UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





x
              QUARTERLY REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
quarterly period ended December 31, 2008





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF
      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
              
              42-1623500(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (I.R.S.
      Employer Identification No.)





5728
Bedford Street


Pasco,
WA  99301


(Address
of principal executive offices, including zip code)





(509)
545-1800


(Registrant's
telephone number, including area code)





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 that 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 is a large accelerated file, an accelerated
filer, a non-accelerated filer, or a smaller reporting company.





Large
      accelerated filer  ̈
              Accelerated
      filer  ̈
              Non-accelerated
      filer  ̈
              Smaller
      reporting company x





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes  ̈No x





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date:





Common
      Stock, $0.0001 par value
                
                13,272,165(Class)
                
                Outstanding
      as of February 12, 2009





VIVID
LEARNING SYSTEMS, INC.


INDEX





PagePART
      I – FINANCIAL INFORMATIONItem
      1
                Financial
      Statements
                3Consolidated
      Balance Sheets as of December 31, 2008 (unaudited) and September 30,
      2008
                3Consolidated
      Statements of Income for the three months ended December 31,
      2008  and December 31, 2007 (unaudited)
                4Consolidated
      Statements of Cash Flows for the three months ended December 31,
      2008  and December 31, 2007 (unaudited)
                5Condensed
      Notes to Unaudited Consolidated Financial Statements
                6Item
      2
                Management’s
      Discussion And Analysis Of Financial Condition And Results Of
      Operations
                17Item
      3
                Quantitative
      and Qualitative Disclosures About Market Risk
                *Item
      4T
                Controls
      and Procedures
                19PART
      II – OTHER INFORMATIONItem
      1
                Legal
      Proceedings
                *Item
      1A
                Risk
      Factors
                *Item
      2
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                *Item
      3
                Defaults
      Upon Senior Securities
                *Item
      4
                Submission
      of Matters to a Vote of Security Holders
                *Item
      5
                Other
      Information
                *Item
      6
                Exhibits
                19SIGNATURES
                20





*  No
information provided due to inapplicability of the item.


2





PART
I – FINANCIAL INFORMATION / ITEM 1 – FINANCIAL STATEMENTS




VIVID
LEARNING SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS





December 31,2008
                    
                    
                    September 30,(unaudited)
                    
                    
                    2008ASSETSCURRENT
      ASSETSCash
                    
                    $
                    457,896
                    
                    
                    $
                    132,391Accounts
      and contracts receivable
                    
                    
                    1,276,066
                    
                    
                    
                    972,151Accounts
      and contracts receivable, Fluor Hanford
                    
                    
                    970
                    
                    
                    
                    24,994Prepaid
      expenses
                    
                    
                    214,142
                    
                    
                    
                    185,793Other
      current assets
                    
                    
                    165,262
                    
                    
                    
                    138,214TOTAL
      CURRENT ASSETS
                    
                    
                    2,114,336
                    
                    
                    
                    1,453,543PROPERTY,
      PLANT AND EQUIPMENTProperty
      and equipment
                    
                    
                    1,604,379
                    
                    
                    
                    1,583,630Less:
      Accumulated depreciation
                    
                    
                    (1,275,577
                    )
                    
                    
                    (1,247,676
                    )TOTAL
      PROPERTY, PLANT AND EQUIPMENT
                    
                    
                    328,802
                    
                    
                    
                    335,954OTHER
      ASSETSSoftware,
      net of amortization
                    
                    
                    1,253,517
                    
                    
                    
                    1,229,722Goodwill
                    
                    
                    375,000
                    
                    
                    
                    375,000Long-term
      contracts receivable
                    
                    
                    -
                    
                    
                    
                    1,321Deferred
      tax asset
                    
                    
                    551,118
                    
                    
                    
                    665,596TOTAL
      OTHER ASSETS
                    
                    
                    2,179,635
                    
                    
                    
                    2,271,639TOTAL
      ASSETS
                    
                    $
                    4,622,773
                    
                    
                    $
                    4,061,136LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable
                    
                    $
                    122,623
                    
                    
                    $
                    120,807Accrued
      contract labor
                    
                    
                    110,060
                    
                    
                    
                    100,933Other
      current liabilities
                    
                    
                    74,841
                    
                    
                    
                    46,811Unearned
      revenue
                    
                    
                    228,950
                    
                    
                    
                    100,518Notes
      payable, related parties
                    
                    
                    -
                    
                    
                    
                    25,000Current
      portion of long-term liabilities
                    
                    
                    208,881
                    
                    
                    
                    108,341TOTAL
      CURRENT LIABILITIES
                    
                    
                    745,355
                    
                    
                    
                    502,410LONG-TERM
      LIABILITIESLong-term
      debt
                    
                    
                    269,132
                    
                    
                    
                    134,095Other
      long-term liabilities
                    
                    
                    103,138
                    
                    
                    
