PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

IsoRay, Inc.

Notes to the Unaudited Consolidated Financial Statements

For the three months ended September 30, 20172018 and 20162017

ITEM 2 – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Caution Regarding Forward-Looking Information

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

All statements contained in this Form 10-Q, other than statements of historical facts, that address future activities, events or developments are forward-looking statements, including, but not limited to, statements containing the words “believe,” “expect,” “anticipate,” “intends,” “estimate,” “forecast,” “project,” and similar expressions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any statements of the plans, strategies and objectives of management for future operations; any statements concerning proposed new products, services, developments or industry rankings; any statements regarding future revenue, economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. These statements are based on certain assumptions and analyses made by us in light of our experience and our assessment of historical trends, current conditions and expected future developments as well as other factors we believe are appropriate under the circumstances. However, whether actual results will conform to the expectations and predictions of management is subject to a number of risks and uncertainties described under Item 1A - Risk Factors beginning on page 2317 below that may cause actual results to differ materially.

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

Critical Accounting Policies and Estimates

The discussion and analysis of the Company’sCompany’s financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with GAAP. 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, derivative liabilities and contingencies. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The accounting policies and related risks described in the Company’s annual report on Form 10-K as filed with the SEC on September 28, 201726, 2018 are those that depend most heavily on these judgments and estimates. As of September 30, 20172018 there had been no material changes to any of the critical accounting policies contained therein.

Overview

IsoRay is a brachytherapy device manufacturer with FDA clearance and CE marking for a single medical device that can be delivered to the physician in multiple configurations as prescribed for the treatment of cancers in multiple body sites. The Company manufactures and sells this product as the Cesium-131 brachytherapy seed.

The brachytherapy seed utilizes Cesium-131, with a 9.7 day half-life, as its radiation source. The Company believes that it is the unique combination of the short half-life and the energy of the Cesium-131 isotope that are yieldingyielding the beneficial treatment results that have been published in peer reviewed journal articles and presented in various forms at conferences and tradeshows.

The Company has distribution agreements outside of the United States through its subsidiary IsoRayIsoRay International LLC. These distributors are responsible for obtaining regulatory clearance to sell the Company’s products in their territories, with the support of the Company. As of the date of this Report, the Company had distributors in Italy, Switzerland, and the Russian Federation, with no$18,000 of reported revenues in the quarter ended September 30, 2017.2018.

Results of Operations

Three months ended September 30, 2018 and 2017 and 2016 (in(in thousands):

Product Sales

Changes in sales personnel and implementation of a revitalized sales and marketing strategy in the second quarter of fiscal 2017 has resultedcontinued to result in ongoing positive sales growth in the first quarter of fiscal 20182019 when compared to prior year first quarter. Ongoing training and support of new sales personnel has led to not only new accounts but also reconnecting with and receiving orders from prior accounts.

Three months ended September 30, 2018 and 2017 and 2016 (in(in thousands)

(a)    Expressed as a percentage of product sales, net

Prostate Brachytherapy

Prostate brachytherapy sales were impacted by changes in sales account managers and by the schedules of some key accounts in the first quarter of the fiscal year. During the quarter ended September 30, 2017,2018, the Company had a full sales team in place contributing to the increase in sales. Also, website improvements and significant investments in product support literature, social media and public relations are increasing the awareness of the Company in the prostate brachytherapy treatment markets providing the Company opportunities to develop new customers and reconnect with past customers.

Management believes growth in prostate brachytherapy revenues will be the result of physicians, payers, and patients increasingly considering overall brachytherapy treatment advantages including costs, better treatment outcomes and improvement in the quality of life for patients, when compared with non-brachytherapy treatments.

Management believes increased pressure to deliver effective healthcare in both terms of outcome and cost drove treatment options, and accordingly drove the Company’s prostate revenues, in the quarter ended September 30, 2017.2018.

Other Brachytherapy

Other brachytherapy includes, but is not limited to, brain, lung, head/neck, and gynecological treatments. Initial applications for these other brachytherapy treatments are primarily used in recurrent cancer treatments or salvage cases that are generally difficult to treat aggressive cancers where other treatment options are either ineffective or unavailable.

