**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **WASHINGTON,
        D.C. 20549**
 
 **FORM
        10-QSB/A**
  AMENDMENT
        No. 1
 
 **xQUARTERLY
        REPORT
        PURSUANT TO SECTION 13 OR 15(D) OF THE**
 **SECURITIES
        EXCHANGE ACT OF 1934**
 For
        the
        quarterly period ended June 30, 2005
 
 **OR**
 
 **oTRANSITION
        REPORT PURSUANT TO SECTION 13
        OR 15(D) OF THE**
 **SECURITIES
        EXCHANGE ACT OF 1934**
 For
        the
        Transition Period from ___________ to ___________
 
 **Commission
        File Number: 333-116255**
 
 **VIVID
        LEARNING SYSTEMS, INC.**
 (Exact
        name of Registrant as specified in its charter)
 
 **Delaware**
                (State
                  or other jurisdiction of
                incorporation
                  or organization)
              **42-1623500**
                (I.R.S.
                  Employer Identification No.)
 
 **723
        The Parkway**
 **Richland,
        Washington 99352**
 (Address
        of principal executive offices, including zip code)
 
 **(509)
        943-5319**
 (Registrant's
        telephone number, including area code)
 
 
 Check
        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, and (2) has been subject to such filing requirements for the past
        90
        days. Yes o  No x
 
 The
        number of shares of the Registrant's common stock issued and outstanding
        at June
        30, 2005, was 10,247,996.
 
 Transitional
        Small Business Disclosure Format:  Yes
o  No
x
  
  **VIVID
        LEARNING SYSTEMS, INC.**
 **JUNE
        30, 2005** **QUARTERLY REPORT ON FORM 10-QSB**
 
 **TABLE
        OF CONTENTS**
  **PAGE**Special
                      Note Regarding Forward Looking Statements
                  3**PART
                      I****FINANCIAL
                      INFORMATION**Item
                      1.
                  Financial
                      Statements
                  4Item
                      2.
                  Management’s
                        Discussion And AnalysisOf
                        Financial Condition And Results Of Operations
                  20Item
                      3
                  Controls
                      and Procedures
                  26**PART
                      II****OTHER
                      INFORMATION**Item
                      6.
                  Exhibits
                  27
 2
  
 **SPECIAL
        NOTE REGARDING FORWARD-LOOKING STATEMENTS**
 
 To
        the
        extent that the information presented in this Quarterly Report on Form 10-QSB
        for the quarter ended June 30, 2005, discusses financial projections,
        information or expectations about our products or markets, or otherwise makes
        statements about future events, such statements are forward-looking. We are
        making these forward-looking statements in reliance on the safe harbor
        provisions of the Private Securities Litigation Reform Act of 1995. Although
        we
        believe that the expectations reflected in these forward-looking statements
        are
        based on reasonable assumptions, there are a number of risks and uncertainties
        that could cause actual results to differ materially from such forward-looking
        statements. These risks and uncertainties are described, among other places
        in
        this Quarterly Report, in “Management’s Discussion And Analysis Of Financial
        Condition And Results Of Operations.”
 
 In
        addition, we disclaim any obligations to update any forward-looking statements
        to reflect events or circumstances after the date of this Quarterly Report.
        When
        considering such forward-looking statements, you should keep in mind the
        risks
        referenced above and the other cautionary statements in this Quarterly
        Report.
  3
 
 **PART
        I - FINANCIAL INFORMATION**
  **ITEM
                    1.**
                **FINANCIAL
                    STATEMENTS**
                **PAGE**Consolidated
                    Balance Sheets
                5Consolidated
                    Statements of Income
                6-7Consolidated
                    Statements of Cash Flows
                8Notes
                    to Financial Statements
                9-19
 4
  **VIVID
        LEARNING SYSTEMS, INC.**
 **CONSOLIDATED
        BALANCE SHEETS**
  June
                    30,2005
                
                September
                      30,(Unaudited)
                
                2004**ASSETS**CURRENT
                    ASSETSCash
                
                $
                32,555
                
                $
                49,451Accounts
                    and contracts receivable
                
                
                1,178,310
                
                
                1,933,573Accounts
                    and contracts receivable, Fluor Hanford
                
                
                20,646
                
                
                59,035Accounts
                    receivable, related party
                
                
                4,605
                
                
                3,894Employee
                    advances
                
                
                7,775
                
                
                22,222Prepaid
                    expenses
                
                
                69,034
                
                
                68,813Other
                    current assets
                
                
                304,505
                
                
                72,179TOTAL
                    CURRENT ASSETS
                
                
                1,617,430
                
                
                2,209,167PROPERTY,
                    PLANT AND EQUIPMENTProperty
                    and equipment
                
                
                1,220,820
                
                
                1,135,030Less:
                    Accumulated depreciation and amortization
                
                
                (877,846
                )
                
                (764,914
                )TOTAL
                    PROPERTY, PLANT AND EQUIPMENT
                
                
                342,974
                
                
                370,116OTHER
                    ASSETSSoftware,
                    net of amortization
                
                
                1,800,880
                
                
                1,684,406Intangibles,
                    net of amortization
                
                
                1,183,693
                
                
                763,160Goodwill
                
                
                375,000
                
                
                375,000Long-term
                    contracts receivable
                
                
                404,792
                
                
                —TOTAL
                    OTHER ASSETS
                
                
                3,764,365
                
                
                2,822,566**TOTAL
                    ASSETS**
                
                $
                5,724,769
                
                $
                5,401,849**LIABILITIES
                    AND STOCKHOLDERS' EQUITY**CURRENT
                    LIABILITIESAccounts
                    payable
                
                $
                233,771
                
                $
                189,588Payable
                    to related party
                
                
                1,830,957
                
                
                823,430Accrued
                    contract labor
                
                
                323,593
                
                
                159,450Other
                    current liabilities
                
                
                174,941
                
                
                271,950Unearned
                    revenue
                
                
                19,473
                
                
                30,286Notes
                    payable, related parties
                
                
                50,000
                
                
                250,000Current
                    portion of long-term liabilities
                
                
                80,000
                
                
                30,000TOTAL
                    CURRENT LIABILITIES
                
                
                2,712,735
                
                
                1,754,704LONG-TERM
                    LIABILITIESOther
                    long-term liability
                
                
                595,000
                
                
                545,000Related
                    party payable
                
                
                44,282
                
                
                299,634TOTAL
                    LONG-TERM LIABILITIES
                
                
                639,282
                
                
                844,634TOTAL
                    LIABILITIES
                
                
                3,352,017
                
                
                2,599,338COMMITMENTS
                    AND CONTINGENCIES
                
                
                —
                
                
                —STOCKHOLDERS'
                    EQUITYPreferred
                    stock, $0.0001 par value;5,000,000 shares authorized, no shares
                    issued and outstanding
                
                
                —
                
                
                —Common
                    stock, $0.0001 par value; 200,000,000
                    shares authorized, 10,247,996 shares
                    issued and outstanding
                
                
                1,020
                
                
                1,020Additional
                    paid-in capital
                
                
                2,535,552
                
                
                2,469,626Retained
                    earnings <deficit>
                
                
                (163,820
                )
                
                331,865TOTAL
                    STOCKHOLDERS' EQUITY
                
                
                2,372,752
                
                
                2,802,511**TOTAL
                    LIABILITIES AND STOCKHOLDERS' EQUITY**
                
                $
                5,724,769
                
                $
                5,401,849
  See
            accompanying condensed notes to consolidated financial statements.
 5
  **VIVID
        LEARNING SYSTEMS, INC.**
 **CONSOLIDATED
        STATEMENTS OF INCOME**
 Three
                      Months Ended
                  
