Perspective Therapeutics, Inc. - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2017

or

For the transition period from __________ to ____________

Commission File No. 001-33407

ISORAY, INC.

(Exact name of registrant as specified in its charter)

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). Yes x No ¨

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

Large accelerated filer ¨      Accelerated filer x      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 ¨ No x

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

ISORAY, INC.

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS 

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

IsoRay, Inc. and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(Dollars and shares in thousands, except for per-share amounts)

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

IsoRay, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

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

IsoRay, Inc.

Notes to the Unaudited Consolidated Financial Statements

For the nine months ended March 31, 2017 and 2016

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-K for the year ended June 30, 2016.

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).  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 2017 will be 0%.

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers" (ASU 2014-09), which supersedes the revenue recognition requirements in FASB Accounting Standards Codification (ASC) Topic 605, "Revenue Recognition". 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 guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, and is to be applied retrospectively, with early application not permitted. This update will be effective as of the beginning of fiscal 2019. This update is not expected to have a material impact on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11: Inventory. The guidance requires an entity’s management to measure inventory within the scope of this ASU at the lower of cost or 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 Company continues to evaluate the new standard and its impact on the Company's consolidated financial statements. This update will be effective as of the beginning of fiscal 2018.

In November 2015, the FASB issued ASU 2015-17 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. This update will be effective as of the beginning of fiscal 2018. This update is not expected to have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02: Leases (Subtopic 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. The Company continues to evaluate the new standard and its impact on the Company's consolidated financial statements. This update will be effective as of the beginning of fiscal 2019.

Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. Except to indicate an evaluation of a recent pronouncement is in process, the Company does not discuss recent pronouncements that are not anticipated to have potential impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures of the Company.

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 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 and June 30, 2016 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 and 2016, 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 and 2016, were as follows (in thousands):

Inventory consisted of the following at March 31, 2017 and June 30, 2016 (in thousands):

Inventory, non-current is raw materials that were ordered in quantities to obtain volume cost discounts which based on current and anticipated sales volumes will not be consumed within an operating cycle and the enriched barium which will only be utilized if required to obtain volumes of isotope not able to be purchased from an existing source in the short or long-term. Management does not anticipate the need to utilize the enriched barium within the current operating cycle.

Property and equipment consisted of the following at March 31, 2017 and June 30, 2016 (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 and June 30, 2016 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 during the three months ended March 31, 2017 and 2016 (in thousands): 

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

As of March 31, 2017, total unrecognized compensation expense related to stock-based options was approximately $512,000 and the related weighted-average period over which it is expected to be recognized is approximately 1.68 years.

A summary of stock options within the Company’s share-based compensation plans as of March 31, 2017 was as follows (in thousands except for exercise prices and terms):

There were 6,800 and 56,260 stock options exercised, with approximately $3,000 and $27,000 of intrinsic value associated with these exercises during the nine months ended March 31, 2017 and 2016, respectively. The Company’s current policy is to issue new shares to satisfy stock option exercises.

There were 20,000 and 482,500 option awards granted with a fair value of approximately $7,700 and $255,739 during the nine months ended March 31, 2017 and 2016, respectively.

There were 303,034 and 442,854 stock option awards which expired during nine months ended March 31, 2017 and 2016, respectively.

There were 179,437 and 84,236 stock option awards forfeited during nine months ended March 31, 2017 and 2016, respectively.

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 journal Brachytherapy 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 captioned Griffith, 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-131 manufactured by the Institute of Nuclear Materials. The total purchase agreement provides the Company with a one year supply of Cesium-131. The agreement was set to expire on March 31, 2017, however on December 22, 2016, the Company agreed to an addendum extending the expiration period to December 31, 2017.

Operating Lease Agreements

The Company leases office 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):

Collaborative Development Agreement

On March 13, 2017, Medical entered into a Collaborative Development Agreement (CDA) with GammaTile, LLC to further develop a brachytherapy medical device for the treatment of cancerous tumors in the brain and to seek regulatory approval for the new product. As the project manager Medical will incur all costs in connection with the collaboration project which will be shared equally by both parties and date back to November 8, 2016 when they informally began the collaboration. In accordance with ASC 808 “Collaborative Arrangements”, this activity is accounted for as a collaborative arrangement and is reported on the financial statements under “Research and development: Collaboration arrangements, net of reimbursement.” As of March 31, 2017 costs incurred in connection with the collaboration agreement total approximately $322,000 of which GammaTile LLC has been invoiced approximately $161,000 and paid approximately $42,000.