These other brachytherapy treatments continue to be subject to the influence of a small pool of innovative physicians who are the early adopters of the technology who also tend to be faculty at teaching hospitals training the next generation ofof physicians. This causes the revenue created by these types of treatment applications to be more volatile and vary significantly from quarter to quarter. This volatility resulted in the increase from the prior year.

Cost of product sales

Cost of product sales consists primarily of the costs of manufacturing and distributing the Company’s products.

Contributing to the quarters ended September 30, 20172018 and 20162017 comparison were decreases attributedincreased isotope and other direct materials purchases as well as increased labor to cost savings initiatives that resulted in lower procurementmeet production demand due to improved sales. Also contributing to the increase are higher depreciation costs of goods and services. Some costs shifted in the quarter ended September 30, 2017due to research and development from cost of product sales as employees performed research and development work. Also, reduced staffing costs were realized with decreased head count. These decreases were partially offset by increased supply of isotope from MURR which increased total cost of product sales but resulted in lower supply cost per curie of Cesium-131.completed automation projects placed into service.

Gross Profit

Contributing to the three months ended September 30, 20172018 and 20162017 gross profit comparison were increased sales as well as reductions in cost of product sales duepartially offset by increased materials and labor costs to cost savings initiatives and reduced staffing costs including utilization ofmeet production personnel on research and development projects.demand.

Research and development

Research and development – proprietary

Proprietary research and development consists primarily of employee and third-partythird party costs related to research and development activities.

Contributing to the quarters ended September 30, 20172018 and 20162017 proprietary research and development comparison were increases associated with participation in new protocols, device development activities, as well as a reallocation of employee costs from cost of product sales as those employees performed work on research anddevice development projects.activities. These increases were partially offset by decreased legal fees.fees and travel.

Research and development – collaborative arrangement

Collaboration arrangement related costscosts are incurred, shared, and separately stated in connection with a collaborative research and development project (see footnotenote 8 of Notes to unaudited consolidatedthe financial statements contained in this filing). For

Contributing to the quarterquarters ended September 30, 2018 and 2017 comparison were decreased costs due to the fact that payments being made pursuant to the collaborative arrangement incurred total costs of approximately $147,000 net of approximately $72,000with GammaTile, LLC were no longer necessary at the same level, as the collaborative arrangement primarily related to work involved in shared cost reimbursements.obtaining 510(k) clearance, which has now been obtained.

Sales and marketing expenses

Sales and marketing expenses consist primarily of the costs related to the internal and external activitiesactivities of the Company’s sales, marketing and customer service functions of the Company. As the Company increasingly focuses on improving sales, the cost associated with marketing and additional staffing continues to increase.

Contributing to the quarters ended September 30, 2018 and 2017 and 2016 comparison were increased advertising and public relationswas a decrease in travel costs as part of the revitalized marketing plan.a tradeshow that occurred in September 2017 did not occur until October 2018. Staffing differences are a major factor in the cost comparison as open positions in the quarter ended September 30, 20162017 were filled in periods prior to the quarter ended September 30, 2017 with increased salaries.2018, thereby increasing personnel costs.

General and administrative expenses

General and administrative expenses consist primarily of the costs related to the executive, human resources/training quality assurance/regulatory affairs, finance, and information technology functions of the Company.

Contributing to the quarters ended September 30, 20172018 and 20162017 comparison were cost decreasesincreases from the prior year. Those include decreases to payroll as a result of the re-organization of the finance department with reduced head count, decreased legal expenses, audit fees,increase in headcount, salary increases implemented in July 2018, and public company related fees. These cost decreases were partially offset in the quarter ended September 30, 2017 by increases associated with share-basedincentive compensation and employment hiring expenses related to the hiring of the Controller.increase in revenue.