                  Three
                      Months EndedJune
                      30, 2005
                  
                  June
                      30, 2004(Unaudited)
                  
                  (Unaudited)REVENUESTraining
                      subscriptions
                  
                  $
                  227,562
                  
                  $
                  819,059Training
                      subscriptions, Fluor Hanford
                  
                  
                  147,338
                  
                  
                  142,363Custom
                      products and services
                  
                  
                  329,513
                  
                  
                  382,352Custom
                      products and services, Fluor Hanford
                  
                  
                  62,884
                  
                  
                  18,567767,297
                  
                  
                  1,362,341COST
                      OF REVENUESTraining
                      subscriptions
                  
                  
                  84,645
                  
                  
                  76,577Custom
                      products and services
                  
                  
                  318,887
                  
                  
                  279,523403,532
                  
                  
                  356,100GROSS
                      PROFIT
                  
                  
                  363,765
                  
                  
                  1,006,241EXPENSESMarketing
                      and related labor expenses
                  
                  
                  230,585
                  
                  
                  331,837Reseller
                      commissions
                  
                  
                  37,312
                  
                  
                  72,030Depreciation
                      and amortization
                  
                  
                  17,595
                  
                  
                  24,030Wages
                      and contract labor
                  
                  
                  230,242
                  
                  
                  128,414Other
                      operating expenses
                  
                  
                  222,778
                  
                  
                  172,407TOTAL
                      OPERATING EXPENSES
                  
                  
                  738,512
                  
                  
                  728,718INCOME
                      (LOSS) FROM OPERATIONS
                  
                  
                  (374,747
                  )
                  
                  277,523OTHER
                      INCOME (EXPENSE)Interest
                      income
                  
                  
                  105
                  
                  
                  697Interest
                      expense
                  
                  
                  (15,027
                  )
                  
                  (914
                  )TOTAL
                      OTHER INCOME (EXPENSE)
                  
                  
                  (14,922
                  )
                  
                  (217
                  )INCOME
                      (LOSS) BEFORE INCOME TAXES
                  
                  
                  (389,669
                  )
                  
                  277,306INCOME
                      TAX BENEFIT (EXPENSE)
                  
                  
                  132,487
                  
                  
                  (95,532
                  )NET
                      INCOME (LOSS)
                  
                  $
                  (257,182
                  )
                  $
                  181,774BASIC
                      AND DILUTED NET INCOME (LOSS) PER SHARE
                  
                  $
                  (0.03
                  )
                  $
                  0.02BASIC
                      AND DILUTEDWEIGHTED
                      AVERAGE NUMBER OF SHARES
                  
                  
                  10,247,996
                  
                  
                  8,100,000
  See
            accompanying condensed notes to consolidated financial statements.
 6
  **VIVID
          LEARNING SYSTEMS, INC.** **CONSOLIDATED
            STATEMENTS OF INCOME**
  Nine
                    Months Ended
                
                Nine
                    Months EndedJune
                    30, 2005
                
                June
                    30, 2004(Unaudited)
                
                (Unaudited)REVENUESTraining
                    subscriptions
                
                $
                1,376,897
                
                $
                2,073,632Training
                    subscriptions, Fluor Hanford
                
                
                442,013
                
                
                427,089Custom
                    products and services
                
                
                969,917
                
                
                863,500Custom
                    products and services, Fluor Hanford
                
                
                116,706
                
                
                55,1472,905,533
                
                
                3,419,368COST
                    OF REVENUESTraining
                    subscriptions
                
                
                256,250
                
                
                221,741Custom
                    products and services
                
                
                921,654
                
                
                582,5281,177,904
                
                
                804,269GROSS
                    PROFIT
                
                
                1,727,629
                
                
                2,615,099EXPENSESMarketing
                    and related labor expenses
                
                
                721,093
                
                
                881,144Reseller
                    commissions
                
                
                210,244
                
                
                287,502Depreciation
                    and amortization
                
                
                54,706
                
                
                69,013Wages
                    and contract labor
                
                
                670,789
                
                
                345,770Other
                    operating expenses
                
                
                783,228
                
                
                394,779TOTAL
                    OPERATING EXPENSES
                
                
                2,440,060
                
                
                1,978,208INCOME
                    (LOSS) FROM OPERATIONS
                
                
                (712,431
                )
                
                636,891OTHER
                    INCOME (EXPENSE)Interest
                    income
                
                
                536
                
                
                1,157Interest
                    expense
                
                
                (39,142
                )
                
                (4,760
                )TOTAL
                    OTHER INCOME (EXPENSE)
                
                
                (38,606
                )
                
                (3,603
                )INCOME
                    (LOSS) BEFORE INCOME TAXES
                
                
                (751,037
                )
                
                633,288INCOME
                    TAX BENEFIT (EXPENSE)
                
                
                255,352
                
                
                (218,177
                )NET
                    INCOME (LOSS)
                
                $
                (495,685
                )
                $
                415,111BASIC
                    AND DILUTED NET INCOME (LOSS) PER SHARE
                
                $
                (0.05
                )
                $
                0.22BASIC
                    AND DILUTEDWEIGHTED
                    AVERAGE NUMBER OF SHARES
                
                
                10,247,996
                
                
                1,873,999
  See
          accompanying condensed notes to consolidated financial statements.
 7
  VIVID
            LEARNING SYSTEMS, INC.
 Nine
                          Months Ended
                    
                    
                    Nine
                          Months EndedJune
                          30,2005
                    
                    
                    June
                          30,2004(Unaudited)
                    
                    
                    (Unaudited)**CASH
                        FLOWS FROM OPERATING ACTIVITIES:**Net
                        income (loss)
                    
                    $
                    (495,685
                    )
                    $
                    415,111Adjustments
                        to reconcile net income (loss)to
                        net cash provided by operating activities:Depreciation
                        and amortization
                    
                    
                    54,706
                    
                    
                    69,013Amortization
                        of capitalized software
                    
                    
                    223,942
                    
                    
                    202,132Deferred
                        federal taxes
                    
                    
                    (255,352
                    )
                    
                    218,177Options
                        issued for services
                    
                    
                    20,910
                    
                    
                    —Changes
                        in assets and liabilities:Accounts
                        and contracts receivable
                    
                    
                    792,941
                    
                    
                    (522,559
                    )Prepaid
                        expenses
                    
                    
                    (221
                    )
                    
                    16,129Other
                        current assets
                    
                    
                    (232,326
                    )
                    
                    (171,375
                    )Accounts
                        payable
                    
                    
                    44,183
                    
                    
                    (11,478
                    )Accrued
                        payroll and related expenses
                    
                    
                    164,143
                    
                    
                    55,308Related
                        party payables, net of line of credit
                    
                    
                    779,552
                    
                    
                    67,171Long-term
                        receivable contracts
                    
                    
                    (404,792
                    )
                    
                    —Other
                        current liabilities
                    
                    
                    (57,822
                    )
                    
                    45,658Net
                        cash provided by operating activities
                    
                    
                    634,179
                    
                    
                    385,787**CASH
                        FLOWS FROM INVESTING ACTIVITIES:**Acquisition
                        of property, equipment and intangible assets
                    
                    
                    (380,496
                    )
                    
                    (413,625
                    )Acquisition
                        of software
                    
                    
                    (298,554
                    )
                    
                    (380,053
                    )Net
                        cash used by investing activities
                    
                    
                    (679,050
                    )
                    