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 thousands):

The Company’s cash and cash equivalent instruments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices.

The Company’s warrant derivative liability is valued using the Black-Scholes option pricing model which requires a variety of inputs. Such instruments are typically included in Level 2.

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

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.

The following table summarizes additional information about the Company’s common warrants outstanding as of March 31, 2017:

¹ – Exercise prices have been rounded to the nearest whole cent.

In previous fiscal years the Company engaged the services of APEX Data Systems, Inc. (APEX), owned by Dwight Babcock, former Chairman and Chief Executive Officer, to build and maintain a web interfaced data collection application to aggregate patient data in a controlled environment. An alternative vendor began providing these services beginning January 2016. The cost recorded during nine months ended March 31, 2016 from APEX Data Systems, Inc. for the maintenance of the web interfaced data collection applications in combination with the updating of the Company website was approximately $6,000. An additional approximately $6,000 was spent on the maintenance of Customer Relationship Management (CRM) software in the nine months ended March 31, 2016.

During the six months ended June 30, 2016, the Company engaged GO Intellectual Capital, LLC (GO) for marketing services in support of the Company’s rebranding effort. Michael McCormick, a member of the Company Board of Directors, is a 1/3 owner of GO. A statement of work was developed defining the scope of the effort and the deliverables to the Company including a new logo with brand messaging and communication tools including a website, sales presentation tools and a public relations strategy. For the nine months ended March 31, 2017, the Company paid approximately $20,000 to GO for its performance of work related to the agreed upon statement of work. No such services were provided in the nine months ended March 31, 2016.

The Company has an asset retirement obligation (ARO) associated with the facility it currently leases. The ARO changed as follows (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 routinely assesses the financial strength of its customers and provides an allowance for doubtful accounts as necessary.

Property Transaction Between Medical and The Port of Benton

Medical has a contract with The Port of Benton (Port) to develop property and relocate its manufacturing facility to that property from its present location. Covenants and a redevelopment plan contained in that contract, among others, require certain milestones for construction and minimum headcount.

The Port of Benton Commissioners previously amended the development plan covenants extending to January 31, 2017 the date by which Medical would need to begin construction or be in default. As Medical failed to comply with this covenant, Medical is required to pay the Port the difference in the sales price and the appraised value of the property. On April 5, 2017 Medical received from the Port the appraisal report on the land indicating a fair market value of $365,900. Medical previously paid $168,000 to purchase the land and to satisfy the default Medical owed the Port $197,900 which was paid on May 4, 2017 and is included in the accounts payable account balance as of March 31, 2017. Medical is no longer subject to a redevelopment plan but solely to the covenants that are attached to the property itself.

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 of the protections of the safe harbor provisions of the PSLRA.

All statements contained in this Form 10-Q, other than statements of historical facts, that address future activities, events or developments are forward-looking statements, including, but not limited to, statements containing the words "believe," "expect," "anticipate," "intends," "estimate," "forecast," "project," and similar expressions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any statements of the plans, strategies and objectives of management for future operations; any statements concerning proposed new products, services, developments or industry rankings; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. These statements are based on certain assumptions and analyses made by us in light of our experience and our assessment of historical trends, current conditions and expected future developments, as well as other factors that 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” under Part II, Item 1A below and in the “Risk Factors” sections of our annual report on Form 10-K for the fiscal year ended June 30, 2016 .

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

Critical Accounting Policies and Estimates

The discussion and analysis of the Company’s financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with 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 9, 2016 are those that depend most heavily on these judgments and estimates. As of March 31, 2017 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 yielding 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 IsoRay 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 and the Russian Federation, with no reported revenues in the quarter ended March 31, 2017.