Liquidity and capital resourcesresources

The Company assesses its liquidity in terms of its ability to generate cash to fund its operating, investing and financing activities. The Company has historically financed its operations through selling equity to investors. During the quarters ended SeptemberSeptember 30, 20172018 and 2016,2017, the Company used existing cash reserves to fund its operations and capital expenditures (in thousands except current ratio):

Cash flows from operating activities

Net cash used by operating activities in the three months ended September 30, 20172018 was primarily due to a net loss of approximately $1.55$1.51 million, net of approximately $128,000$140,000 in adjustments for non-cash activity such as depreciation and amortization expense, and share-based compensation. Changes in operating assets and liabilities used approximately $243,000$249,000 to fund operating activities; increases to prepaid expenses and other current assets, along with decreases to accounts payable and accrued radioactive waste disposalexpenses and accrued payroll and related taxes were partially offset by decreases in accounts receivable resulting from improved collections as well as an increase in accounts payable and accrued expenses resulting from better cash management procedures to more effectively utilize payment terms.protocol expense.

Cash flows from investing activities

Investing activities consisted of transactions related to the purchase of fixed assets, including automation of production processes and advance planning and design work on the Company’s new production facility, as well as the purchase and subsequent maturity of certificates of deposit. Management will continue to invest in technology and machinery that improves and streamlines production processes and to invest maturing certificates of deposit in low-risk investment opportunities that safeguard assets and provide greater assurance those resources will be liquid and available for business needs as they arise.

ProjectedCash flows from Financing activities

Financing activities in the quarter ended September 30, 2018 were due to the sale of common stock through a registered direct offering (see note 12 to the financial statements). There were no financing activities in the quarter ended September 30, 2017.

Projected 2019 liquidity and capital resources

Operating activities

Management forecasts that current cash and cash equivalents along with certificates of deposit will be sufficient to meet projected operating cash needs for the remainder of fiscal 2018. Assuming no extraordinary expenses occur (whether operating or capital), if management is successful at implementing its strategy of renewed emphasis on driving the consumer to the prostate market, meets or exceeds its annual growth targets of twentytwenty-five percent increase in revenue in fiscal 20182019 and this annual growth continues, the Company anticipates reaching cashflow break-even in three to five years. Although theThe Company did not reachexceeded that target of twentytwenty-five percent increased revenue in the first quarter of fiscal 2018, the Company is continuing to project revenue growth in fiscal 2018 of at least twenty percent over fiscal 2017.2019. There is no assurance that targeted sales growth will materializecontinue over the next three to five years. However, management is encouraged by the results for the quarter ended September 30, 20172018 and withby the depth and experience of its restructured sales team.

Capital expenditures

Management has completed the design of a future productionproduction and administration facility. If financing is obtained and the facility constructed, it is believed that the new facility will have non-cash depreciation cost equal to or greater than the monthly rental cost of the current facility.

Management is reviewingreviewing and implementing changes in all aspects of production operations (including process automation), research and development, sales and marketing, and general and administrative functions to evaluate the most efficient deployment of capital to ensure that the appropriate materials, systems, and personnel are available to support and drive product sales.

During the quarter ended September 30, 2017,2018, the Company invested approximately $44,000$50,000 in the automation of thirteen production processes, threefour of which have been received, tested and evaluated, and were placed in service in the quarter. One additional machine has been received and is currently being tested. Beginning in fiscal 2017 and continuing throughinto service. Through September 30, 2017,2018, the Company has invested approximately $349,000$430,000 in these automation projects, and management is expecting to invest approximately $260,000$215,000 more over the next 119 months on the remaining projects. This investment is designed to allow the Company to significantly increase the output of Cs-131 brachytherapy seeds while allowing the Company to decrease the labor costs related to seed production and also improving the overall safety of our operations. 

Financing activities

There was no material change in the use of proceeds from our public offering as described in our final prospectus supplement filed with the SEC pursuant to Rule 424(b) on March 24, 2014. Through September 30, 2017,2018, the Company had used the net proceeds raised through the March 2014 offering as described in the public offering. No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning ten percent or more of any class of our equity securities or to any other affiliates.

On August 25, 2015, the Company filed a registration statement on Form S-3 to registerregister securities up to $20 million in value for future issuance in our capital raising activities. The registration statement became effective on November 19,23, 2015, and the SEC file number assigned to the registration statement is 333-206559.