                    (793,678
                    )**CASH
                        FLOWS FROM FINANCING ACTIVITIES:**Proceeds
                        from stock issuances
                    
                    
                    —
                    
                    
                    422,799Payments
                        on notes payable, related party
                    
                    
                    (200,000
                    )
                    
                    —Proceeds
                        from related party line of credit
                    
                    
                    227,975
                    
                    
                    —Net
                        cash provided by financing activities
                    
                    
                    27,975
                    
                    
                    422,799Net
                        increase (decrease) in cash
                    
                    
                    (16,896
                    )
                    
                    14,908Cash
                        at beginning of period
                    
                    
                    49,451
                    
                    
                    11,612Cash
                        at end of period
                    
                    $
                    32,555
                    
                    $
                    26,520SUPPLEMENTAL
                        CASH FLOW INFORMATION:
                    
                    
                    —Interest
                        paid
                    
                    $
                    39,142
                    
                    $
                    2,438Income
                        taxes paid
                    
                    $
                    —
                    
                    $
                    —NON-CASH
                        TRANSACTIONS:Options
                        issued for services
                    
                    $
                    20,910
                    
                    $
                    —
  See
                accompanying condensed notes to consolidated financial
                statements.
 8
  **VIVID
          LEARNING SYSTEMS, INC.**
 **CONDENSED
          NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
          30, 2005**
 
 
 NOTE
        1 -
**BUSINESS ORGANIZATION**
 
 Nature
        of Operations
 Vivid
        Learning Systems, Inc. (hereinafter “Vivid Washington”) was incorporated in 1995
        in the State of Washington under the name of Applied TecKnowledgey, and was
        shortly thereafter renamed Vivid Concepts, Inc. Prior to December 23, 2003,
        Vivid Washington was a wholly owned subsidiary of Nuvotec, Inc., a technology
        commercialization corporation based in Washington State. On December 23,
        2003,
        Nuvotec, Inc., exchanged all of its 7,000,000 common stock shares in Vivid
        Washington for 8,100,000 shares of common stock with a par value of $0.0001
        in a
        newly formed Delaware corporation also named Vivid Learning Systems, Inc.
        The
        Delaware company (“Company” or “Vivid Delaware”) serves as the holding company
        and parent and sole shareholder of the operating entity (“Vivid Washington”).
        The common stock of the Delaware company was held 100% by Nuvotec, Inc.,
        until
        an additional 1,987,996 of the Company’s common stock was issued in a private
        placement to approximately seventy individual shareholders at September 30,
        2004. Vivid Washington develops and provides computer-based training products
        and services, which are marketed nationally. The reorganization caused no
        change
        in the accounting in the financial statements of Vivid Washington as Vivid
        Washington continues to be the operating company and the financial information
        provided is the historical financial information of Vivid Washington. Vivid
        Delaware and its subsidiaries have a year end of September 30.
 
 Basis
        of Presentation
 The
        accompanying unaudited consolidated financial statements have been prepared
        in
        accordance with generally accepted accounting priciples for interim financial
        information and the instructions to Form 10-QSB and Rule 10-01 of Regulation
        S-X. Accordingly, they do not include all of the information and footnotes
        required by accounting principles generally accepted in the United States
        for
        complete financial statements. In the opinion of management, all adjustments
        (consisting of normal recurring adjustments) considered necessary for a fair
        presentation of interim results have been included. Operating results for
        the
        nine months ended June 30, 2005 are not necessarily indicative of the results
        that may be expected for the fiscal year ending September 30, 2005. For further
        information, refer to the Company’s consolidated audited financial statements
        and footnotes thereto.
 
 Certain
        prior year amounts may have been reclassified to conform to the current period’s
        presentation.
 
 
 **NOTE
        2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
 
 This
        summary of significant accounting policies is presented to assist in
        understanding the financial statements. The financial statements and notes
        are
        representations of the Company’s management, which is responsible for their
        integrity and objectivity. These accounting policies conform to accounting
        principles generally accepted in the United States and have been consistently
        applied in the preparation of the financial statements.
 
 9
  **VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**




Accounting
      Methods and Consolidation


The
      Company’s financial statements are prepared using the accrual method of
      accounting.





The
      consolidated financial statements include the accounts of the Company and its
      wholly owned subsidiaries, after elimination of inter-company accounts and
      transactions. The wholly owned subsidiaries of the Company are Vivid Washington,
      Inc., and ImageWorks Media Group, Inc.





Earnings
      Per Share


The
      Company has adopted Statement of Financial Accounting Standards No. 128, which
      provides for calculation of "basic" and "diluted" earnings per share. Basic
      earnings per share for Vivid includes no dilution and is computed by dividing
      net income available to common shareholders by the weighted average number
      of
      common shares outstanding for the period. Diluted earnings per share reflect
      the
      potential dilution of securities that could share in the earnings of an entity.
      There were 666,834 and 882,353 common stock equivalents outstanding at June
      30,
      2005 and September 30, 2004, respectively. Earnings per share at June 30, 2005
      and September 30, 2004 reflect the forward stock split which occurred on
      November 25, 2003.





Management
      Services Provided by Nuvotec


In
      Vivid’s consolidated statements of income, “other operating expenses” contains
      amounts that represent allocations from Nuvotec of central overhead expenses,
      including rent, director fees, central office overhead expense accounts, legal
      and contracts, finance (including accounting and reporting, receivables and
      collection activities, payables and cash management, budgeting, etc.), executive
      and administrative expenses that are applied to the Vivid operation. Most of
      the
      allocated expenses represent labor related costs.





Provision
      for Taxes


The
      current tax provision represents the federal income tax which the Company would
      have incurred on a separate, stand-alone basis. The Company receives the benefit
      of losses resulting from the federal income tax returns filed on a consolidated
      basis by its majority shareholder, Nuvotec, Inc. The consolidated tax returns
      are filed on a calendar year basis.





Income
      taxes are provided based upon the liability method of accounting pursuant to
      Statement of Financial Accounting Standards No. 109, “Accounting for Income
      Taxes.” Under this approach, deferred income taxes are recorded to reflect the
      tax consequences in future years of differences between the tax basis of assets
      and liabilities and their financial reporting amounts at each year end. A
      valuation allowance is recorded against deferred tax assets if management does
      not believe the Company has met the “more likely than not” standard imposed by
      Statement of Financial Accounting Standard No. 109 to allow recognition of
      such
      an asset.




10


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**
 
  Recent
      Accounting Pronouncements


In
      December 2004, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 153. This statement addresses the measurement
      of exchanges of nonmonetary assets. The guidance in APB Opinion No. 29,
“Accounting for Nonmonetary Transactions,” is based on the principle that
      exchanges of nonmonetary assets should be measured based on the fair value
      of
      the assets exchanged. The guidance in that opinion, however, included certain
      exceptions to that principle. This statement amends Opinion 29 to eliminate
      the
      exception for nonmonetary exchanges of similar productive assets and replaces
      it
      with a general exception for exchanges of nonmonetary assets that do not have
      commercial substance. A nonmonetary exchange has commercial substance if the
      future cash flows of the entity are expected to change significantly as a result
      of the exchange. This statement is effective for financial statements for fiscal
      years beginning after June 15, 2005. Earlier application is permitted for
      nonmonetary asset exchanges incurred during fiscal years beginning after the
      date of this statement is issued. Management believes the adoption of this
      statement will have no impact on the financial statements of the Company.




