      2006. The note, which bore interest at the rate of 10.0%, was paid in full
      on
      its due date of December 1, 2005. In connection with the loan, the Company
      granted a warrant to purchase 12,500 shares of common stock at an aggregate
      total exercise price of $10. The Company recorded financing expenses of $60,000
      related to the issuance of these warrants.





Principal
      maturities on notes payable are due as follows:





Year
                ending June 30,2008
            
            $
            49,2122009
            
            
            53,6092010
            
            
            182,5662011
            
            
            38,4362012
            
            
            41,983Thereafter
            
            
            211,652$
            577,458





**9.**
            **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 30,2008
            
            $
            214,2692009
            
            
            27,626Total
                future minimum lease payments
            
            
            241,895Less
                amounts representing interest
            
            
            (21,480
            )Present
                value of net minimum lease payments
            
            
            220,415Less
                amounts due within one year
            
            
            (194,855
            )Amounts
                due after one year
            
            $
            25,560





**10.**
            **Convertible
                Debentures Payable**





Through
      June 30, 2005, the Company had sold $3,587,875 of convertible debentures
      pursuant to the January 31, 2005 Offering (see Note 12). In July 2005, the
      Company sold an additional $550,000 of these convertible debentures. The
      debentures, which bore interest at 8% and matured two years from the date of
      issuance (through June 2007), could be converted into shares of the Company’s
      common stock at a rate of $4.15 per share plus, at the discretion of the
      Company, either a cash payment for accrued interest, or that number of common
      shares equal to the amount of unpaid accrued interest at $4.15 per share. Based
      upon reviews of SFAS 133, EITF 00-19, and EITF 98-5, the Company determined
      that
      the conversion feature did not have a derivative value.


F-16





On
      December 13, 2005, the Board of Directors announced a short-term conversion
      inducement to current holders of the convertible debentures, originally issued
      in conjunction with the January 31, 2005 Private Placement Offering. Holders
      were permitted two conversion options: 1) convert under the original terms
      of
      the debenture to the Company’s common stock at a $4.15 conversion price, and
      register the newly issued shares in the Form SB-2 Registration Statement filed
      with the SEC on November 10, 2005, or 2) convert under terms essentially
      identical to those offered to purchasers of Units in the Offering of October
      17,
      2005 – a $4.00 conversion price and one callable warrant to purchase one
      share of the Company's common stock at an exercise price of $6.00 per share
      for
      each share issued upon conversion (waiving registration rights for approximately
      one year).





As
      of
      June 30, 2006, holders of $3,682,875 of debentures had converted to common
      stock
      of the Company, responding to the inducement of the second exercise method
      described above. As of June 30, 2006, the Company had issued 911,271 shares
      of
      common stock (including approximately 23,840 incremental shares not previously
      available to holders of debentures under the original conversion terms), and
      659,469 warrants to purchase shares of common, exercisable at $6.00 per share.
      During the fiscal year ended June 30, 2006, the Company recognized $385,511
      in
      non-cash short-term inducement expense, in accordance with SFAS No. 84. The
      Company reviewed SFAS 133 and EITF 00-19 and determined that the warrants issued
      in connection with the short-term conversion inducement did not have derivative
      value.





The
      remaining convertible debentures matured during the fiscal year ended June
      30,
      2006. One $50,000 convertible debenture holder converted into 12,048 common
      shares and the remaining balance and accrued interest was paid in cash. All
      other debenture holders elected to receive cash payments of their principal
      and
      accrued interest on the maturity dates.





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





Prior
      to
      July 1, 2006, the Company accounted for share-based employee compensation,
      including stock options, using the method prescribed by APB 25. Under APB 25,
      for stock options granted at market price, no compensation cost was recognized,
      and a disclosure was made regarding the pro forma effect on net earnings
      assuming compensation cost had been recognized in accordance with SFAS 123.
      Effective July 1, 2006, the Company adopted SFAS 123R using the modified
      prospective method.