Results of Operations

Three months ended March 31, 2017 and 2016 (in thousands):

Nine months ended March 31, 2017 and 2016 (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 resulted in positive sales growth in the third quarter of fiscal 2017 when compared to prior year third 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 March 31, 2017 and 2016 (in thousands)

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

Nine months ended March 31, 2017 and 2016 (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 three quarters of the fiscal year. During the quarter ended March 31, 2017, the Company had turnover with sales managers in two territories resulting in fewer sales in those territories. However, improved relationships with customers in other territories resulted in increased sales. 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 March 31, 2017

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 of 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 decrease 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 March 31, 2017 and 2016 comparison were decreases attributed to cost savings initiatives that resulted in lower procurement costs of goods and services. Some costs shifted in the quarter ended March 31, 2017 to research and development from cost of product sales as employees performed research and development work. Also, reduced staffing costs were realized with one employee retiring in the quarter.

Contributing to the nine months ended March 31, 2017 and 2016 comparison were reduced staffing costs associated with the elimination of five positions: two retirements and three employees being laid off following process improvements in the production facility. Further decreases were attributed to a reduction in the accretion expense related to the asset retirement obligation and reduced depreciation expense as several production related assets became fully depreciated.

Gross Profit

Contributing to the quarter’s and nine months ended March 31, 2017 and 2016 gross profit comparison were reductions in cost of product sales due to reduced staffing costs including utilization of production personnel on research and development projects. The Company was able to leverage minimum supply agreements during the quarter’s and nine months ended March 31, 2017 and 2016 such that increased sales did not also result in additional isotope costs.

Research and development

Research and development – proprietary

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

Contributing to the quarters ended March 31, 2017 and 2016 proprietary research and development comparison were decreases in protocol related expenses due to changed participation in various protocols during the quarter ended March 31, 2017. These cost decreases were partially offset with cost increases associated with device development activities as well as a reallocation of employee costs from cost of product sales as those employees performed work on research and development projects.

Contributing to the nine months ended March 31, 2017 and 2016 comparison were increased legal expenses related to maintenance of intellectual property, additional device development activities, and a reallocation of employee costs from cost of product sales as those employees performed work on research and development projects.

Research and development – collaborative arrangement

Collaboration arrangement related costs are incurred, shared, and separately stated in connection with a collaborative research and development project (see footnote 8 of Notes to unaudited consolidated financial statements contained in this filing). For the quarter ended March 31, 2017 the collaborative arrangement incurred costs of approximately $322,000 net of approximately $161,000 in shared cost reimbursements.

Sales and marketing expenses

Sales and marketing expenses consist primarily of the costs related to the internal and external activities 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 March 31, 2017 and 2016 comparison were increased costs related to participation in six tradeshows to further implement the Company’s marketing strategy. Staffing differences are a major factor in the cost comparison as unfilled positions in the quarter ended March 31, 2016 were filled in periods prior to the quarter ended March 31, 2017.

Contributing to the nine months ended March 31, 2017 and 2016 comparison increase were rebranding efforts and a website redesign that launched during the first quarter of fiscal year 2017 and increased participation in prostate tradeshows to further implement the Company’s marketing strategy. Increased costs are also attributed to filling open positions in the department, including the position of Vice President of Sales and Marketing. Other staffing changes in the comparative periods include adding a Product Manager and a Senior Marketing Consultant, as well as changes to five of the Company’s six sales account manager positions.

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 March 31, 2017 and 2016 comparison were cost decreases from the prior year. Those include decreases in legal expenses related to the retirement of the Company’s Chief Executive Officer (CEO), decreases in option-based compensation for the new CEO, and decreases associated with discontinuing the GliaSite® RTS product. These cost decreases were partially offset in the quarter ended March 31, 2017 by increases associated with the separation agreement with the Company’s former Chief Financial Officer (CFO) which were recorded in the quarter as well as increased salary, benefits, and share-based compensation associated with the Director of Quality Assurance and Regulatory Affairs, Senior Accountant and Vice President of Human Resources positions that were vacant during the quarter ended March 31, 2016.

Further contributing to the nine months ended March 31, 2017 and 2016 comparison were decreases associated with overhead costs recovered in connection with the collaboration arrangement which were offset by increased travel expenses, increased public company related costs associated with the annual shareholder meeting held in December 2016 this fiscal year as opposed to June 2016 in the prior fiscal year, and listing fees associated with the 2016 Employee Stock Option Plan.

Gain on change in estimate of Asset Retirement Obligation (ARO)

The Company extended the term of the lease on its production facility, resulting in a revision of the estimated cost associated with restoring the facility to its original condition, which will be required when the lease expires and the Company vacates the production facility.