In
      December 2004, the Financial Accounting Standards Board issued a revision to
      Statement of Financial Accounting Standards No. 123R, “Accounting for Stock
      Based Compensations.” This statement supersedes APB Opinion No. 25, “Accounting
      for Stock Issued to Employees,” and its related implementation guidance. This
      statement establishes standards for the accounting for transactions in which
      an
      entity exchanges its equity instruments for goods or services. It also addresses
      transactions in which an entity incurs liabilities in exchange for goods or
      services that are based on the fair value of the entity’s equity instruments or
      that may be settled by the issuance of those equity instruments. This statement
      focuses primarily on accounting for transactions in which an entity obtains
      employee services in share-based payment transactions. This statement does
      not
      change the accounting guidance for share based payment transactions with parties
      other than employees provided in Statement of Financial Accounting Standards
      No.
      123. This statement does not address the accounting for employee share ownership
      plans, which are subject to AICPA Statement of Position 93-6, “Employers’
      Accounting for Employee Stock Ownership Plans.” The Company previously adopted
      SFAS No. 123.




In
      November 2004, the Financial Accounting Standards Board issued Statement
      of
      Financial Accounting Standards No. 151, “Inventory Costs— an amendment of ARB
      No. 43, Chapter 4. “This statement amends the guidance in ARB
      No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for
      abnormal amounts of idle facility expense, freight, handling costs, and wasted
      material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously
      stated that “. . . under some circumstances, items such as idle facility
      expense, excessive spoilage, double freight, and rehandling costs may be so
      abnormal as to require treatment as current period charges. . . .” This
      statement requires that those items be recognized as current-period charges
      regardless of whether they meet the criterion of “so abnormal.” In addition,
      this statement requires that allocation of fixed production overhead to the
      costs of conversion be based on the normal capacity of the production
      facilities. This statement is effective for inventory costs incurred during
      fiscal years beginning after June 15, 2005. The Company does not at
      present
      have inventory that would be affected by this statement.




11


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**
 
  In
      May
      2003, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards No. 150, “Accounting for Certain Financial Instruments with
      Characteristics of Both Liabilities and Equity” (hereinafter “SFAS No. 150”).
      SFAS No. 150 establishes standards for classifying and measuring certain
      financial instruments with characteristics of both liabilities and equity and
      requires that those instruments be classified as liabilities in statements
      of
      financial position. Previously, many of those instruments were classified as
      equity. SFAS No. 150 is effective for financial instruments entered into or
      modified after May 31, 2003 and otherwise is effective at the beginning of
      the
      first interim period beginning after September 15, 2003. The Company has adopted
      SFAS No. 150 during the year ended September 30, 2004.




Reseller
      Commissions


Reseller
      commissions are recorded as an expense if the cumulative affirmative impact
      of indicators of gross revenue reporting, as outlined in EITF
      99-19, Indicators 7-14, are met by the Company in the
      transaction. **** The
      Company pays each of the channel partners a commission, or a referral fee,
      recorded as a selling expense, strictly on a success basis as a result of
      selling the Company’s products and services to third party customers. The
      Company has contractual arrangements with each of these partners that range
      from
      one to two years. The Company pays these partners a referral fee, or a
      commission, of between five and fifty percent of net revenue depending upon
      their annual sales levels and other criteria.





None
      of
      these U.S.-based contracts is exclusive, or restricts the Company from selling
      directly or through other channel partners into any markets. The Company does
      have one contract in place with a European reseller that is country-specific,
      exclusive, and has a duration of two years. Such expenses paid to resellers
      are
      recorded as a reduction to the underlying selling price if the cumulative
      affirmative impact of indicators of net revenue reporting, as outlined in EITF
      99-19, Indicators 15-17 are present in the transaction. The Company does not
      provide any consideration to end-users other than negotiated price discounts
      for
      subscriptions based on the size of the contract. Contract size is defined by
      the
      number of employees (seats), number of lessons and length of the
      contract.





The
      Company renewed, effective July 1, 2004 for two additional years, a material
      reseller agreement with Element K of Rochester, New York.





Software
      Development Costs


Costs
      incurred for the internal development of software products and enhancements,
      after technological feasibility has been established for the related product,
      are capitalized and stated at the lower of cost or net realizable value.
      Amortization is provided based on the greater of the amount computed using
      (a)
      the ratio that current gross revenues for a product bears to the total of
      current and anticipated future gross revenues for that product, or (b) the
      straight-line method over the remaining estimated economic life of the product,
      not to exceed five years.




12


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**
 
  Production
      costs incurred subsequent to the establishment of technological feasibility
      are
      capitalized. Also capitalized are the component costs incurred associated with
      the development of product templates in accordance with Statement of Financial
      Accounting Standards No. 86, which consist primarily of labor related costs.
      As
      revenue generation commences on specific training content, additional costs
      incurred are classified as maintenance expense, or customer marketing expense,
      in the period they are incurred. Hours expended via time sheets, and costs
      incurred by production personnel on lesson content development on a per lesson
      basis are maintained so that cost efficiency in software content development
      can
      be analyzed on a lesson content by lesson content basis. Net realizable value
      is
      determined by comparing the unamortized cost of each developed software lesson
      content and the remaining available market (quantified by dollars) for that
      content in the industry in which Vivid is selling the content. The unamortized
      software development cost is then aggregated by lesson content and a grand
      total
      is compared to the total remaining available aggregate market for the content
      to
      determine if a write-down is required. The Company’s amortization method assumes
      that sales of the Company’s existing software products will continue for at
      least the ensuing five years. For the three months ended June 30, 2005 and
      2004,
      $76,653 and $68,943 of amortization expense were recorded, respectively.





Software
      development costs consist of the following at the dates shown:





June
                30 2005,
            
            September
                30,
              2004Software
                development costs
            
            $
            3,441,580
            
            $
            $3,101,164Accumulated
                amortization
            
            
            (1,640,700
            )
            
            (1,416,758
            )$
            1,800,880
            
            $
            $1,684,406





In
      November 2003, the Company purchased software and related materials from
      FoodSafety.com, Inc. for $305,000, which is included in software on the balance
      sheet.





The
      amount charged to amortization expense for the nine months ending June 30,
      2005
      was $223,942. The amount written down to net realizable value during this period
      was zero. The amount charged to amortization expense for the nine months ending
      June 30, 2004 was $202,132. The amount written down to net realizable value
      during this period was zero.





Use
      of
      Estimates


The
      process of preparing financial statements in conformity with accounting
      principles generally accepted in the United States of America requires the
      use
      of estimates and assumptions regarding certain types of assets, liabilities,
      revenues, and expenses. Such estimates primarily relate to unsettled
      transactions and events as of the date of the financial statements. Accordingly,
      upon settlement, actual results may differ from estimated amounts.




13


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**
 Revenue
          and Cost Recognition


The
      Company’s revenues are recognized at the time of shipment of products or
      performance of the contracted services. The Company sells its products and
      services both directly, using in-house sales employees, and indirectly, using
      channel sales partners. Channel sales partners are classified as independent
      resellers, value-added resellers, industry consultants and industry
      associations. Cost of goods is primarily made up of labor costs associated
      with
      software development and training.





The
      Company’s sales contracts are primarily on a time and material basis, with
      hourly billing rates negotiated with the customer. Contract revenues are earned
      as hours are expended and reimbursable costs are incurred.





Training
      revenues are recognized at the time of shipment of products or performance
      of
      contracted services. Products are shipped FOB shipping point and title passes
      upon shipment. Training contracts may contain elements of both custom contract
      work (contracted services) and subscription arrangements (delivery of training
      products). Training subscription revenues are recorded when collection of the
      subscription is highly probable and no significant Company obligations remain
      after the product has been delivered. The Company defers revenue recognition
      on
      training contracts related to payments received during the current period for
      the portion of the subscription contract that extends into future periods.
      At
      June 30, 2005 and September 30, 2004, no subscription contracts were paid in
      advance. In accordance with EITF 01-14, the Company’s reimbursable costs are
      recorded as gross revenue, with the actual costs recorded as a direct
      cost.





