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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2017

or

Commission File No. 001-33407

ISORAY, INC.

(Exact name of registrant as specified in its charter)

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x☒ No¨ ☐

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

Yesx ☒ No¨ ☐

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

Large accelerated filer¨ ☐        Accelerated filerx ☐        Non-accelerated filer¨ ☐

Smaller reporting company¨ ☒       Emerging growth company¨ ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.¨  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨☐ Nox ☒

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

ISORAY, INC.

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The accompanying unaudited interim consolidated financial statements are those of IsoRay, Inc., and its wholly-owned subsidiaries referred to herein as “IsoRay” or the “Company”. All significant intercompany accounts and transactions have been eliminated in the consolidation. In the opinion of management, all adjustments necessary for the fair presentation of the consolidated financial statements have been included. These unaudited interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and related footnotes as set forth in the Company’s annual report filed on Form 10-K10-K for the year ended June 30, 2016.2017.

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (GAAP) have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures are adequate for the information not to be misleading.

Certain prior period amounts have been reclassified to conform to the current period’s presentation. The results of operations for the periods presented may not be indicative of those which may be expected for a full year.  The Company anticipates that as the result of continuing operating losses and the significant net operating losses available from prior fiscal years, its effective income tax rate for fiscal year 20172018 will be 0%.

In May 2014, the Financial Accounting Standards Board (FASB)(“FASB”) issued Accounting Standards Update (ASU) 2014-09,(“ASU”) No.2014-09   Revenue from ContractsRecognition, replacing guidance currently codified in Subtopic 605-10 Revenue Recognition-Overall with Customers" (ASU 2014-09), which supersedes thevarious SEC Staff Accounting Bulletins providing interpretive guidance. The guidance establishes a new five step principle-based framework in an effort to significantly enhance comparability of revenue recognition requirements in FASB Accounting Standards Codification (ASC) Topic 605, "Revenue Recognition".practices across entities, industries, jurisdictions, and capital markets. The guidance requires that an entity recognize revenue in a way that depicts the transfer of promised goods or services to customers in the amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods and services. The guidancestandard will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period,the Company in the first quarter of its fiscal year 2019, but early adoption is permitted starting in the first quarter of fiscal year 2018. The Company intends to adopt the new standard in the first quarter of fiscal year 2019 and isexpects to be applied retrospectively, with early application not permitted. This update will be effective asuse the modified retrospective method. The Company has evaluated the impact of the beginningfuture adoption of fiscal 2019. This update is not expected to have a material impactASU 2014-09 on the Company’sits consolidated financial statements.statements and does not currently expect significant changes in the timing of revenue recognition compared to the existing methodology. 

In July 2015, the FASB issued ASU 2015-11:No.2015-11: Inventory. The guidance requires an entity’s management to measure inventory within the scope of this ASU at the lower of cost orand net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early application is permitted. The ASU became effective for the Company continues to evaluate the new standard and itson July 1, 2017. This update did not have a material impact on the Company'sCompany’s consolidated financial statements. This update will be effective as of the beginning of fiscal 2018.statements upon adoption.

In November 2015, the FASB issued an ASU 2015-172015-17 to simplify the balance sheet classification of deferred taxes. This update requires all deferred tax assets and liabilities to be reported as non-current in the consolidated balance sheets. The ASU became effective for the Company on July 1, 2017. This update will be effective as of the beginning of fiscal 2018. This update is did not expected to have a material impact on the Company’s consolidated financial statements.statements upon adoption.

In February 2016, the FASB issued ASU 2016-02:2016-02 Leases (Subtopic 842)842), which will require lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by most leases. The update is effective for annual and interim reporting periods beginning after December 15, 2018. Early adoption is permitted. The ASU will be effective for the Company continues to evaluatein the new standard and itsfirst quarter of fiscal year 2020. We are currently evaluating the impact of the guidance on the Company'sCompany’s consolidated financial statements. This update will be effective as of the beginning of fiscal 2019.

Certificate of Deposit Account Registry Service (CDARS) is a system that allows the Company to invest in certificates of deposit through a single financial institution that exceed the $250,000$250,000 limit to be fully insured by the Federal Deposit Insurance Corporation (FDIC). That institution utilizes the CDARS system to purchase certificates of deposit at other financial institutions while keeping the investment at each institution fully insured by the FDIC. CDARS held by the Company as of March 31, 2017 2018 and June 30, 2016 2017 are as follows (in thousands):

Basic and diluted earnings (loss) per share are 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. At March 31, 2017 2018 and 2016,2017, the calculation of diluted weighted average shares did not include convertible preferred stock, common stock warrants, or options that are potentially convertible into common stock as those would be antidilutive due to the Company’s net loss position.