The
      following table presents the share-based compensation expense recognized in
      accordance with SFAS 123R during the year ended June 30, 2007 and in accordance
      with APB 25 during the year ended June 30, 2006:





Year
                ended June 30,2007
            
            2006Cost
                of product sales
            
            $
            120,710
            
            $
            –Research
                and development
            
            
            41,481
            
            
            –Sales
                and marketing expenses
            
            
            216,432
            
            
            –General
                and administrative expenses
            
            
            1,449,491
            
            
            –Total
                share-based compensation
            
            $
            1,828,114
            
            $
            –





The
      adoption of SFAS 123R reduced net income for the year ended June 30, 2007 by
      $1,828,114. Basic loss per common share for the year ended June 30, 2007 would
      have been $0.44 if the Company had not adopted SFAS 123R, compared to reported
      basic loss per common share of $0.54. 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, 2007, total unrecognized compensation cost related
      to
      stock-based options and awards was $1,707,843 and the related weighted-average
      period over which it is expected to be recognized is approximately
      1.23 years.


F-17


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.





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. The options issued to the employees vest over 3 years while the
      options granted to the non-employee directors were immediately
      vested.





The
      Company’s CEO, who also serves as Chairman of the Board, was granted 150,000
      options, the Executive Vice President Operations (EVP-Operations), who also
      serves 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 CEO and 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 CEO and 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 CEO’s and EVP-Operations’s 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.




F-18


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





Shares
            
            Price
                (a)
            
            Life
                (b)
            
            Value
                (c)Outstanding
                at June 30, 2007
            
            
            3,683,439
            
            $
            2.86
            
            
            8.67
            
            $
            8,259,814Vested
                and expected to vest at June 30, 2007
            
            
            3,270,441
            
            $
            2.85
            
            
            8.68
            
            $
            8,150,622Vested
                  and exercisable at June 30, 2007
            
            
            2,278,172
            
            $
            2.45
            
            
            8.42
            
            $
            6,726,822





(a)
            Weighted
                average 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,
      2007 and 2006 was $2,286,370 and $391,908, respectively. The Company’s current
      policy is to issue new shares to satisfy option exercises.





The
      weighted average fair value of stock option awards granted and the key
      assumptions used in the Black-Scholes valuation model to calculate the fair
      value are as follows for the year ended June 30, 2007 and 2006:




Year
                ended June 30,2007
            
            2006Weighted
                average fair value of options granted
            
            $
            2.29
            
            $
            1.38Key
                assumptions used in determining fair value:Weighted
                average risk-free interest rate
            
            
            4.86
            %
            
            4.67
            %Weighted
                average life of the option (in years)
            
            
            5.58
            
            
            7.31Weighted
                average historical stock price volatility
            
            
            69.87
            %
            
            31.24
            %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 lives of options and the
      volatility are based on historical data of the Company.





The
      following table illustrates the effect on net loss and net loss per common
      share
      for the year ended June 30, 2006 as if the Company had applied the fair value
      recognition provisions of SFAS 123 to all outstanding stock option awards for
      periods presented prior to the Company’s adoption of SFAS 123R. The fair value
      of these options was estimated at the date of grant using the Black-Scholes
      method set forth in SFAS No. 123R.





2006Net
                loss, as reported
            
            $
            8,218,130SFAS
                No. 123 stock option expense
            
            
            1,167,086Pro
                forma net loss
            
            $
            9,385,216Net
                loss per share:Basic
                and Diluted, as reported
            
            $
            0.68Basic
                and Diluted, pro forma
            
            $
            0.77


F-19


**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, 2007, 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.





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, 2007, there were 59,065 Series B preferred
      shares outstanding and cumulative dividends in arrears were $5,272.





In
      addition to the shares of common stock and Series B preferred stock issued
      pursuant to the merger transaction (see Note 1), the Company had the following
      transactions that affected shareholders’ equity during the years ended June 30,
      2007 and 2006.