The
      Company’s internet sales are less than 0.5% of total revenue. Such internet
      transactions are recorded as training subscriptions and training is delivered
      via the hosted web sites of Vivid. The revenue is recorded when the training
      is
      delivered, when evidence of a persuasive arrangement exists, and when collection
      is reasonably assured.





The
      Company does not offer warranties or returns.





Royalty
      expenses


Reseller
      commissions or royalty payments are recorded as an expense if the Company bears
      the primary responsibility for the fulfillment of the underlying customer’s
      order and for the acceptance by the customer of the training services sold.
      Such
      costs paid to resellers are recorded as a reduction to the underlying selling
      price if the reseller is the primary obligor to the customer in the
      transaction.





14




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**





**NOTE
      3 - RELATED PARTY TRANSACTIONS**





The
      Company was awarded a three-year contract with a minimum value of $1,708,353
      with Fluor Hanford, Inc., a Nuvotec, Inc. shareholder, for the period from
      October 2002 to September 30, 2005. The Company provides computer-based training
      monthly for the employees of Fluor Hanford, Inc. and its contractors. The
      accounts receivable due from Fluor Hanford at June 30, 2005 and September 30,
      2004, was $20,646 and $59,035 respectively. Revenue from Fluor Hanford for
      the
      nine months ended June 30, 2005 and September 30, 2004 was $558,719 and
      $482,236, respectively.





At
      June
      30, 2005 and September 30, 2004, the recorded related party payable consisted
      of
      $1,000,000 and $772,025 of borrowing from the line of credit and $779,952 and
      $51,405 of management fees allocated and expenses paid on behalf of Vivid,
      by
      the majority shareholder, Nuvotec, Inc.




The
      total
      amount payable by Vivid on Nuvotec’s line of credit at June 30, 2005 and
      September 30, 2004 was $1,000,000 and $772,025, respectively. The portion of
      drawing on the line of credit attributed to Nuvotec as of June 30, 2005 and
      September 30, 2004 was $0 and $227,577, respectively, leaving $0 available
      for
      use by either company at June 30, 2005.








**NOTE
      4 - STOCKHOLDERS’ EQUITY**





The
      Company has authorized 5,000,000 shares of $0.0001 par value preferred stock,
      which may be issued in one or more series. The Company’s board of directors is
      also authorized to determine or alter the rights, preferences, privileges and
      restrictions granted to or imposed upon any series of preferred
      stock . At
      June
      30, 2005 and September 30, 2004, no preferred stock has been issued by the
      Company.





During
      the year ended September 30, 2004 the Company completed a private placement
      of
      1,987,996 common stock shares at $0.25 per share for total proceeds of $496,999
      less costs to issue of $74,200. In addition, the Company issued 10,000 shares
      of
      common stock for $2,500 as a gift to an employee’s family member. The Company
      has committed 100,000 shares of common stock with a value of $25,000 for the
      acquisition of ImageWorks.








**NOTE
      5 - STOCK-BASED COMPENSATION**





During
      2004, the Company issued to executives and employees a total of 816,334 common
      stock options, exercisable at $0.25 per share for four years and vesting at
      a
      rate of 25% per year. No expense was recorded at September 30, 2004 because
      none
      of the options were vested and the benefit period begins October 1, 2004. In
      October 2004, 191,583 options vested and the Company recorded compensation
      expense of $13,410. In addition, the Company issued 50,000 options for legal
      fees. The fair market value of these options is $7,500, which was recorded
      October 1, 2004 when the benefit period began.




15


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**


The
      fair
      value of each option granted under the Company’s 2003 Stock Option Plan is
      estimated on the grant date using the Black-Scholes Option Price Calculation. The
      following assumptions were made in estimating the fair value: risk-free interest
      is 4%; volatility is 0.3; and expected life is 4 years or 3 years.





The
      following is a summary of stock option activity:





Equity
                compensation plans not approved by shareholders
            
            Number
                of securities to be issued upon exercise of outstanding
                options
            
            Weighted-average
                exercise price of outstanding options
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans2003
                Stock Option Plan
            
            
            666,834
            
            $
            0.25
            
            
            1,683,166Total
            
            
            666,834
            
            
            
            
            
            1,683,166





Number
                of Shares Under Options
            
            Weighted
                Average Exercise PriceOutstanding
                at October 1, 2003
            
            
            —
            
            $
            —Granted
            
            
            866,334
            
            
            0.25Exercised
            
            
            —
            
            
            —Outstanding
                at September 30, 2004
            
            
            866,334
            
            $
            0.25Options
                exercisable at September 30, 2004
            
            
            —
            
            
            —Outstanding
                at September 30, 2004
            
            
            866,334
            
            
            0.25Expired
                or terminated options outstandingat
                June 30, 2005
            
            
            199,500
            
            
            0.25Outstanding
                at June 30, 2005
            
            
            666,834
            
            
            0.25Options
                exercisable at June 30, 2005
            
            
            —
            
            
            —






**NOTE
      6** - **ECONOMIC
      DEPENDENCY**





The
      Company provides services in Washington State to a dozen large corporate
      contractors within the framework of a diverse set of programs and tasks. Most
      of
      the funding for these services originates from the Department of Energy/ Federal
      Government. During the nine months ended June 30, 2005 and 2004, services
      provided to these contractors aggregated $569,965 and $726,182, **** representing20%
      and 21% of total revenue, respectively. At June 30, 2005 and 2004, amounts
      due
      from these contractors are included in accounts receivable in the amounts of
      $20,646 and $15,002, respectively.




16


**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2005**




The
      Company’s concentration risks for customer accounts receivable and revenues
      greater than 10% of the total account balances for the respective periods are
      as
      follows:





Nine Months
                EndingJune 30,2005
            
            Nine
                Months Ending June 30, 2004Revenues—Fluor
              Hanford
            
            $
            537,495
            
            $
            482,236Revenues—ERG
              (State
                of PA)
            
            $
            60,640
            
            $
            691,604Accounts
                Receivable
              Fluor
                Hanford
            
            $
            20,646
            
            $
            15,002Accounts
                Receivable
              ERG
                (State of PA)
            
            $
            326,725
            
            $
            278,113








**NOTE
      7 - COMMITMENTS AND CONTINGENCIES**





Commitments


The
      Company is obligated, under separate agreements, to make royalty payments based
      on varying percentages (8% to 25%) of cash collections from the sale of specific
      software applications. For the nine months ending June 30, 2005 and 2004, the
      Company incurred $20,021 and $45,541 in royalty obligations, respectively,
      which
      are recorded in marketing expense. At June 30, 2005 and September 30, 2004
      the
      Company accrued $11,720 and $10,997, respectively, in royalty obligations which
      are recorded in other current liabilities on the balance sheet.








**NOTE
      8 -** **SEGMENT
      INFORMATION**





The
      Company adopted Statement of Financial Accounting Standards No. 131,
      "Disclosures about Segments of an Enterprise and Related Information,"
      (hereinafter “SFAS No. 131”) **** during
      the year ended September 30, 2002. SFAS No. 131 established standards for
      reporting information about operating segments in annual financial statements
      and requires selected information about operating segments in interim financial
      reports issued to stockholders. It also established standards for related
      disclosures about products and services and geographic areas. Operating segments
      are defined as components of an enterprise about which separate financial
      information is available, evaluated regularly by the chief operating decision
      makers, or a decision making group, in deciding how to allocate resources and
      in
      assessing performance. The Company has three operating segments at June 30,
      2005
      and September 30, 2004: corporate training subscriptions; custom products and
      services; ImageWorks-related revenues.