Liquidity and capital resources

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 March 31, 2017 and 2016, 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 nine months ended March 31, 2017 was primarily due to a net loss of approximately $4.3 million, net of approximately $199,000 in adjustments for non-cash activity such as depreciation and amortization expense, ARO adjustments, the change in fair value of the warrant derivative liability and share-based compensation. Changes in operating assets and liabilities used approximately $193,000 to fund operating activities; an increase in accounts receivables resulted from improved sales followed by accelerated timing of accounts payable and accrued expenses were offset by the additional liability recorded in connection a land purchase as discussed in footnote 15 of Notes to unaudited consolidated financial statements contained in this filing.

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. Also, included in property and equipment is an increase in the recorded value of land as discussed in footnote 15 of Notes to unaudited consolidated financial statements contained in this filing. 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.

Cash flows from financing activities

Financing activities in the nine months ended March 31, 2017 included payment of preferred dividends and proceeds of sales of common stock through option exercises.

Projected 2017 liquidity and capital resources

Operating activities

Management forecasts that fiscal 2017 cash requirements will be approximately $800,000 more than the previous year, the result of filling sales staffing positions which were vacant in fiscal 2016 and increased costs associated with rebranding and marketing the Company’s products. 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 the fiscal 2017 and for 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 twenty percent increase in revenue in fiscal 2017 and this annual growth continues, the Company anticipates reaching cashflow break-even in three to five years. So far, the Company has not reached that target, and as there is only one quarter remaining in the fiscal year management does not believe this twenty percent increase in revenue will be achieved by the end of fiscal 2017. There is no assurance that targeted sales growth will materialize over the three to five years. However, management is encouraged by the results for the quarter ended March 31, 2017 and with the depth and experience of its restructured sales team.

Capital expenditures

Management has completed the design of a future production 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. The Company paid an additional $197,900 on May 4, 2017, to satisfy the default with the Port regarding the land purchased earlier in the fiscal year. The Company is no longer subject to a redevelopment plan but solely to the covenants that are attached to the property itself.

Management is reviewing 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.

Through the quarter ended March 31, 2017, the Company has invested approximately $240,000 towards the automation of thirteen production processes, three of which have been received, tested and evaluated, and were placed in service in the quarter. Management is expecting to invest approximately $260,000 over the next 11 months on the remaining production process automation 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 March 31, 2017, 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 register securities up to $20 million in value for future issuance in our capital raising activities. The registration statement became effective on November 19, 2015, and the SEC file number assigned to the registration statement is 333-206559.

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.

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, 2016. There have been no material changes outside of the ordinary course of business in those obligations during the quarter ended March 31, 2017 other than those previously disclosed in footnotes 8 and 15 of Notes to unaudited consolidated 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 March 31, 2017, 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, 2016.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes to the disclosure in the “Quantitative and Qualitative Disclosures about Market Risk Factors” section of our annual report on Form 10-K for the year ended June 30, 2016.

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 March 31, 2017. 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 Reporting

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

PART II - OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

The Company may, in the ordinary course of business, be subject 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.

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 on May 20, 2015 regarding a May 19 online publication of the peer-reviewed article in the journal Brachytherapy 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 US 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.

As IsoRay previously disclosed on March 9, 2017, the parties have 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 United States 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 Mr., Kitley’s complaint.  On January 23, 2017, instead of opposing defendants’ motion, Mr. Kitley 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 re Equity Plans

On January 31, 2017, a putative class action complaint captioned Griffith, 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.

ITEM 1A – RISK FACTORS

A description of the risk factors associated with our business is included under “Risk Factors” contained in Part I, Item 1A of our annual report on Form 10-K for the year ended June 30, 2016, 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 Five Customers

For the nine months ended March 31, 2017 approximately 46% of the Company’s revenues were dependent on five customers with approximately 23% being generated by one customer. 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.

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

None.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4 - MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5 – OTHER INFORMATION

The Company leases office and laboratory space under an operating lease with Energy Northwest. On November 15, 2016, the Company agreed to a contract modification which became effective November 1, 2016 to extend the lease termination date to April 30, 2021. No other terms of the lease, as modified through November 1, 2016, were changed.

ITEM 6. EXHIBITS

* Filed herewith

** Furnished herewith

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.