F-20


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 4-year term. A total of 826,100 warrants were
      issued under these terms. The closing took place on March 22, 2007. The
      shares of common stock offered by the Company in this transaction were
      registered under the Company’s existing shelf registration statement (File
      No. 333-140246) on Form S-3, which was declared effective by the Securities
      and Exchange Commission on February 15, 2007, and the prospectus supplement
      dated March 21, 2007.





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





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.





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.


F-21





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 10 business days, and cause suspension periods for the
      registration statement to not exceed 60 days in any 360 day period. If the
      Company fails to comply with these provisions, the Company will be required
      to
      pay as liquidated damages an amount equal to 2% of the aggregate purchase price
      paid by the investors for each 30 day period during which the failure continues,
      not to exceed 10% of the aggregate purchase price. 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.





IsoRay,
      Inc. June 2006 Warrant Exercise Solicitation





In
      June
      2006, the Board of Directors approved a limited one-time discount of the
      exercise price of outstanding warrants (with exercise prices over $3.00) to
      $3.00 per share of common stock if the warrants were exercised on or before
      June
      30, 2006.  The warrants exercised as part of this one-time discount were
      primarily held by investors who purchased them as part of the Company’s October
      2005 and February 2006 private placement offerings and had original exercise
      prices of $6.00 and $6.50. The change in exercise price 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. The Company issued
      427,764 common shares and raised $1,223,602, net of offering costs, through
      this
      warrant exercise solicitation.





IsoRay,
      Inc. February 2006 Private Placement





On
      February 1, 2006 the Company commenced an offering of Investment Units (Units)
      for sale, pursuant to a Private Placement Offering (the February 2006 Offering),
      which management believes was exempt from registration under the Securities
      Act
      of 1933 (the Act) pursuant to Section 4(2) of the Act and Rule 506 of Regulation
      D. The February 2006 Offering consisted of a maximum of 89 Units, each Unit
      consisting of 5,000 shares of common stock and a warrant to purchase 5,000
      shares of common stock at an exercise price of $6.50 per share. The Units were
      sold for $22,500 per Unit. The Company closed this offering on February 24,
      2006. Approximately $1.1 million, net of offering costs, was raised under the
      February 2006 Offering. The warrants issued in the February 2006 Offering were
      not accounted for as derivatives in accordance SFAS 133 paragraph 11(a) and
      EITF
      00-19.





IsoRay,
      Inc. Subscriptions Receivable





On
      December 7, 2005, the Company entered into a SICAV ONE Securities Purchase
      Agreement and a SICAV TWO Securities Purchase Agreement (collectively, the
      December 2005 Purchase Agreements) with Mercatus & Partners, Limited, a
      United Kingdom private limited company (Mercatus). The December 2005 Purchase
      Agreements permitted Mercatus to purchase 1,748,146 shares of the Company's
      common stock at a purchase price of $3.502 per share subject to receipt of
      funding. As no funding had been received, on May 18, 2006, the Company requested
      immediate return of the certificates representing all shares of common stock
      to
      which Mercatus had previously subscribed in accordance with the terms of the
      December 2005 Purchase Agreements. The December 2005 Purchase Agreements called
      for return of certificates within ten days if funding is not received within
      two
      days of receipt of the notice. After significant delay and the Company's
      attainment of a court order, the share certificates were returned. On August
      8,
      2006, the share certificates were cancelled and the December 2005 Purchase
      Agreements were terminated.