17




**VIVID
      LEARNING SYSTEMS, INC.**


**CONDENSED
      NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**


**June
      30, 2005**







Segment
      information (after inter-company eliminations) for the nine months ended June
      30, 2005 and 2004 are as follows:




June
                    30,2005
              
              June
                    30,2004Revenues:Corporate
              
              $
              —
              
              $
              —Training
                  subscriptions
              
              
              1,818,910
              
              
              2,500,721Custom
                  products and services
              
              
              369,963
              
              
              794,781ImageWorks
              
              
              716,660
              
              
              123,866Total
                  Revenues
              
              $
              2,905,533
              
              $
              3,419,368Operatingincome
                  (loss):Corporate
              
              $
              (2,478,666
              )
              $
              (1,981,811
              )Training
                  subscriptions
              
              
              1,562,660
              
              
              2,278,980Custom
                  products and services
              
              
              (250,799
              )
              
              288,886ImageWorks
              
              
              415,768
              
              
              47,233Income
                  before income taxes
              
              $
              (751,037
              )
              $
              633,288




June
                  30, 2005
              
              June
                  30, 2004Identifiable
                  assets:Corporate
              
              $
              5,463,204
              
              $
              4,272,221Training
                  subscriptions
              
              
              —
              
              
              —Custom
                  products and services
              
              
              —
              
              
              —ImageWorks
              
              
              261,565
              
              
              169,275****Total
                  Identifiable Assets
              
              $
              5,724,769
              
              $
              4,441,496Depreciation
                  and amortization:Corporate
              
              $
              41,060
              
              $
              69,013Training
                  subscriptions
              
              
              —
              
              
              —Custom
                  products and services
              
              
              —
              
              
              —ImageWorks
              
              
              16,346
              
              
              —Total
                  Depreciation and Amortization
              
              $
              54,706
              
              $
              69,013




18


**VIVID
      LEARNING SYSTEMS, INC.**


**CONDENSED
      NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**


**June
      30, 2005**







Separate
      management of each segment is required because each business unit is subject
      to
      different marketing, production, and technology strategies.





Training
      subscriptions, the first reportable segment, derives revenues from the sale
      of
      computer-based safety training products and services throughout the United
      States. Custom products and services which is the second reportable segment,
      expects to derive its revenue from custom products and services designed
      specifically for the end user. ImageWorks, the third segment, derives its
      revenues from custom media products and services.








**NOTE
      9 - PURCHASE OF TRUEACTIVE SOFTWARE**





On
      March
      14, 2005, Vivid Learning Systems, Inc. entered into an asset purchase agreement
      with TrueActive Software, Inc., (“Seller”) a Washington corporation. Pursuant to
      the agreement, the Company purchased from the Seller intellectual property
      with
      respect to certain software and other assets including Seller’s customer
      database, accounts receivable, inventory and marketing materials. The
      consideration for the purchase of assets consists of $120,000 in cash, an
      interest free $120,000 one year promissory note with principal payments payable
      monthly beginning May, 2005, four year warrants to purchase 80,000 shares of
      the
      Company’s common stock at an exercise price of $1.00 per share vesting over two
      years, and a two year employment agreement with the president of the Seller.
      The
      agreement also provides for royalties of 8% of net sales of certain software
      products purchased and 4% of net sales on derivative software products for
      a
      period of three years. The original note balance of $120,000 has been paid
      down
      to $100,000 and is recorded in current and long-term liabilities at June 30,
      2005.





Effective
      July 1, 2005, Vivid transferred to Nuvotec (its majority shareholder) the
      TrueActive Software assets it was holding in addition to the attendant
      liabilities incurred from the original asset acquisition in March 2005. The
      asset transfer, made at Vivid’s original cost, was part of a corporate
      restructuring.




19





**ITEM
      2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**





**Results
      of Operations:**





**RESULTS
      OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2005 COMPARED WITH THREE MONTHS
      ENDED JUNE 30, 2004**





**Revenues:**





Overall
      revenues decreased 44% to $767,297 in the third quarter of fiscal year 2005
      from
      $1,362,341 in the third quarter of fiscal year 2004. The decrease was due to
      a
      reduction in training subscription revenues. Also, if the revenues attributable
      to subsidiary, ImageWorks Media Group, Inc. (“ImageWorks”) of $245,361 during
      the third quarter of fiscal 2005 are partially excluded for comparison purposes,
      which revenue stream was not fully available to the Company during the same
      quarter in 2004 because the subsidiary was not acquired until May, 2004, overall
      revenues decreased by 53% due to a reduction in both training subscription
      and
      custom products and services revenues.





Training
      subscription revenues decreased by 61% to $374,900 in the third quarter of
      fiscal year 2005 from $961,422 in the third quarter of fiscal year 2004 because
      of a reduction of revenue earned from a large east coast customer.





Custom
      products and services revenues decreased overall by 2% to $392,397 in the third
      quarter of fiscal year 2005 from $400,919 in the third quarter of fiscal year
      2004. However, custom products and services revenues decreased 63% to $147,036
      during the third quarter of fiscal year 2005 if the revenues from ImageWorks
      are
      excluded, because of the reduction of contracted federal custom work on the
      Hanford Site in Richland, WA from the Department of Energy and their
      subcontractors.





**Operating
      Expenses**





Cost
      of
      Revenues:





Overall,
      cost of revenues increased by 13% to $403,532 in the third quarter of fiscal
      year 2005 from $356,100 in the third quarter of fiscal year 2004. The increase
      is primarily due to a larger proportionate share of lower margin custom products
      and services revenues as compared to training subscription revenues in comparing
      the third quarter of fiscal 2005 to the third quarter of fiscal year 2004.
      Much
      of the increase in custom products and services direct expenses in the third
      quarter of fiscal year 2005 is attributable to the custom type of the revenues
      generated by the newly acquired subsidiary, ImageWorks, and technical assistance
      support expenses incurred in the delivery of custom projects.





Training
      subscription cost of revenues increased by 11% to $84,645 in the third quarter
      of fiscal year 2005 from $76,577 in the third quarter of fiscal year 2004.
      This
      increase is due to higher expenses incurred in the delivery of training
      subscription contracts sold.





20




Custom
      products and services cost of revenues increased by 14% to $318,887 in the
      third
      quarter of fiscal year 2005 from $279,523 in the third quarter of fiscal year
      2004. The increase is partially due to the new costs of revenue attributable
      to
      the ImageWorks operation of $112,998 in the third quarter of fiscal 2005. Also,
      significant expenses were incurred in building the infrastructure of the custom
      products and services operating segment, which had the effect of increasing
      the
      direct costs attributable to custom products and services revenues in the third
      quarter of fiscal year 2005. These infrastructure expenses included increased
      salaries of newly acquired production personnel and technical assistance support
      for custom projects.





Marketing/Reseller
      Commissions:





Marketing
      and reseller commission expenses decreased by 34% to $267,897 in the third
      quarter of fiscal year 2005 from $403,867 in the third quarter of fiscal year
      2004. The decrease is mainly attributable to the ongoing reduction in sales
      management employment related expenses and internal commissions paid to sales
      employees due to a restructuring of the commission compensation plan applicable
      to sales employees.