Securities not considered in the calculation of diluted weighted average shares, but that could be dilutive in the future as of March 31, 2017 2018 and 2016,2017, were as follows (in thousands):

Inventory consisted of the following at March 31, 2017 2018 and June 30, 20162017 (in thousands):

Property and equipment consisted of the following at March 31, 2017 2018 and June 30, 20162017 (in thousands):

¹ – Represents items that meet the capitalization threshold or which management believes will meet the threshold at the time of completion and which have yet to be placed into service as of the date of the balance sheet. Also included at March 31, 2017 2018 and June 30, 2016 2017 are costs associated with automation of production processes and advance planning and design work on the Company’s new production facility.

The following table presents the share-based compensation expense recognized for stock-based options during the three months ended March 31, 2017 2018 and 2016(in2017 (in thousands): 

The following table presents the share-based compensation expense recognized for stock-based options during the nine months ended March 31, 2017 2018 and 2016(in2017 (in thousands): 

Class Action Lawsuit Related to Press Release

On May 22, 2015, the first of three lawsuits was filed against IsoRay, Inc. and two of its then-current officers – Dwight Babcock (the Company’s retired CEO) and Brien Ragle (the Company’s former CFO) – related to a press release issued on May 20, 2015 regarding a May 19 online publication of the peer-reviewed article in the journalBrachytherapy titled “Analysis of Stereotactic Radiation vs. Wedge Resection vs. Wedge Resection Plus Cesium-131 Brachytherapy in Early-Stage Lung Cancer” by Dr. Bhupesh Parashar, et al. The lawsuits are class actions alleging violations of the federal securities laws. By Order dated August 17, 2015, all of the pending lawsuits were consolidated into one case – In re IsoRay, Inc. Securities Litigation; Case No. 4:15-cv-05046-LRS, in the U.S. District Court for the Eastern District of Washington. On October 16, 2015, an amended complaint was filed with more detailed allegations relating to alleged violations of federal securities laws. On December 15, 2015, IsoRay filed a motion to dismiss the complaint altogether. On June 1, 2016, the court entered an order denying IsoRay's motion to dismiss, holding that the complaint's allegations, if accepted as true, state a plausible claim to relief. The order did not adjudicate the merits of the lawsuit. No other issues were decided in the ruling.

On March 9, 2017, the parties settled this matter and the court entered an order and final judgment that (i) dismissed with prejudice and released the claims asserted in the complaint against the defendants, including IsoRay, and (ii) approved the payment of the $3,537,500 settlement fund (paid by IsoRay’s insurers), minus the payment of attorneys' fees and costs to plaintiff's counsel, to members of the settlement class.  This lawsuit is concluded.

Derivative Complaint Related to Shareholder Value

On September 29, 2016, a purported shareholder derivative complaint captioned Kitley v. Babcock, et al., No. 0:16-cv-03297, was filed on behalf of the Company in the U.S. District Court for the District of Minnesota against certain of the Company’s current and former officers and directors.  The complaint alleges that the defendants breached their fiduciary duties by causing the Company to issue allegedly false and misleading statements in a May 20, 2015 press release – the same press release at issue in the settled securities class action – concerning the results from a peer reviewed study of the Company’s Cesium-131 isotope seeds and mesh product for the treatment of non-small cell lung cancers.  The complaint brings claims of breach of fiduciary duty, gross mismanagement, and unjust enrichment, and seeks unspecified compensatory damages, changes in corporate governance, and attorney’s fees and costs.  Because the complaint is derivative in nature, it does not seek monetary damages from the Company.  The Company may be obligated pursuant to indemnification obligations to advance fees and costs incurred by the individuals defending against the action.  The Company has applicable directors and officers insurance policies. 

On November 17, 2016, the defendants filed a motion to dismiss the complaint.  On January 23, 2017, instead of opposing defendants’ motion, plaintiffs filed an amended complaint. On March 9, 2017, defendants moved to dismiss the amended complaint.  On April 20, 2017, plaintiffs filed an opposition to defendants’ motion. Defendants’ reply in support of the motion is due May 17, 2017.

Class Action Lawsuit Related to Equity Plans

On January 31, 2017, a putative class action complaint captionedGriffith, et al. v. LaVoy, et al., No. 17-2-00194-2, was filed in the Superior Court of Washington in and for Benton and Franklin Counties against the Company, its Board of Directors, and a former director and officer of the Company. The complaint alleges that the defendants violated Section 302A.437 of the Minnesota Business Corporation Act because, due to a significant number of broker non-votes at the respective meetings, the Company did not receive at least a majority of the voting power of the minimum number of shares entitled to vote that would constitute a quorum in favor of proposals to approve the Company’s 2014 Employee Stock Option Plan (2014 Plan) and 2016 Equity Incentive Plan (2016 Plan) (collectively, the “Plans”). The complaint alleges that since the Plans were not properly approved by shareholders under Minnesota law, the Plans and the Company’s equity awards under the Plans are invalid. The complaint also alleges that members of the Board breached their fiduciary duties by deeming these Plans approved by shareholders when they were not under Minnesota law and by authorizing equity awards to be made under these Plans. Unless the Company obtains the requisite shareholder approvals under Minnesota law, the complaint seeks cancellation of the Plans and rescission of all awards made under the Plans, an injunction prohibiting the Company from making further awards under the Plans, and an award of fees and costs to plaintiffs’ counsel. The Company and the other defendants have not yet answered or otherwise responded to the complaint.

