"DLL Isolation" is used when your application needs a specific version of a shared DLL for it to work. This is how you deal with needing 2 versions of the same DLL on the same machine. What it does is copy the DLL into the same folder as the EXE that needs it. The caveat is that you can only have one version of the DLL loaded in memory at a time. (ie: app A loads DLL version 1 and then App B tries to load DLL version 2 but can't. App B ends up hanging or blowing up...) This is meant as a band-aid until you update one application or the other.
Taken from WIFI.PDF
On the Components tab in Setup Editor, right-click the .DLL you want to isolate.
From the right-click menu, select New > Isolated Component. The Isolated Component Details dialog appears where you pick a file for isolation from the feature that contains the component.
If the key path for the current component is not an .EXE, then the drop-down list shows all .EXEs in the containing feature that are key paths of .DLL files.
If the key path for the current component is an .EXE, then the drop-down list shows all files from the containing feature that are key paths other than the current component.
From the Associated File drop-down list, select the .EXE you want to assign to this .DLL.
Click OK.