On July 11, 2018, the Company sold 11,000,000 shares of its common stock at a price of $0.75 per share, for aggregate gross proceeds of $8.25 million, pursuant to the registration statement on Form S-3 that became effective on November 23, 2015. The CompanyCompany has not yet used any proceeds from this offering. Additionally, the Company issued to the purchasers unregistered warrants to purchase up to 5,500,000 shares of common stock. The warrants have an exercise price of $0.75 per share common stock, are exercisable commencing six months following the issuance date, and expire five and one-half years from the issuance date. If exercised for cash, future exercises of these warrants will provide additional capital to the Company. As a result of this recent capital raise, the Company does not anticipate the need to finance its operations for the next fiscal year from additional capital raises.

The Company expects to finance its future cash needs through sales of equity, possible strategic collaborations, debt financing or through other sources that may be dilutive to existing shareholders. Management anticipates that if it raises additional financing that it will be at a discount to the market price and it will be dilutive to shareholders.

The Company’s common stock is currently listed on the NYSE American stock exchange, which will consider delisting a company’s securities if, among other things, a company fails to maintain minimum stockholder's equity.  With the Company’s existing cash reserves we believe we will not be able to maintain our listing on the NYSE American unless we raise capital in the next six to nine months assuming we maintain our projected budgeted expenses and contemplated level of revenues. 

Other commitments and contingencies

The Company presented its other commitments and contingencies in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.30, 2018. There have been no material changes outside of the ordinary course of business in those obligations during the quarter ended September 30, 20172018 other than those previously disclosed in footnotesnote 8 and 12 of Notes to unaudited consolidatedthe financial statements contained in this filing.

Off-balance sheet arrangements

The Company has no off-balance sheet arrangements.

Critical accounting policies and estimates

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as revenue and expenses during the reporting periods. The Company evaluates its estimates and judgments on an ongoing basis. The Company bases its estimates on historical experience and on various other factors the Company believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities. Actual results could therefore differ materially from those estimates if actual conditions differ from our assumptions.

During the quarter ended September 30, 2017,2018, there have been no changes to the critical accounting policies and estimates discussed in Part II, Item 7 of our Form 10-K for the year ended June 30, 2017.2018.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes to the disclosure in the “Quantitative“Quantitative and Qualitative Disclosures about Market Risk Factors” section of our annual report on Form 10-K for the year ended June 30, 2017.2018, which is incorporated herein by reference.

ITEM 4 – CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the design and operation of our disclosure controls and procedures, as such term is defined under Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of September 30, 2017.2018. Based on that evaluation, our principal executive officer and our principal financial officer concluded that the design and operation of our disclosure controls and procedures were effective. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. However, management believes that our system of disclosure controls and procedures are designed to provide a reasonable level of assurance that the objectives of the system will be met.

Changes in Internal Control over Financial ReportingReporting

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

PART II - OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

The Company may, in the ordinary course of business, be subjectNothing to various legal proceedings. Some legal proceedings are discussed in footnote 8 of Notes to Unaudited Consolidated Financial Statements contained in this filing. We refer you to that footnote for important information concerning those legal proceedings, including the basis for such actions and, where known, the relief sought.disclose.

Derivative Complaint related to Shareholder Value

On September 29, 2016, David M. Kitley, purportedly on behalf of IsoRay, filed a derivative lawsuit in the United States District Court for the District of Minnesota under the case caption Kitley v. IsoRay, Inc., Case No. 0:16-cv-03297-DTS. The complaint named as defendants current and former IsoRay directors Dwight Babcock, Thomas LaVoy, Philip J. Vitale and Michael W. McCormick, alleging that they violated their fiduciary duties to IsoRay in connection with a press release allegedly containing false and misleading statements concerning the results from a peer reviewed study of its Cesium-131 isotope seeds for the treatment of non-small cell lung cancers, thereby artificially inflating the price of IsoRay stock. The complaint sought unspecified damages, in an amount not presently determinable, among other forms of relief. 