The Company, members of the Board, and the former director and officer of the Company vigorously deny that they violated Minnesota law and, as to the non-company defendants, that they breached any fiduciary duty. No awards were issued to then-outside directors under the 2014 Plan. No awards made to anyone under the 2014 Plan have been exercised. No awards were issued under the 2016 Plan. In order to correct mistakes, if any, in connection with the approvals of these Plans or the issuance of these equity awards under the 2014 Plan, the Company reached an agreement in principle with the plaintiffs to settle this lawsuit in order to remedy the claims alleged in the complaint and to eliminate the burden and expense of further litigation. This settlement in principle includes an agreement to seek approval of the 2014 Plan and approval of prior grants under the 2014 Plan, each from shareholders pursuant to the higher voting threshold imposed by Minnesota corporate laws, and cancel the 2016 Plan altogether. The Company has called a Special Meeting of the Shareholders, to be held on June 15, 2017, primarily to seek these approvals. As part of the settlement in principle, the parties have agreed to either (a) negotiate an attorneys’ fee award for plaintiffs’ counsel or (b) if an agreement cannot be reached, accept the court’s decision as to an appropriate attorneys’ fee award. We cannot at this time estimate the attorneys’ fee award.

Irradiation Services Agreement

On November 29, 2016, IsoRay Medical, Inc. (Medical), a wholly owned subsidiary of IsoRay entered into an Irradiation Services Agreement (MURR Agreement) with the Curators of the University of Missouri, a public corporation of the State of Missouri, on behalf of its University of Missouri Research Reactor (MURR). The MURR Agreement replaces the month-to-month informal arrangement between Medical and MURR and provides Medical with access to reactor space for the irradiation of natural or enriched barium to produce Ba-131, which is used by Medical to produce Cesium-131 for use in its product. The MURR Agreement has a term of five years concluding November 29, 2021 and will automatically renew for successive twelve-month periods unless terminated by either party, and can be terminated by either party upon three months written notice. The MURR Agreement does not require minimum orders or obligate Medical to future minimum payments.

Isotope Purchase Agreement

In December 2015, the Company completed negotiations with The Open Joint Stock Company <<Isotope>> (located in Russia) for the purchase of Cesium-131Cesium-131 manufactured by the Institute of Nuclear Materials. The total purchase agreement providesprovided the Company with a one year year’s supply of Cesium-131.Cesium-131. The original agreement was setdue to expire on March 31, 2017, however on but in December 22, 2016 the Company agreed to an addendum was signed extending the expiration period to it until December 31, 2017.On October 23, 2017, the Company, together with The Open Joint Stock Company signed an addendum to the contract to include Cesium-131 manufactured at the Research Institute of Atomic Reactors ("SSC RIAR") and extended it until December 31, 2018.

Operating Lease Agreements

The Company leases officeResearch and laboratory space under an operating lease. The lease may be terminated by either party with a six month written notice. The Company agreed to a modification which became effective November 1, 2016 to extend the lease termination date to April 30, 2021. The lease terms require monthly lease payments and include a contractually permitted annual rent increase based on changes in the CPI index. Future minimum lease payments under this operating lease are as follows (in thousands):

The following table sets forth the Company’s financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement(in (in thousands):

One group of customers, facilities or physician practices has revenues that aggregate to greater than 10% of total Company product sales:

¹ – This group of facilities individually each comprise less than 10% of total Company product sales. They are serviced by the same physician group, one of whom is our Medical Director.

The Company’s warrant derivative liability is valued usingCompany routinely assesses the Black-Scholes option pricing model which requires a varietyfinancial strength of inputs. Such instruments are typically included in Level 2.its customers and provides an allowance for doubtful accounts as necessary.

On December 12, 2016, the Board of Directors declared a dividend on the Series B Preferred Stock of all currently payable and accrued outstanding and cumulative dividends through December 31, 2016 in the amount of $10,632. The dividends outstanding and cumulative through December 31, 2016 of $10,632 and through December 31, 2015 of $10,632 were paid as of those dates.

Warrants

On October 3, 2017, the Company entered into a Media Advertising Agreement with Al & J Media Inc. (“Al & J”). As part of the compensation for the services, Al & J received 250,000 warrants upon execution of the Agreement, which vested immediately, entitling Al & J to purchase shares of IsoRay common stock, exercisable on or before October 3, 2020, at an exercise price of $0.54 each. These warrants, using the Black-Scholes model, resulted in approximately $72,000 of share based compensation during the nine months ended March 31, 2018. On December 29, 2017, the Company notified Al & J of its decision to terminate the Media Advertising Agreement.

The key assumptions used in the Black-Scholes valuation model to calculate the fair value of the warrants are as follows:

The following table summarizes all warrants outstanding as of the beginning of the fiscal year, all activity related to warrants issued, cancelled, exercised or expired during the period and weighted average prices by category.