**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





**FORM
      10-QSB**





**xQUARTERLY
      REPORT
      PURSUANT TO SECTION 13 OR 15(D) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


For
      the
      quarterly period ended June 30, 2006





**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 x No
o





The
      number of shares of the Registrant's common stock issued and outstanding at
      June
      30, 2006, was 12,030,674.





Transitional
      Small Business Disclosure Format:  Yes
o  No
x















**VIVID
      LEARNING SYSTEMS, INC.**


**JUNE
      30, 2006** **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
            19Item
                3
            Controls
                and Procedures
            24**PART
                II****OTHER
                INFORMATION**Item
                6
            Exhibits
            25








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, 2006, 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
              6Consolidated
                  Statements of Cash Flows
              7Notes
                  to Financial Statements
              8-18





4





**VIVID
                  LEARNING SYSTEMS, INC. - CONSOLIDATED BALANCE
                  SHEETS**June
                  30,
              
              September
                  30,2006
              
              2005(Unaudited)ASSETSCURRENT
                  ASSETSCash
              
              $
              9,393
              
              $
              16,622Accounts
                  and contracts receivable
              
              
              676,421
              
              
              1,028,197Accounts
                  and contracts receivable, Fluor Hanford
              
              
              43,298
              
              
              81,272Prepaid
                  expenses
              
              
              86,765
              
              
              105,867Other
                  current assets
              
              
              144,949
              
              
              374,059TOTAL
                  CURRENT ASSETS
              
              
              960,826
              
              
              1,606,017PROPERTY,
                  PLANT AND EQUIPMENTProperty
                  and equipment
              
              
              1,291,916
              
              
              1,223,847Less:
                  Accumulated depreciation and amortization
              
              
              (865,027
              )
              
              (892,570
              )TOTAL
                  PROPERTY, PLANT AND EQUIPMENT
              
              
              426,889
              
              
              331,277OTHER
                  ASSETSSoftware,
                  net of amortization
              
              
              1,521,141
              
              
              1,654,305Intangibles,
                  net of amortization
              
              
              536,943
              
              
              537,943Goodwill
              
              
              375,000
              
              
              375,000Long-term
                  contracts receivable
              
              
              284,380
              
              
              368,542Deferred
                  tax asset
              
              
              545,859
              
              
              460,081TOTAL
                  OTHER ASSETS
              
              
              3,263,323
              
              
              3,395,871TOTAL
                  ASSETS
              
              $
              4,651,038
              
              $
              5,333,165LIABILITIES
                  AND STOCKHOLDERS' EQUITYCURRENT
                  LIABILITIESAccounts
                  payable
              
              $
              120,433
              
              $
              129,539Payable
                  to related party
              
              
              925,279
              
              
              1,000,000Accrued
                  contract labor
              
              
              96,682
              
              
              243,879Other
                  current liabilities
              
              
              25,701
              
              
              183,035Unearned
                  revenue
              
              
              21,462
              
              
              44,376Notes
                  payable, related parties
              
              
              75,000
              
              
              75,000Current
                  portion of long-term liabilities
              
              
              36,000
              
              
              36,000TOTAL
                  CURRENT LIABILITIES
              
              
              1,300,557
              
              
              1,711,829LONG-TERM
                  LIABILITIESRelated
                  party payable
              
              
              432,118
              
              
              1,753,145Other
                  long-term liabilities
              
              
              139,528
              
              
              -TOTAL
                  LONG-TERM LIABILITIES
              
              
              571,646
              
              
              1,753,145TOTAL
                  LIABILITIES
              
              
              1,872,203
              
              
              3,464,974COMMITMENTS
                  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, 12,030,674 and 10,247,996shares
                  issued and outstanding, respectively
              
              
              1,203
              
              
              1,025Additional
                  paid-in capital
              
              
              3,589,456
              
              
              2,512,061Accumulated
                  deficit
              
              
              (811,824
              )
              
              (644,895
              )TOTAL
                  STOCKHOLDERS' EQUITY
              
              
              2,778,835
              
              
              1,868,191TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              $
              4,651,038
              
              $
              5,333,165




5


**VIVID
                  LEARNING SYSTEMS,
                  INC.****CONSOLIDATED
                  STATEMENTS OF
                  OPERATIONS**Three
                  Months Ended
              
              Nine
                  Months EndedJune
                  30, 2006
              
              June
                  30, 2005
              
              June
                  30, 2006
              
              June
                  30, 2005(Unaudited)
              