                    116,709TOTAL
      LONG-TERM LIABILITIES
                    
                    
                    372,270
                    
                    
                    
                    250,804TOTAL
      LIABILITIES
                    
                    
                    1,117,625
                    
                    
                    
                    753,214COMMITMENTS
      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, 13,272,165 and 13,372,203 shares issued and
      outstanding, respectively
                    
                    
                    1,337
                    
                    
                    
                    1,337Additional
      paid-in capital
                    
                    
                    4,383,564
                    
                    
                    
                    4,408,564Accumulated
      deficit
                    
                    
                    (879,753
                    )
                    
                    
                    (1,101,979
                    )TOTAL
      STOCKHOLDERS'  EQUITY
                    
                    
                    3,505,148
                    
                    
                    
                    3,307,922TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                    
                    $
                    4,622,773
                    
                    
                    $
                    4,061,136





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


3





VIVID LEARNING SYSTEMS, INC.


CONSOLIDATED
STATEMENTS OF INCOME








Three
      Months
                          
                          
                          Three
      MonthsEnded
                          
                          
                          EndedDecember
      31, 2008
                          
                          
                          December
      31, 2007(unaudited)
                          
                          
                          (unaudited)REVENUESTraining
      subscriptions
                          
                          $
                          886,738
                          
                          
                          $
                          751,508Training
      subscriptions, Fluor Hanford
                          
                          
                          139,709
                          
                          
                          
                          138,332Custom
      products and services
                          
                          
                          664,492
                          
                          
                          
                          397,487Custom
      products and services, Fluor Hanford
                          
                          
                          5,371
                          
                          
                          
                          17,0571,696,310
                          
                          
                          
                          1,304,384COST
      OF REVENUESTraining
      subscriptions
                          
                          
                          210,637
                          
                          
                          
                          252,429Custom
      products and services
                          
                          
                          431,214
                          
                          
                          
                          295,449641,851
                          
                          
                          
                          547,878GROSS
      PROFIT
                          
                          
                          1,054,459
                          
                          
                          
                          756,506EXPENSESMarketing
      and related labor expenses
                          
                          
                          319,839
                          
                          
                          
                          265,023Bad
      debt expense
                          
                          
                          -
                          
                          
                          
                          2,038Reseller
      commissions
                          
                          
                          121,630
                          
                          
                          
                          44,502Depreciation
      and amortization
                          
                          
                          27,901
                          
                          
                          
                          24,780Wages
      and contract labor
                          
                          
                          105,387
                          
                          
                          
                          114,981Other
      operating expenses
                          
                          
                          134,495
                          
                          
                          
                          102,284TOTAL
      OPERATING EXPENSES
                          
                          
                          709,252
                          
                          
                          
                          553,608INCOME
      (LOSS) FROM OPERATIONS
                          
                          
                          345,207
                          
                          
                          
                          202,898OTHER
      INCOME (EXPENSE)Interest
      income
                          
                          
                          286
                          
                          
                          
                          807Interest
      expense
                          
                          
                          (8,789
                          )
                          
                          
                          (6,289
                          )TOTAL
      OTHER INCOME (EXPENSE)
                          
                          
                          (8,503
                          )
                          
                          
                          (5,482
                          )INCOME
      BEFORE INCOME TAXES
                          
                          
                          336,704
                          
                          
                          
                          197,416INCOME
      TAX EXPENSE
                          
                          
                          114,478
                          
                          
                          
                          67,096NET
      INCOME
                          
                          $
                          222,226
                          
                          
                          $
                          130,320BASIC
      NET INCOME PER COMMON SHARE
                          
                          $
                          0.02
                          
                          
                          $
                          0.01DILUTED
      NET INCOME PER COMMON SHARE
                          
                          $
                          0.02
                          
                          
                          $
                          0.01WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:BASIC
                          
                          
                          13,297,440
                          
                          
                          
                          13,372,165DILUTED
                          
                          
                          13,297,440
                          
                          
                          
                          13,372,165





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


4





VIVID LEARNING SYSTEMS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS








Three Months
                
                
                Three MonthsEnded
                
                
                EndedDecember 31, 2008
                
                
                December 31, 2007(unaudited)
                
                
                (unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
                
                $
                222,226
                
                
                $
                130,320Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                27,901
                
                
                
                24,780Amortization
      of capitalized software
                
                
                68,424
                
                
                
                68,424Bad
      debt expense
                
                
                -
                
                
                
                2,038Options
      issued for compensation
                
                
                -
                
                
                
                5,743Changes
      in assets and liabilities:Accounts
      and contracts receivable
                
                
                (279,891
                )
                
                
                318,959Prepaid
      expenses
                
                
                (28,349
                )
                
                
                (39,927
                )Other
      current assets
                
                
                (27,048
                )
                