F-22


IsoRay,
      Inc. October 2005 Private Placement





On
      January 30, 2006 the Company closed an offering of Units for sale, pursuant
      to a
      Private Placement Offering (the October 2005 Offering) of October 17, 2005,
      which management believes was exempt from registration under the Act pursuant
      to
      Section 4(2) of the Act and Rule 506 of Regulation D. The October 2005 Offering
      consisted of a maximum of 200 Units, each Unit consisting of 5,000 shares of
      common stock and a warrant to purchase 5,000 shares of common stock at an
      exercise price of $6.00 per share. This maximum was increased, pursuant to
      the
      terms of the October 2005 Offering, at the sole discretion of the Company,
      to a
      maximum of 300 Units. The Units were sold for $20,000 per Unit. Approximately
      $5.4 million, net of offering costs, was raised under the October 2005 Offering.
      The warrants issued in the October 2005 Offering were not accounted for as
      derivatives in accordance SFAS 133 paragraph 11(a) and EITF 00-19.





IsoRay
      Medical, Inc. January 2005 Private Placement





In
      January 2005, Medical commenced an offering (the January 2005 Offering) of
      up to
      $2,000,000 of 8% convertible debentures (see Note 10) to accredited investors
      in
      a private placement, which management believes was exempt from registration
      under the Act pursuant to Section 4(2) of the Act and Rule 506 of Regulation
      D.
      On May 27, 2005, Medical amended and restated the January 2005 Offering to
      increase the maximum amount of the offering to $4,150,000.





Through
      June 30, 2005, Medical sold debentures totaling $3,587,875. In connection with
      the sales of these debentures, Medical paid commissions totaling $216,783 and
      legal expenses totaling $56,470, which amounts have been recorded as deferred
      financing costs.





In
      July
      2005, Medical sold an additional $550,000 of debentures pursuant to this
      offering. The sale of these additional debentures was not subject to payment
      of
      commissions.





In
      2006,
      $3,682,875 of the debentures were converted to common stock pursuant to a
      short-term conversion inducement (see Note 10).





Issuance
      of Common Stock in Payment of Consulting Services





During
      2006, the Company issued 173,472 shares of its common stock in full satisfaction
      of consulting services including 168,472 shares that were issued as payment
      for
      merger consulting services (see Note 1). The shares were valued using the market
      price of the stock on the date of issue.





Issuance
      of Common Stock in Partial Payment of Equipment Purchase





During
      2006, the Company issued 10,000 shares of its common stock and paid $962 of
      cash
      in full satisfaction for the purchase of production equipment and repairs and
      maintenance invoices totaling $40,962. The shares were valued using the market
      price of the stock on the date of issue.





Cash
      Payments for Fractional Shares





During
      2006, the Company paid a combined total of $734 to the former common and
      preferred shareholders of Medical and Century for fractional shares that
      resulted from the merger that was effective July 28, 2005 (see Note
      1).


F-23


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:





2007
            
            2006 (a)Warrants
            
            Price (b)
            
            Warrants
            
            Price (b)Beginning
                balance outstanding
            
            
            179,512
            
            $
            0.79
            
            
            233,008
            
            $
            0.84Converted
                to common warrants (c)
            
            
            (142,190
            )
            
            0.70
            
            
            –
            
            
            –Exercised
            
            
            (37,322
            )
            
            1.12
            
            
            (53,496
            )
            
            1.03Ending
                balance outstanding
            
            
            –
            
            $
            –
            
            
            179,512
            
            $
            0.79





(a)
            The
                2006 beginning balance has been adjusted to reflect the 0.842362
                conversion ration (see Note 1).


(b)
            Weighted
                average price per share.


(c)
            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.




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


F-24


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:





2007
            
            2006
                (a)Warrants
            
            Price
                (b)
            
            Warrants
            
            Price
                (b)Beginning
                balance outstanding
            
            
            2,502,769
            
            $
            5.73
            
            
            136,158
            
            $
            1.20Warrants
                issued
            
            
            3,301,926
            
            
            3.59
            
            
            2,878,522
            
            
            5.85Converted
                from preferred (c)
            
            
            142,190
            
            
            0.70
            
            
            -
            
            
            -Cancelled/expired
            
            
            (23,615
            )
            
            2.54
            
            
            -
            
            
            -Exercised
            
            
            (2,295,506
            )
            
            2.99
            
            
            (511,911
            )
            
            2.49Ending
                balance outstanding
            
            
            3,627,764
            
            $
            5.31
            
            
            2,502,769
            
            $
            5.73





(a)
            The
                2006 beginning balance has been adjusted to reflect the 0.842362
                conversion ratio (see Note 1).