Depreciation
      and Amortization:





Depreciation
      and amortization decreased by 27% to $17,595 in the third quarter of fiscal
      year
      2005 from $24,030 in the third quarter of fiscal year 2004 due to an increase
      in
      fully depreciated assets in comparing the two quarters.





General
      and Administrative Expenses:





General
      and Administrative expenses increased by 51% to $453,020 in the third quarter
      of
      fiscal year 2005 from $300,821 in the third quarter of fiscal year 2004. The
      significant expense categories of increase in comparing the third quarters
      of
      fiscal year 2005 to 2004 are labor, professional fees, rents, and insurance.
      The
      labor increase ($230,242 in the third quarter of fiscal year 2005 compared
      to
      $128,414 in the third quarter of fiscal year 2004) is due to additional
      administrative labor support from newly acquired ImageWorks and the hiring
      of
      new employees, especially in management, to meet the internal administrative
      needs of a growing operation. The increase in professional fees ($58,849 in
      the
      third quarter of fiscal year 2005 compared to $28,647 in the third quarter
      of
      fiscal year 2004) is related to increasing auditing, board, and legal fees
      associated with becoming a publicly traded entity. The increase in rents
      ($55,518 in the third quarter of fiscal year 2005 compared to $28,268 in the
      third quarter of fiscal year 2004) is due to the expiration of rent abatement
      from the landlord, Port of Benton, in the current fiscal year, partially offset
      by new rents incurred attributable to ImageWorks. The increase in insurance
      (22%
      increase to $12,609 in the third quarter of fiscal year 2005 compared to $10,374
      in the third quarter of fiscal year 2004) is due to new premiums for directors
      and officers liability coverage and an overall increase in liability coverage
      requirements for becoming a publicly traded entity.





21




**Income
      from Operations**





Income
      from Operations decreased by $652,270 to ($374,747) in the third quarter of
      fiscal year 2005 from $277,523 in the third quarter of fiscal year 2004.
      Principally, the decrease is due to a reduction in training subscription
      revenues and increased direct and general and administrative expenses in the
      comparison of the two quarters.





**Other
      Income (Expense)**





The
      main
      increase in other expenses is attributable to interest expense on the line
      of
      credit in the third quarter of fiscal year 2005 compared to 2004. Interest
      expense on the line of credit was $15,027 in the quarter ended June 30, 2005
      compared to $914 in the quarter ended June 30, 2004. The line of credit was
      utilized more frequently to finance the timing of expenses incurred in the
      expansion of the operation in the third quarter of fiscal year 2005 compared
      to
      fiscal year 2004.





**Net
      Income (Loss)**





The
      operation sustained a loss of $257,182 in the third quarter of fiscal year
      2005
      compared to a profit of $181,774, or 13% of revenues, in the third quarter
      of
      fiscal year 2004. The decrease in net income of $438,956 is due to reductions
      in
      training subscription revenues and increased infrastructure expenses to meet
      the
      needs of an expanding operation partially offset by a federal income tax benefit
      related to the quarterly loss.





**Seasonality
      and Other Factors Affecting Quarterly Results**





The
      revenues of the Company normally fluctuate during the holiday season of the
      year. The October through December quarter is typically lower in revenues than
      the other quarters of the year due to less emphasis on training and fewer
      training courses delivered during this period by many of our clients. We expect
      quarterly fluctuations in operating results as a result of many factors
      including acquisitions and roll-out of new product offerings. The operating
      results for any quarter are not necessarily indicative of the results for any
      future period.





**Liquidity
      and Capital Resources**





Historically,
      the Company has financed its cash flow requirements through the management
      of
      its line of credit and cash generated from operations. As of June 30, 2005,
      the
      Company had cash and cash equivalents of $32,555 as compared to $49,451 as
      of
      September 30, 2004.





Cash
      flows provided by operating activities amounted to $440,872 in the third quarter
      of fiscal year 2005 compared to $52,671 in the same period of fiscal year 2004.
      The main reason for the increase is attributable to the decreases in accounts
      and contracts receivable and an increase in related party payables, partially
      offset by the net loss of $257,182 sustained by the Company in the third quarter
      of fiscal year 2005, in the comparison of the two quarters.





22




Cash
      flows used in investing activities decreased by $174,485 to $333,660 in the
      third quarter of fiscal year 2005 from $508,145 in the third quarter of fiscal
      year 2004. The decrease is attributable to lower expenditures related to the
      acquisition of software and internally developed software.





Cash
      flows used in financing activities increased by $56,850 to $75,000 in the third
      quarter of fiscal year 2005 compared to $18,150 in the third quarter of fiscal
      year 2004. The increase in the current year’s quarter ending June 30, 2005 is
      attributable to payments on notes payable to a related party in the current
      year’s quarter ending June 30, 2005.







**RESULTS
      OF OPERATIONS - NINE MONTHS ENDED JUNE 30, 2005 COMPARED WITH NINE MONTHS ENDED
      JUNE 30, 2004**





**Revenues:**





Overall
      revenues decreased 15% to $2,905,533 in the nine months year to date of fiscal
      year 2005 from $3,419,368 in the nine months year to date of fiscal year 2004.
      The decrease would have been larger if it were not due to the revenues
      attributable to newly acquired subsidiary, ImageWorks Media Group, Inc.
      (“ImageWorks”) of $716,660 during the nine months year to date of fiscal 2005,
      which revenue stream was first available to the Company in May, 2004 when the
      subsidiary was acquired. If the revenues from the subsidiary ImageWorks are
      excluded for comparison purposes, overall revenues decreased by 34% in comparing
      the nine months year to date of the two fiscal years.





Training
      subscription revenues decreased by 27% to $1,818,910 in the nine months year
      to
      date of fiscal year 2005 from $2,500,721 in the nine months year to date of
      fiscal year 2004 because of a decrease in subscription renewals and the loss
      of
      revenue attributable to a large east coast customer in the comparison of the
      year to date totals of the two fiscal years.





Custom
      products and services revenues increased overall by 18% to $1,086,623 in the
      nine months year to date of fiscal year 2005 from $918,647 in the nine months
      year to date of fiscal year 2004. However, custom products and services revenues
      decreased by 53% to $369,963 during the nine months year to date of fiscal
      year
      2005 compared to the same period in fiscal year 2004, if the revenues from
      ImageWorks are excluded, because of reduced custom revenue earned from a large
      east coast customer, and the reduction of contracted federal custom work on
      the
      Hanford Site in Richland, WA from the Department of Energy and their
      subcontractors.





23





**Operating
      Expenses**





Cost
      of
      Revenues:





Overall,
      cost of revenues increased by 46% to $1,177,904 in the nine months year to
      date
      of fiscal year 2005 from $804,269 in the nine months year to date of fiscal
      year
      2004. The increase is due to a larger proportionate share of lower margin custom
      products and services revenues as compared to training subscription revenues
      in
      comparing the nine months year to date of fiscal 2005 with the same period
      in
      fiscal year 2004. Much of the proportionate increase in custom products and
      services revenue in the nine months year to date of fiscal year 2005 is
      attributable to the newly acquired subsidiary, ImageWorks.





Training
      subscription cost of revenues increased by 16% to $256,250 in the nine months
      year to date of fiscal year 2005 from $221,741 in the nine months ended June
      30,
      2004. This increase is due to higher direct expenses incurred in the delivery
      of
      training subscription contracts sold.