                
                (173,217
                )Deferred
      tax asset
                
                
                114,478
                
                
                
                67,096Accounts
      payable
                
                
                1,816
                
                
                
                (121,172
                )Accrued
      contract labor and related expenses
                
                
                9,127
                
                
                
                (92,592
                )Long-term
      receivable contracts
                
                
                1,321
                
                
                
                40,229Other
      current liabilities
                
                
                28,030
                
                
                
                (16,192
                )Unearned
      revenue
                
                
                128,432
                
                
                
                (42,702
                )Net
      cash provided by operating activities
                
                
                266,467
                
                
                
                171,787CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisition
      of property, equipment and intangible assets
                
                
                (20,749
                )
                
                
                (12,399
                )Acquisition
      of software
                
                
                (92,220
                )
                
                
                (20,695
                )Net
      cash used by investing activities
                
                
                (112,969
                )
                
                
                (33,094
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Payments
      on notes payable, related party
                
                
                (25,000
                )
                
                
                -Treasury
      Stock
                
                
                (25,000
                )
                
                
                -Payments
      on line of credit payable
                
                
                -
                
                
                
                (57,072
                )Proceeds
      from term loan
                
                
                250,000
                
                
                
                -Payments
      on long-term debt
                
                
                (13,581
                )
                
                
                (12,744
                )Payments
      on long-term liabilities
                
                
                (14,412
                )
                
                
                (5,741
                )Net
      cash provided (used) by financing activities
                
                
                172,007
                
                
                
                (75,557
                )Net
      increase (decrease) in cash
                
                
                325,505
                
                
                
                63,136Cash
      at beginning of period
                
                
                132,391
                
                
                
                80,331Cash
      at end of period
                
                $
                457,896
                
                
                $
                143,467SUPPLEMENTAL
      CASH FLOW INFORMATION:Interest
      paid
                
                $
                8,789
                
                
                
                6,289Income
      taxes paid
                
                $
                -
                
                
                $
                -NON-CASH
      TRANSACTIONS:Options
      issued as compensation
                
                $
                -
                
                
                $
                5,743





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


5


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





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, Inc. and then
later known as 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 (the “Company” or “Vivid
Delaware”) serves as the holding company and parent and sole shareholder of the
operating entity Vivid Washington.  An additional 1,987,996 shares 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.  Vivid Delaware and its subsidiaries,
Vivid Washington and ImageWorks Digital Media, Inc., have a year end of
September 30.





Nuvotec
prior to June 13, 2007 held approximately 83% of the Company.  On June
13, 2007, Nuvotec closed on an acquisition transaction wherein one of the
conditions to closing was that the shares of the Company were to be distributed
on a pro-rata basis to the Nuvotec shareholders according to the Agreement and
Plan of Distribution.  Due to rounding, 38 shares that had been held
by Nuvotec were retired as treasury shares.  The shares in common
stock of the Company were distributed to approximately 300
individuals.  The effective date of the transaction, June 13, 2007,
resulted in the change of control of the Company.  No individual who
received the distribution from Nuvotec was given a controlling interest in the
Company.  There was no consideration as this was a Nuvotec shareholder
tax-free distribution.





Basis of
Presentation


The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q 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.  These unaudited interim
financial statements should be read in conjunction with the audited financial
statements for the period ended September 30, 2008 included in the Company’s
annual report on Form 10-KSB/A which was filed with the SEC on December 30,
2008.  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 three
months ended December 31, 2008 are not necessarily indicative of the results
that may be expected for the fiscal year ending September 30,
2009.  For further information, refer to the Company’s consolidated
audited financial statements at September 30, 2008 and footnotes
thereto.


6


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





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.





Recent
Pronouncements





Hierarchy of Generally
Accepted Accounting Principles


In May,
2008, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 162, “The Hierarchy of Generally Accepted Accounting
Principles” (SFAS No. 162). This Statement identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy). The sources of accounting principles1
that are generally accepted are categorized in descending order of authority as
follows:





a. FASB
Statements of Financial Accounting Standards and Interpretations, FASB Statement
133 Implementation Issues, FASB Staff Positions, and American Institute of
Certified Public Accountants (AICPA) Accounting Research Bulletins and
Accounting Principles Board Opinions that are not superseded by actions of the
FASB





b. FASB
Technical Bulletins and, if cleared2 by the FASB, AICPA Industry Audit and
Accounting Guides and Statements of Position





c. AICPA
Accounting Standards Executive Committee Practice Bulletins that have been
cleared by the FASB, consensus positions of the FASB Emerging Issues Task Force
(EITF), and the Topics discussed in Appendix D of EITF Abstracts(EITF
D-Topics)





d.
Implementation guides (Q&As) published by the FASB staff, AICPA Accounting
Interpretations, AICPA Industry Audit and Accounting Guides and Statements of
Position not cleared by the FASB, and practices that are widely recognized and
prevalent either generally or in the industry.