(b)
            Weighted
                average price per share.


(c)
            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 Preferred Warrants section of this
                footnote.





The
      following table summarizes additional information about the Company’s common
      warrants outstanding as of June 30, 2007:


Number
                  of Warrants
              
              Range
                  of Exercise Prices
              
              Expiration
                  Date277,614
              
              $4.15
              
              July
                  200712,500
              
              $0.0008
              
              October
                  200756,876
              
              $0.70
              
              October
                  200753,000
              
              $6.00
              
              October
                  2007162,500
              
              $6.00
              
              November
                  2007934,469
              
              $5.75
                  to $6.00
              
              December
                  2007700,250
              
              $6.00
              
              January
                  2008276,923
              
              $6.00
                  to $6.50
              
              February
                  20085,000
              
              $7.00
              
              March
                  20085,692
              
              $4.15
              
              May
                  200828,438
              
              $0.70
              
              January
                  200956,876
              
              $0.70
              
              March
                  2010826,100
              
              $5.00
              
              March
                  2011206,526
              
              $4.40
              
              March
                  201225,000
              
              $2.00
              
              July
                  20153,627,764




F-25


Stock
      Options





A
      summary
      of the Company’s stock option activity and related information for the years
      ended June 30, 2007 and 2006 is as follows:





2007
            
            2006
                (a)Shares
            
            Price
                (b)
            
            Shares
            
            Price
                (b)Beginning
                balance outstanding
            
            
            3,129,692
            
            $
            2.05
            
            
            2,237,802
            
            $
            1.31Granted
                (c) (d)
            
            
            1,488,700
            
            
            3.67
            
            
            1,189,722
            
            
            3.23Cancelled
            
            
            (179,454
            )
            
            2.68
            
            
            (196,548
            )
            
            1.19Exercised
            
            
            (755,499
            )
            
            1.16
            
            
            (101,284
            )
            
            1.18Ending
                balance outstanding
            
            
            3,683,439
            
            $
            2.86
            
            
            3,129,692
            
            $
            2.05Exercisable
                at end of year
            
            
            2,528,172
            
            $
            2.45
            
            
            2,649,576
            
            $
            1.79





(a)
            The
                2006 beginning balances have been adjusted to reflect the 0.842362
                conversion ratio (see Note 1).


(b)
            Weighted
                average price per share.


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


(d)
            Included
                in options granted 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 CEO and Executive Vice-President Operations and were to vest
                over three years. The remaining 250,000 options were granted to
                non-employee Directors and were immediately vested. See Note 11 for
                a
                further discussion of these cancelled
                options.





The
      following table summarizes additional information about the Company’s stock
      options outstanding as of June 30, 2007:


Options
                    Outstanding
                
                Options
                    ExercisableRange of Exercise Prices
                
                Shares
                
                Price
                    (a)
                
                Life
                    (b)
                
                Shares
                
                Price
                    (a)$1.00
                    to $1.19
                
                1,002,892
                
                $                           1.16
                
                7.85
                    yrs
                
                934,322
                
                $                           1.16$1.96
                    to $2.00
                
                653,791
                
                1.98
                
                8.09
                    yrs
                
                653,791
                
                1.98$3.10
                    to $3.20
                
                676,234
                
                3.12
                
                9.16
                    yrs
                
                342,075
                
                3.12$3.50
                    to $3.85
                
                200,000
                
                3.74
                
                9.00
                    yrs
                
                116,666
                
                3.81$4.14
                    to $4.15
                
                820,472
                
                4.14
                
                9.54
                    yrs
                
                334,235
                
                4.14$4.40
                
                108,800
                
                4.40
                
                9.68
                    yrs
                
                -
                
                -$5.50
                    to $6.50
                
                221,250
                
                6.06
                
                8.65
                    yrs
                
                147,083
                
                6.18Total
                    options
                
                3,333,439
                
                
                
                
                
                2,278,172





(a)
            Weighted
                average exercise price. (b)
            Weighted
                average remaining contractual life.