On November 17, 2016, IsoRay moved to dismiss the complaint, arguing that plaintiff was not entitled to pursue his derivative claims due to his failure to serve a pre-suit demand on IsoRay’s board. Rather than respond to the motion to dismiss, plaintiff filed an amended complaint on January 23, 2017. The amended complaint alleged the same derivative claims as the original, and added IsoRay director Alan Hoffmann as a defendant. Plaintiff sought an award of damages and an order directing IsoRay to undertake reforms of its corporate governance and internal procedures. IsoRay moved to dismiss the amended complaint on March 9, 2017. Plaintiff responded on April 20, 2017, and IsoRay replied on May 17, 2017. The court heard oral argument on the motion on August 22, 2017, and took the matter under advisement at that time. On October 19, 2017, the court granted IsoRay’s motion to dismiss.  The matter is now resolved.

ITEM 1A – RISK FACTORS

A description of the risk factors associated with our business is included under “Risk“Risk Factors” contained in Part I, Item 1A of our annual report on Form 10-K for the year ended June 30, 2017,2018, and is incorporated herein by reference. There have been no material changes in our risk factors since such filing, except for the following:

We Rely Heavily on FourFive Customers

For the three months ended September 30, 20172018 approximately 54%48% of the Company’sCompany’s revenues were dependent on five customers with approximately 26%25% being generated by one physician group.group of customers. The loss of any of these customers would have a material adverse effect on the Company’s revenues that may not be replaced by other customers particularly as these customers are in the prostate sector which is facing substantial competition from other treatments.

We May Need Additional Capital In The Future To Maintain Our NYSE American Listing And For Acquisitions And Expansion Into Other Markets.

Our common stock is currently listed on the NYSE American stock exchange which will consider delisting a company’s securities if, among other things, a company fails to maintain minimum stockholder's equity.  With our existing cash reserves we believe we will not be able to maintain our listing on the NYSE American unless we raise capital in the next six to nine months assuming we maintain our projected budgeted expenses and contemplated level of revenues.  In the event that our common stock is delisted from the NYSE American, trading, if any, in the common stock would be conducted in the over-the-counter market.  As a result, our shareholders would likely find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock.  We may also need to raise capital for strategic acquisitions or expansion into other markets and there is no assurance management will not pursue this additional capital if available.

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

None.On July 11, 2018, the Company completed the closing of a registered direct offering with several institutional and accredited investors (each an “Investor”) for the sale of a total of 11,000,000 shares of common stock of the Company (“Shares”) at a price per share of $0.75, for aggregate gross proceeds to the Company of $8.25 million.

In a concurrent private placement, the Company sold to each Investor, at no additional consideration, unregistered warrants to purchase up to the number of shares of common stock of the Company equal to 50% of such Investor’s Shares or a total of 5,500,000 shares, with an exercise price of $0.75 per share, exercisable from January 11, 2019 until January 11, 2024 (the “Investor Warrants”). The Company also issued warrants to purchase up to 330,000 shares of common stock of the Company, at an exercise price of $0.9375, to representatives of Wainwright, the placement agent for the registered direct offering, as part of its compensation (the “Placement Agent Warrants” and together with the Investor Warrants, the “Warrants”).

The aggregate number of shares of our common stock issuable upon the exercise of the Warrants is 5,830,000 shares. The offer and sale of the Warrants was made without registration in reliance on the exemption provided in Section 4(a)(2) under the Securities Act and Rule 506 promulgated thereunder. We will receive gross proceeds from this offering solely to the extent any Warrants are exercised for cash.

The Company has not yet used any proceeds from our sale of 11,000,000 shares of common stock on July 11, 2018.

Although we have identified some of the potential uses of the proceeds from this offering, we have and reserve broad discretion in the application of these proceeds. Accordingly, we reserve the right to use these proceeds for different purposes or uses which we have not listed above, particularly if there is a change in demand for certain applications of our Cesium-131 and other products which may require increased investment in protocols and research studies and the hiring of additional sales staff

ITEMITEM 3 – DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 - MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5 – OTHER INFORMATION

None

ITEM 6. EXHIBITS

* Filed herewith

** Furnished herewith

*** Denotes Management Contract or Compensatory Plan or Arrangement

SIGNATURES

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

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