The
adoption of this statement will have no material effect on the Company’s
financial condition or results of operations.





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 and ImageWorks Media Group,
Inc.


7


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





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 (loss) available to common shareholders by the
weighted average common shares outstanding for the period.





Fair Value
Measurement


On April
1, 2008, the Company adopted the provisions of SFAS No. 157 related to its
financial assets and liabilities measured at fair value on a recurring
basis.  SFAS No. 157 establishes a fair value hierarchy that
prioritizes the inputs used to measure fair value. The hierarchy gives the
highest priority to unadjusted quoted prices in active markets for identical
assets or liabilities (Level 1 measurement) and the lowest priority to
unobservable inputs (Level 3 measurement).




The three
levels of the fair value hierarchy defined by SFAS No. 157 are as
follows:




Level 1 – Quoted prices are
available in active markets for identical assets or liabilities. Active markets
are those in which transactions for the asset or liability occur with sufficient
frequency and volume to provide pricing information on an ongoing
basis.




Level 2 – Pricing inputs are
other than quoted prices in active markets included in Level 1, which are either
directly or indirectly observable as of the reporting date. Level 2 includes
those financial instruments that are valued using models or other valuation
methodologies. These models are primarily industry-standard models that consider
various assumptions, including quoted forward prices for commodities, time
value, volatility factors, and current market and contractual prices for the
underlying instruments, as well as other relevant economic measures.
Substantially all of these assumptions are observable in the marketplace
throughout the full term of the instrument, can be derived from observable data
or are supported by observable levels at which transactions are executed in the
marketplace.




Level 3 – Pricing inputs
include significant inputs that are generally unobservable from objective
sources. These inputs may be used with internally developed methodologies that
result in management’s best estimate of fair value. Level 3 instruments include
those that may be more structured or otherwise tailored to the Company’s
needs.




As
required by SFAS No. 157, financial assets and liabilities are classified
in their entirety based on the lowest level of input that is significant to the
fair value measurement.  The Company’s assessment of the significance
of a particular input to the fair value measurement requires judgment, and may
affect the valuation of fair value assets and liabilities and their placement
within the fair value hierarchy levels.





There
were no money market accounts or investments in equity securities requiring
disclosure by level within the fair value of Company assets and liabilities
measured and reported on the Consolidated Balance Sheet as of December 31, 2008
at fair value on a recurring basis.


8





VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





On
December 14, 2007 the FASB issued a proposed FASB staff position ("FSP")
that would amend SFAS 157 to delay its effective date for all non-financial
assets and non-financial liabilities, except for those that are recognized or
disclosed at fair value in the financial statements on a recurring basis, that
is, at least annually.  For items within the scope of the proposed FSP
the effective date of SFAS 157 would be delayed to fiscal years beginning
after November 15, 2008 (fiscal 2010 for the Company) and interim periods
within those fiscal years. During February 2008, the FASB confirmed and made
effective the FSP.  The Company has chosen not to implement SFAS 157
for non-financial assets and non-financial liabilities at this
time.





Provision for
Taxes


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.





Reclassifications


Certain
prior year amounts in the accompanying financial statements have been
reclassified to conform to the fiscal year 2009 presentation.  The
reclassifications have no effect on net assets, net revenues, or net
earnings.





Reseller Commissions and
Royalty Expenses


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 of
between five and fifty percent of net revenue depending upon their annual sales
levels and other criteria, which is 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.





Expenses
paid to resellers are recorded as a reduction of 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 the resellers’ 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.





Royalty
payments are recorded as an expense if the ownership of the training content
does not reside with the Company.





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.


9


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





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 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 lesson content by lesson content
basis.  Net realizable value of each course is determined by comparing
the unamortized cost of each developed software course and the remaining
available market (quantified by dollars) for that content in the industry in
which Vivid Washington is selling the content.  This unamortized
software development cost is then aggregated by course and a grand total is
compared to the total remaining available aggregate market for the content to
determine if a write-down is required.





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





December 31,
                    2008
                  
                  
                  September30,
                    2008Software
      development costs
                  
                  $
                  3,846,783
                  
                  
                  $
                  3,754,564Accumulated
      amortization
                  
                  
                  (2,593,266
                  )
                  
                  
                  (2,524,842
                  )$
                  1,253,517
                  
                  
                  $
                  1,229,722





The
amount of software costs written down to net realizable value was zero during
the three months ended December 31, 2008 and 2007, respectively.





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.





Revenue and Cost
Recognition


The
Company’s custom products and services contracts are contracted primarily on a
fixed unit rate basis, with underlying hourly billing rates negotiated with the
customer.  The contract revenues are earned as hours are expended and
reimbursable costs are incurred.