**13.**
            **Income
                Taxes**





The
      Company recorded no income tax provision or benefit for the years ended June
      30,
      2007 and 2006.





The
      Company had a net deferred tax asset of approximately $6.7 million and $3.8
      million as of June 30, 2007 and 2006, 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, 2007 and 2006 has been established.


F-26


At
      June
      30, 2007, the Company had tax basis net operating loss carryforwards of
      approximately $19 million available to offset future regular taxable income.
      These net operating loss carryforwards expire through 2027.





**14.**
            **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.





**15.**
            **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 is a member of the Company’s
      Board of Directors. The total amounts paid in 2007 and 2006 to the law firm
      were
      $458,534 and $390,000, respectively. The 2007 amount includes approximately
      $18,000 accrued in accounts payable as of June 30, 2007.





During
      fiscal year 2006, the Company paid $60,000 to a shareholder for strategic
      business and financial consulting.





**16.**
            **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 transactions (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 2007 and 2006, the Company recorded royalty expenses of $2,161
      and
      $0, respectively.





Patent
      and Know-How Royalty License Agreement





IsoRay
      Products LLC was the holder of an exclusive license to use certain “know-how.”
This license was transferred to Medical and subsequently to the Company in
      connection with the merger transactions (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, the Company participated in
      nonbinding mediation and no settlement was reached. The parties have agreed
      to
      extend mediation discussions until early October, 2007. If no settlement is
      reached, the parties may demand binding arbitration.


F-27


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 transactions (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, 2007 and 2006, the Company incurred $151,065 and
      $868,650, respectively, of costs for production-related services and facilities
      provided by Battelle. At June 30, 2007, accrued liabilities included $494
      related to this agreement. The agreement, which expires December 31, 2007,
      may
      be terminated at any time by either party, upon giving a 60-day written notice
      to the other party.





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 June 2011. The Company’s two
      significant leases are 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 provides 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 will vacate its
      leased space at the PEcoS-IsoRay Radioisotope Laboratory (PIRL). The
      APEL
      lease has a three year term expiring on April 30, 2010, an option to renew
      for
      two additional three-year terms, and monthly rent of approximately $26,700,
      subject to annual increases based on the Consumer Price Index, 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.





In
      February 2005, the Company entered into a lease agreement for leased space
      at
      PIRL in which it established production facilities. The lease term commenced
      on
      regulatory licensing approval, which was obtained in October 2005. The lease
      had
      a base term of one year with a one year renewal option. The first year of rent
      was paid using 24,000 shares of the Company’s common stock which was valued at
      $120,035 based on the date of issuance. The Company has agreed to pay $5,000
      per
      month for its second year of occupancy.





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 30,2008
            
            $
            372,1182009
            
            
            338,4962010
            
            
            338,3542011
            
            
            337,9252012
            
            
            328,749Thereafter
            
            
            1,260,206$
            2,975,848





Rental
      expense (including rent paid with common stock) amounted to $207,044 and
      $155,838 for the years ended June 30, 2007 and 2006,
      respectively.


F-28





License
      Agreement with IBt





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





As
      of the
      date of this report, the August 2006 payment has not been made. In the fourth
      quarter of fiscal year 2007, the Company reviewed the carrying values of
      licenses, including the IBt license. As of the date of this report, the August
      2006 payment has not been made as the Company has been in continued negotiations
      with IBt concerning the license agreement and other business arrangements (see
      Note 19).