Custom
      products and services cost of revenues increased by 58% to $921,654 in the
      nine
      months year to date of fiscal year 2005 from $582,528 in the nine months ended
      June 30,, 2004. The increase is partially due to the new costs of revenue
      attributable to the ImageWorks operation of $300,892 in the nine months year
      to
      date of fiscal 2005. Also, significant expenses were incurred in building the
      infrastructure of the custom products and services operating segment, which
      had
      the effect of increasing the direct costs attributable to custom products and
      services revenues in the nine months year to date of fiscal year 2005. These
      infrastructure expenses included increased salaries of newly acquired production
      personnel and technical assistance support for custom projects.





Marketing/Reseller
      Commissions:





Marketing
      and reseller commission expenses decreased by 20% to $931,337 in the nine months
      year to date of fiscal year 2005 from $1,168,646 in the nine months year to
      date
      of fiscal year 2004. The decrease is mainly attributable to a 26% reduction
      in
      internal and external sales commissions to $314,772 in the nine months year
      to
      date of fiscal year 2005 from $423,670 in the same comparable period of fiscal
      year 2004. Also, a reduction in sales management and staff employment related
      expenses due to a restructuring of the commission compensation plan applicable
      to sales employees contributed to the decrease in comparing the two
      periods.





Depreciation
      and Amortization:





Depreciation
      and amortization decreased by 21% to $54,706 in the nine months to date of
      fiscal year 2005 from $69,013 in the comparable period of fiscal year 2004
      due
      to an increase in fully depreciated assets in comparing the two
      quarters.





24





General
      and Administrative Expenses:





General
      and Administrative expenses increased by 96% to $1,454,017 in the nine months
      year to date of fiscal year 2005 from $740,549 in the nine months year to date
      of fiscal year 2004. The significant expense categories of increase in comparing
      the nine months year to date of fiscal year 2005 to 2004 are labor, professional
      fees, rents, and insurance. The labor increase ($670,789 in the nine month
      year
      to date of fiscal year 2005 compared to $345,770 in the same period of fiscal
      year 2004) is due to additional administrative labor support from newly acquired
      ImageWorks, and the hiring of new employees, especially in management, to meet
      the internal administrative needs of a growing operation. The increase in
      professional fees ($183,937 in the nine months year to date of fiscal year
      2005
      compared to $62,460 in the same period of fiscal year 2004) is related to
      increasing auditing, board, and legal fees associated with becoming a publicly
      traded entity. The increase in rents ($171,529 in the nine months year to date
      of fiscal year 2005 compared to $55,230 in the same period of fiscal year 2004)
      is due mainly to the expiration of rent abatement from the landlord, Port of
      Benton, in the current fiscal year. The increase in insurance (62% increase
      to
      $39,259 in the nine months year to date of fiscal year 2005 compared to $24,200
      in the same period of fiscal year 2004) is due to new premiums for directors
      and
      officers liability coverage and an overall increase in liability coverage
      requirements for becoming a publicly traded entity.





**Income
      from Operations**





Income
      from Operations decreased by $1,349,322 to ($712,431) in the nine months year
      to
      date of fiscal year 2005 from $636,891 in the nine months year to date of fiscal
      year 2004. Principally, the decrease is due to reductions in training
      subscription revenues and increased direct and general and administrative
      expenses in the comparison of the nine months year to date of the two fiscal
      years.





**Other
      Income (Expense)**





The
      main
      increase in other expenses is attributable to interest expense on the line
      of
      credit in the nine months year to date of fiscal year 2005 compared to 2004.
      Interest expense on the line of credit was $39,142 in the nine months ended
      June
      30, 2005 compared to $4,760 in the nine months ended June 30, 2004. The line
      of
      credit was utilized more frequently to finance the timing of expenses incurred
      in the combination of the losses sustained by the operation and the expansion
      of
      the operation in the nine months year to date of the current fiscal year
      compared to the same period in fiscal year 2004.





**Net
      Income (Loss)**





The
      operation sustained a loss of $495,685 in the nine months year to date of fiscal
      year 2005 compared to a profit of $415,111, or 12% of revenues, in the nine
      months year to date of fiscal year 2004. The decrease in net income of $910,796
      is due to reductions in training subscription revenues and increased
      infrastructure expenses to meet the needs of an expanding operation partially
      offset by a federal income tax benefit related to the nine months year to date
      loss.





**Liquidity
      and Capital Resources**





Historically,
      the Company has financed its cash flow requirements through the management
      of
      its line of credit and cash generated from operations.





25




Cash
      flows provided by operating activities amounted to $634,179 in the nine months
      year to date of fiscal year 2005 compared to $385,787 in the same period of
      fiscal year 2004. The main reasons for the increase are attributable to
      decreases in accounts and contracts receivable, and an increase in related
      party
      payables, partially offset by the net loss of $495,685 sustained by the Company
      in the nine months year to date of fiscal year 2005 in the comparison of the
      same period of the two fiscal years.





Cash
      flows used in investing activities decreased by $114,628 to $679,050 in the
      nine
      months year to date of fiscal year 2005 from $793,678 in the nine months year
      to
      date of fiscal year 2004. The decrease is mainly attributable to lower
      expenditures related to the acquisition of software and internally developed
      software.





Cash
      flows provided by financing activities decreased by $394,824 to $27,975 in
      the
      nine months year to date of fiscal year 2005 compared to $422,799 in the nine
      months year to date of fiscal year 2004. The decrease in the current year’s nine
      month period ending June 30, 2005 is attributable to collections from the
      private placement in the previous year’s nine month period ending June 30,
      2004.





The
      Company believes that equity/debt financing together with cash generated by
      operations are required to achieve market objectives in terms of timeliness
      into
      the market and market share. If cash generated from operations is insufficient
      to satisfy our liquidity requirements and the Company is unable to raise needed
      equity/debt funds on acceptable terms or at all the Company may not be able
      to
      develop or enhance its products, take advantage of future opportunities, or
      respond to competitive pressures. A material shortage of capital may require
      the
      Company to take steps such as reducing its level of operations, disposing of
      selected assets, or seeking an acquisition partner. ****





**ITEM
      3. CONTROLS AND PROCEDURES**





Our
      chief
      executive officer and chief financial officer evaluated the effectiveness of
      our
      disclosure controls and procedures (as defined in Rule 13a-14(c) under the
      Securities Exchange Act of 1934) as of the end of the three month and nine
      months to date periods ended June 30, 2005. Based on this evaluation, our chief
      executive officer and chief financial officer have concluded that our controls
      and procedures are effective in providing reasonable assurance that the
      information required to be disclosed in this report is accurate and complete
      and
      has been recorded, processed, summarized and reported within the time period
      required for the filing of this report. Subsequent to the date of this
      evaluation, there have not been any significant changes in our internal controls
      or, to our knowledge, in other factors that could significantly affect our
      internal controls.





26





**PART
      II - OTHER INFORMATION**





**ITEM
      6.****EXHIBITS.**





(a)  Exhibits





The
      following exhibits are filed as a part of this report on Form 10-QSB:





**Exhibit
                No.**
            
            **Description**31.1
            
            Rule
                13(a)-14(a)/15(d)-14(a) Certification of Chief Executive
                Officer31.2
            
            Rule
                13(a)-14(a)/15(d)-14(a) Certification of Chief Financial
                Officer32.1
            
            Rule
                1350 Certification of Chief Executive Officer32.2
            
            Rule
                1350 Certification of Chief Financial
                Officer




27


**SIGNATURES**




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


Vivid
                  Learning Systems, Inc.Dated: August
                15, 2005
              By:
              /s/ Robert
                L. FergusonRobert
                  L. FergusonChairman
                  andChief
                  Executive
                  Officer