10


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





Training
revenues are recognized at the time of shipment of products or performance of
contracted services.  Products are shipped FOB shipping
point.  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 December 31, 2008 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.  Internet transactions are recorded as training
subscriptions, with training delivered via the hosted web sites of Vivid
Washington.  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.





NOTE
3 – RELATED PARTY TRANSACTIONS





At
December 31, 2008 and September 30, 2008, the current related party payables
consisted of $0 and $25,000, respectively, of current amounts due to the former
owners of ImageWorks.





NOTE
4 – STOCKHOLDERS’ EQUITY





Preferred
Stock


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 December 31 and September 30, 2008, no preferred stock has
been issued by the Company.





On May 1,
2004, the Company acquired ImageWorks Digital Media Group, Inc. (ImageWorks)
through a share exchange agreement with the former owners. The Company issued as
part of the original acquisition 100,000 shares of the Company’s common stock to
the former owners of ImageWorks.  The share exchange agreement
provided that if said shares did not achieve a certain public market value as of
May 24, 2008, the former owners would have the option to request a buyback of
the shares from the Company.  At the request of the former owners the
share certificates were returned to the Company on October 24, 2008 as treasury
stock in exchange for full payment of the buyback amount.





NOTE
5 – STOCK-BASED COMPENSATION





During
the year ended September 30, 2007, 225,250 options vested which had been issued
in 2004 and had a fair value of $36,040.  During the year ended
September 30, 2008, 34,564 options vested which had been issued in 2004 and had
a fair value of $5,743.


11





VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





Options
issued in 2004 and 2005 were originally valued at approximately $0.16 per option
using the Black-Scholes Option Price Calculation.  As of September 30,
2008 a total of 323,511 of these options had vested and had a fair value of
$51,762.  During the year ended September 30, 2008, 44,069 options
vested which had been issued in 2005 and had a fair value of
$7,051.  The following assumptions were made in estimating the fair
value:  risk-free interest is 3%, volatility is 0.3, and expected life
is seven years.





During
the year ended September 30, 2006, additional options totaling 153,606 were
issued of which 65,939 vested and had a fair value of $32,777.  During
the year ended September 30, 2007, 10,939 of these options vested and had a fair
value of $4,525.  During the year ended September 30, 2008, a total of
10,939 of these options vested and had a fair value of $4,525. The fair value of
each option granted 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 4.75%; volatility is
101.36%; expected life is three to six years, and with no effective dividend
yield.





During
the year ended September 30, 2007, additional options totaling 89,500 were
issued and had a fair value of $19,730.  During the year ended
September 30, 2008, a total of 29,333 of these options vested and had a fair
value of $6,770.  The assumptions made in estimating the fair value
included an annual risk-free interest rate of 4.75%, volatility of 101.11%,
expected life of six years, and with no effective dividend yield.





During
the year ended September 30, 2008, additional options totaling 69,740 were
issued and had a fair value of $6,734.  During the year ended
September 30, 2008, none of these options vested.  The assumptions
made in estimating the fair value included an annual risk-free interest rate of
4.75%, volatility of 39.32%, expected life of six years, and with no effective
dividend yield.





None of
the issued options expired or vested during the three months ended December 31,
2008.





The
following is a summary of stock option activity:





Equity compensation
                    plans approved by
                    shareholders
                  
                  Number of
                    shares to be
                    issued upon
                    exercise of
                    outstanding
                    options
                  
                  
                  Weighted-average
                    exercise price
                    of outstanding
                    options
                  
                  
                  Number of shares
                    remaining
                    available for future
                    issuance under
                    equity
                    compensation
                    plans2003 Stock Option
      Plan
                  
                  
                  581,638
                  
                  
                  $
                  0.33
                  
                  
                  
                  1,734,862




12


VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





Number of
                                Shares
                              
                              
                              Weighted
                                Average Exercise
                                PriceOutstanding
      at October 1, 2006
                              
                              
                              570,940
                              
                              
                              $
                              0.33Granted
                              
                              
                              89,500
                              
                              
                              
                              0.29Exercised
                              
                              
                              (125
                              )
                              
                              
                              0.25Expired
      or terminated
                              
                              
                              (144,417
                              )
                              
                              
                              0.25Outstanding
      at September 30, 2007
                              
                              
                              515,898
                              
                              
                              $
                              0.34Options
      exercisable at September 30, 2007
                              
                              
                              304,265
                              
                              
                              $
                              0.33Outstanding
      at October 1, 2007
                              
                              
                              515,898
                              
                              
                              $
                              0.34Granted
                              
                              
                              69,740
                              
                              
                              
                              0.23Exercised
                              
                              
                              -
                              
                              
                              
                              -Expired
      or terminated
                              
                              
                              (4,000
                              )
                              
                              
                              0.29Outstanding
      at September 30, 2008
                              
                              
                              581,638
                              
                              
                              $
                              0.33Options
      exercisable at September 30, 2008
                              