**17.**
            **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, 2007, uninsured cash balances
      totaled $9,418,359.





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. Management regularly monitors the composition
      and
      maturities of these investments and the Company has not experienced any material
      loss on its investments.





The
      Company’s accounts receivable result from credit sales to customers. The Company
      had two and three customers whose sales were greater than 10% for each of the
      years ended June 30, 2007 and 2006, respectively. These customers represented
      37.7% and 49.2% of the Company’s total revenues for the years ended June 30,
      2007 and 2006, respectively. Those same customers accounted for 25.6% and 47.9%
      of the Company’s net accounts receivable balance at June 30, 2007 and 2006,
      respectively.





The
      Company’s Proxcelan brachytherapy seed is currently its only product and all of
      the Company’s revenues are derived from sales of the Proxcelan seed in the
      United States. Sales to the Company’s largest customer totaled 24.5% and 20.6%
      of total revenues in 2007 and 2006, 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.


F-29


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 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.





**18.**
            **New
                Accounting Standards**





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





In
      September 2006, the FASB issued statement No. 157, Fair Value Measurements,
      (SFAS 157). SFAS 157 defines fair value, establishes a framework for
      measuring fair value in accordance with accounting principles generally accepted
      in the United States, and expands disclosures about fair value measurements.
      SFAS 157 is effective for fiscal years beginning after November 15,
      2007, with earlier application encouraged. Any amounts recognized upon adoption
      as a cumulative effect adjustment will be recorded to the opening balance of
      retained earnings in the year of adoption. The Company is currently evaluating
      the impact this statement will have on its financial statements.





In
      February 2007, the FASB issued statement No. 159, The Fair Value Option for
      Financial Assets and Financial Liabilities Including an Amendment of FASB
      Statement No. 115 (SFAS 159). The statement allows entities to value financial
      instruments and certain other items at fair value. The statement provides
      guidance over the election of the fair value option, including the timing of
      the
      election and specific items eligible for the fair value accounting. Changes
      in
      fair values would be recorded in earnings. The statement is effective for fiscal
      years beginning after November 15, 2007. The Company is currently
      evaluating the impact this statement will have on its financial
      statements.





**19.**
            **Subsequent
                Events**





The
      following events and transactions have occurred subsequent to June 30,
      2007:





Option
      Cancellations





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. The options issued to the employees vest over 3 years while the
      options granted to the non-employee directors were immediately
      vested.





The
      Company’s CEO, who also serves as Chairman of the Board, was granted 150,000
      options, the EVP-Operations, who also serves 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.


F-30


After
      the
      cancellation, the CEO and 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 CEO and
      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 CEO’s and EVP-Operations’s 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.


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





Global
      Strategic Alliance with IBt





In
      September 2007, the Company entered into a letter of intent with IBt to enter
      into a Global Strategic Alliance incorporating various cooperative initiatives
      which will be the subject of a number of future agreements and transactions.
      Each of the following proposed initiatives are subject to Board approval by
      each
      of the respective parties:


§
            An
                amendment to the IsoRay’s license agreement with IBt for the use of its
                polymer seed technology whereby IsoRay would pay the remaining $225,000
                license fee but would not be subject to ongoing royalty payments.
                IsoRay
                would purchase polymer seed components at cost plus a profit margin
                to be
                determined.


§
            The
                Company would grant IBt an exclusive license to distribute Cs-131
                brachytherapy seeds in certain markets outside of North and South
                America,
                including the European Union.


§
            The
                Company would receive the exclusive right to manufacture and distribute
                polymer I-125 brachytherapy seeds in North and South
                America.


§
            The
                Company would also receive IBt’s US subsidiary’s customer list and the
                right to offer employment to certain IBt US
                employees.




F-31


SIGNATURES





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





Dated:
      September 28, 2007





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




63