                              
                              382,128
                              
                              
                              $
                              0.31Outstanding
      at October 1, 2008
                              
                              
                              581,638
                              
                              
                              $
                              0.33Granted
                              
                              
                              -
                              
                              
                              
                              -Exercised
                              
                              
                              -
                              
                              
                              
                              -Expired
      or terminated
                              
                              
                              -
                              
                              
                              
                              -Outstanding
      at December 31, 2008
                              
                              
                              581,638
                              
                              
                              $
                              0.33Options
      exercisable at December 31, 2008
                              
                              
                              382,128
                              
                              
                              $
                              0.31





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 three months
ended December 31, 2008 and 2007, services provided to these contractors
aggregated $224,444 and $213,084, representing 13% and 16% of total revenue,
respectively.





At
December 31, 2008 and 2007, amounts due from these contractors are included in
accounts receivable in the amounts of $37,085 and $44,349,
respectively.





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





Three
      Months EndingDecember 31,2008
                  
                  
                  2007Revenues—Fluor
                    Hanford
                  
                  $
                  145,079
                  
                  
                  $
                  155,389Accounts
      Receivable
                    Fluor
      Hanford
                  
                  $
                  970
                  
                  
                  $
                  5,276Revenues—Key
                    Technology
                  
                  $
                  288,613
                  
                  
                  $
                  -Accounts
      Receivable
                    Key
      Technology
                  
                  $
                  116,409
                  
                  
                  $
                  -




13





VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





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 three months ending December 31, 2008 and 2007,
the Company incurred $20,283 and $10,490 in royalty obligations, respectively,
which are recorded in marketing expense.  At December 31, 2008 and
2007, there were no incurred royalty obligations to be accrued and recorded in
other current liabilities on the balance sheet.





NOTE
8 – BANK FINANCING





The Company secured a line of credit
facility on December 22, 2008 with Wells Fargo Bank, N.A.  The line
has a maximum credit facility of $250,000 and an initial annual interest rate of
4.25%.  The rate is a variable rate tied to the bank’s prime rate plus
one, and is subject to an annual pricing adjustment.  The availability
period is subject to renewal on January 10, 2010.  The previous line
of credit facility with Bank of the West has been paid in full and is no longer
in effect.  The Company offers its assets as collateral as described
in an executed commercial security agreement.





The
Company secured a $250,000 promissory note on December 22, 2008 with Wells Fargo
Bank, N.A.  The term of the note is two years payable monthly at
$11,079 starting February 10, 2009 including annual interest of 5.9%.The final payment on the
note is January 10, 2011.  The Company offers its assets as collateral
as described in an executed commercial security agreement.





NOTE
9 – SEGMENT INFORMATION





The
Company has two operating segments at December 31, 2008: training subscriptions
and custom products and services.





Separate
management of each segment is required because each business unit is subject to
different marketing, production, and technology strategies.  Training
subscriptions derives revenues from the sale of computer-based safety training
products and services throughout the United States.  The custom
products and services segment derives its revenues from custom products and
services designed specifically for the end user.


14





VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





Segment
information (after inter-company eliminations) for the three months
ended


December
31, 2008 and 2007 is as follows:


December 31,
                          
                          
                          December 31,2008
                          
                          
                          2007Revenues:Training
      subscriptions
                          
                          $
                          1,026,447
                          
                          
                          $
                          889,840Custom
      products and services
                          
                          
                          669,863
                          
                          
                          
                          414,544Total
      Revenues
                          
                          $
                          1,696,310
                          
                          
                          $
                          1,304,384Cost
      of Revenues:Training
      subscriptions
                          
                          $
                          210,637
                          
                          
                          $
                          252,429Custom
      products and services
                          
                          
                          431,214
                          
                          
                          
                          295,449Total
      Cost of Revenues
                          
                          $
                          641,851
                          
                          
                          $
                          547,878Gross
      Profit:Training
      subscriptions
                          
                          $
                          815,810
                          
                          
                          $
                          637,411Custom
      products and services
                          
                          
                          238,649
                          
                          
                          
                          119,095Total
      Gross Profit
                          
                          $
                          1,054,459
                          
                          
                          $
                          756,506Operating
      Expenses:Training
      subscriptions
                          
                          $
                          367,502
                          
                          
                          $
                          259,666Custom
      products and services
                          
                          
                          91,876
                          
                          
                          
                          64,917Corporate
                          
                          
                          258,377
                          
                          
                          
                          234,507Total
      Operating Expenses
                          
                          $
                          717,755
                          
                          
                          $
                          559,090Income
      (Loss) before Income TaxesTraining
      subscriptions
                          
                          $
                          448,308
                          
                          
                          $
                          377,745Custom
      products and services
                          
                          
                          146,773
                          
                          
                          
                          54,178Corporate
                          
                          
                          (258,377
                          )
                          
                          
                          (234,507
                          )Total
      Income (Loss) before Income Taxes
                          
                          $
                          336,704
                          
                          
                          $
                          197,416





December 31,
                  
                  
                  December 31,2008
                  
                  
                  2007Identifiable
      assets:Training
      subscriptions
                  
                  $
                  1,253,517
                  
                  
                  $
                  1,280,695Custom
      products and services
                  
                  
                  423,196
                  
                  
                  
                  322,347Corporate
                  
                  
                  2,946,060
                  
                  
                  
                  2,750,655Total
      Identifiable Assets
                  
                  $
                  4,622,773
                  
                  
                  $
                  4,353,697Depreciation
      and amortization:Training
      subscriptions
                  
                  $
                  68,424
                  
                  
                  $
                  68,424Custom
      products and services
                  
                  
                  9,406
                  
                  
                  
                  7,538Corporate
                  
                  
                  18,495
                  
                  
                  
                  17,242Total
      Depreciation and Amortization
                  
                  $
                  96,325
                  
                  
                  $
                  93,204




15





VIVID
LEARNING SYSTEMS, INC.


CONDENSED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS


December
31, 2008





NOTE
10 – INCOME TAXES





During
the three months ended December 31, 2008, the Company realized a profit before
income taxes of $336,704.  As a result, the Company has recognized
$114,478 of federal income tax expense, calculated at a rate of approximately
34%, and a decrease in its deferred tax asset for this same
amount.   The Company’s deferred tax asset at December 31, 2008
principally consists of the prospective income tax benefit (at 34%) of net
operating losses in 2005, 2006, and 2007.





NOTE
11 – SUBSEQUENT EVENT





The
Company formerly leased all of its employees, via a professional employer
organization (PEO) from HRnovations, Inc., which was formerly co-owned and
managed by a member of Vivid’s Board of Directors.  HRnovations, Inc.
provided payroll processing services and benefits administration for the
Company.  The Company was also part of a multi-employer 401K plan,
which was administered by HRnovations, Inc.





Effective
January 1, 2009, the Company no longer utilizes a PEO for leased employee
services, and employs its own contractors to assist in the processing of payroll
and administration of benefits for its employees.  The Company also
sponsors its own 401K plan, which utilizes the same investment advisor, Benefits
Acceptance Corporation of Bellevue, Washington.  Effective January 1,
2009, plan assets were transferred to the Company plan with the identical
features and services of the previous plan.


16





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





Results
of Operations:





RESULTS
OF OPERATIONS – THREE MONTHS ENDED DECEMBER 31, 2008 COMPARED WITH THREE MONTHS
ENDED DECEMBER 31, 2007





Revenues


Overall
revenues increased 30% to $1,696,310 in the first quarter of fiscal year 2009
from $1,304,384 in the first quarter of fiscal year 2008. The increase was due
to the acquisition of substantial new contracts within the Custom Products and
Services segment combined with increasing revenue volume within the Training
Subscriptions segment in the fiscal quarter ending December 31, 2008 compared to
the fiscal quarter ending December 31, 2007.





Training
subscription revenues increased by 15% to $1,026,447 in the first quarter of
fiscal year 2009 from $889,840 in the first quarter of fiscal year 2008 due to
the addition of new subscription customers and consistent year over year
subscription renewals.





Custom
Products and Services revenues increased by 62% to $669,863 during the first
quarter of fiscal year 2009 from $414,544 during the first quarter of fiscal
year 2008.  The large increase is attributable to the acquisition of
large new custom contracts combined with the timely completion of custom
projects and related revenues generated within this business
segment.





Operating
Expenses





Cost
of Revenues:


Overall,
cost of revenues increased to $641,851 in the first quarter of fiscal year 2009
from $547,878 in the first quarter of fiscal year 2008.  The increase
is due to increasing revenue volumes in both business segments in the quarter
ending December 31, 2008 compared to the quarter ending December 31,
2007.  The gross profit margin achieved on total revenues increased to
62% from 58% in comparing the first quarter of fiscal year 2009 to the first
quarter of fiscal year 2008.  The increase reflects a higher
incremental gross profit realized on increasing revenue volumes which provide
excess cost coverage.





Training
subscription cost of revenues decreased by 17% to $210,637 in the first quarter
of fiscal year 2009 from $252,429 in the first quarter of fiscal year
2008.  This decrease is attributable to efficiencies realized in
production management of direct costs and similar levels of fixed indirect costs
within this business segment in the quarter ending December 31, 2008 compared to
the quarter ending December 31, 2007.





Custom products and services cost of
revenues increased by 46% to $431,214 in the first quarter of fiscal year 2009
from $295,449 in the first quarter of fiscal year 2008.  The increase
is due to significantly higher revenue volumes and related direct costs from new
custom contracts in the Custom Products and Services business segment in the
first quarter of fiscal year 2009 compared to the first quarter of fiscal year
2008.


17





Marketing
and Related Labor Expenses:


Marketing
and related labor expenses increased by 21% to $319,839 in the first quarter of
fiscal year 2009 from $265,023 in the first quarter of fiscal year
2008.  The reasons for the increase are due to increased marketing
labor costs related to higher revenues and royalty fees on revenue generated
from third party content.





Reseller
Commissions:


Reseller
commissions increased to $121,630 in the first quarter of fiscal year 2009 from
$44,502 in the first quarter of fiscal year 2008.  The increase is
attributable directly to the timing of training subscription revenues generated
from external sales resources during the fiscal quarter as compared to the same
quarter in the previous fiscal year.





Depreciation
and Amortization:


Depreciation
and Amortization increased to $27,901 in the first quarter of fiscal year 2009
compared to $24,780 in the first quarter of fiscal year 2008.  The
increase in depreciation is attributable to an increase in fixed assets
purchased in the comparison of the two fiscal quarters.





General
and Administrative Expenses:


General
and Administrative expenses increased by 10% to $239,882 in the first quarter of
fiscal year 2009 from $217,265 in the first quarter of fiscal year
2008.  Labor related expenses decreased by 8% to $105,387 during the
fiscal quarter from $114,981 in the same fiscal quarter of one year
ago.  The decrease is attributable to labor cost efficiencies and
reductions within administrative staff.  Non-labor related
administrative expenses increased by 31% to $134,495 during the fiscal quarter
from $102,284 in the same fiscal quarter of one year ago.  The
increase is primarily attributable to office related expenses.





Income
from Operations:


Income
from Operations increased by $142,309 to $345,207 in the first quarter of fiscal
year 2009 from $202,898 in the first quarter of fiscal year 2008.  The
increase is due principally to an increase in the gross profit margin partially
offset by increases in operating expenses incurred during the quarter ending
December 31, 2008 as compared to the quarter ending December 31,
2007.





Other
Income (Expense):


The
increase in Other Expenses is attributable to a slight increase in interest
expense in the first quarter of the current fiscal year resulting from the
increase in capital equipment financing.  Interest expense on debt was
$8,789 in the quarter ended December 31, 2008 compared to $6,289 in the quarter
ended December 31, 2007.





Net
Income


The
operation generated Net Income of $222,226 in the first quarter of fiscal year
2009 compared to $130,320 in the first quarter of fiscal year 2008. The increase
in net income of $91,906 is due to higher Training Subscription and Custom
Products and Services revenues partially offset by increases in operating and
income tax expenses during the first fiscal quarter in the current year compared
to the same period in the previous year.





Seasonality
and Other Factors Affecting Quarterly Results


We expect
quarterly fluctuations in operating results due to 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.


18





Liquidity
and Capital Resources


As of
December 31, 2008 the Company had cash of $457,896 compared to $132,391 as of
December 31, 2007.  The Company’s current ratio is 2.84 as of December
31, 2008 compared to 2.89 at the audit date of September 30, 2008.





Cash
flows provided by operating activities amounted to $266,467 in the first quarter
of fiscal year 2009 compared to cash flows provided by operating activities of
$171,787 in the first quarter of fiscal year 2008.  The increase is
attributable to net income generated by the operation.





Cash
flows used in investing activities amounted to $112,969 in the first quarter of
fiscal year 2009 compared to $33,094 in the first quarter of fiscal year
2008.  The increase is attributable to increased cost expenditures for
software development and acquisitions of property and equipment.





Cash
flows provided by financing activities amounted to $172,007 in the first quarter
of fiscal year 2009 compared to cash flows used in financing activities of
$75,557 in the first quarter of fiscal year 2008.  The increase in
cash flows provided by financing activities is attributable to proceeds from
term loan financing partially offset by payment requirements for notes payable
related party indebtedness and by debt service payments for long-term
liabilities.





ITEM
4T – 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 period ended
December 31, 2008. 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.





PART
II – OTHER INFORMATION





ITEM 6 – EXHIBITS





Exhibit
                        No.
                      
                      Description31.1
                      
                      302
      Certification of Matthew J. Hammer, Chief Executive
  Officer31.2
                      
                      302
      Certification of Robert M. Blodgett, Chief Financial
    Officer32.1
                      
                      906
      Certification of Matthew J. Hammer, Chief Executive
  Officer32.2
                      
                      906
      Certification of Robert M. Blodgett, Chief Financial
    Officer




19




SIGNATURES




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




Date:
      February 12,  2009
              Vivid
      Learning Systems, Inc.By:
              /s/ Matthew J. HammerMatthew
      J. HammerChief
      Executive Officer(Principal
      Executive
                Officer
      and duly
                authorized
      to sign on
                behalf
      of the Registrant)




20