              (Unaudited)
              
              (Unaudited)
              
              (Unaudited)REVENUESTraining
                  subscriptions
              
              $
              439,258
              
              $
              227,562
              
              $
              1,478,163
              
              $
              1,376,897Training
                  subscriptions, Fluor Hanford
              
              
              140,505
              
              
              147,338
              
              
              424,498
              
              
              442,013Custom
                  products and services
              
              
              352,833
              
              
              329,513
              
              
              858,121
              
              
              969,917Custom
                  products and services, Fluor Hanford
              
              
              57,422
              
              
              62,884
              
              
              167,970
              
              
              116,706990,018
              
              
              767,297
              
              
              2,928,752
              
              
              2,905,533COST
                  OF REVENUESTraining
                  subscriptions
              
              
              276,322
              
              
              84,645
              
              
              433,267
              
              
              256,250Custom
                  products and services
              
              
              50,359
              
              
              318,887
              
              
              527,993
              
              
              921,654326,681
              
              
              403,532
              
              
              961,260
              
              
              1,177,904GROSS
                  PROFIT
              
              
              663,337
              
              
              363,765
              
              
              1,967,492
              
              
              1,727,629EXPENSESMarketing
                  and related labor expenses
              
              
              290,250
              
              
              230,585
              
              
              822,852
              
              
              721,093Bad
                  debt expense
              
              
              7,834
              
              
              5,489
              
              
              12,111
              
              
              11,555Reseller
                  commissions
              
              
              59,161
              
              
              37,312
              
              
              214,098
              
              
              210,244Depreciation
                  and amortization
              
              
              17,246
              
              
              17,595
              
              
              46,312
              
              
              54,706Wages
                  and contract labor
              
              
              145,550
              
              
              230,242
              
              
              476,078
              
              
              670,789Other
                  operating expenses
              
              
              196,773
              
              
              217,289
              
              
              618,089
              
              
              771,673TOTAL
                  OPERATING EXPENSES
              
              
              716,814
              
              
              738,512
              
              
              2,189,540
              
              
              2,440,060LOSS
                  FROM OPERATIONS
              
              
              (53,477
              )
              
              (374,747
              )
              
              (222,048
              )
              
              (712,431
              )OTHER
                  INCOME (EXPENSE)Gain
                  on sale of equipment and intangible assets
              
              
              106
              
              
              -
              
              
              30,382
              
              
              -Interest
                  income
              
              
              444
              
              
              105
              
              
              1,615
              
              
              536Interest
                  expense
              
              
              (24,617
              )
              
              (15,027
              )
              
              (62,872
              )
              
              (39,142
              )TOTAL
                  OTHER INCOME (EXPENSE)
              
              
              (24,067
              )
              
              (14,922
              )
              
              (30,875
              )
              
              (38,606
              )LOSS
                  BEFORE INCOME TAXES
              
              
              (77,544
              )
              
              (389,669
              )
              
              (252,923
              )
              
              (751,037
              )INCOME
                  TAX BENEFIT
              
              
              26,365
              
              
              132,487
              
              
              85,993
              
              
              255,352NET
                  LOSS
              
              $
              (51,179
              )
              $
              (257,182
              )
              $
              (166,930
              )
              $
              (495,685
              )BASIC
                  AND DILUTED NET LOSS PER SHARE
              
              $
              -
              
              $
              (0.03
              )
              $
              (0.01
              )
              $
              (0.05
              )BASIC
                  AND DILUTEDWEIGHTED
                  AVERAGE NUMBER OF SHARES
              
              
              11,997,299
              
              
              10,247,996
              
              
              11,280,521
              
              
              10,247,996




6





**VIVID
                  LEARNING SYSTEMS, INC.****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS**Nine
                  Months EndedJune
                  30,
              
              June
                  30,2006
              
              2005(Unaudited)
              
              (Unaudited)CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (166,930
              )
              $
              (495,685
              )Adjustments
                  to reconcile net income (loss)to
                  net cash provided by operating activities:Depreciation
                  and amortization
              
              
              46,312
              
              
              54,706Amortization
                  of capitalized software
              
              
              204,963
              
              
              223,942Bad
                  debt expenses
              
              
              12,111
              
              
              11,555Gain
                  on sale of assets
              
              
              (30,276
              )
              
              -Changes
                  in deferred tax assets and liabilities
              
              
              (85,778
              )
              
              (255,352
              )Common
                  stock and options issued for services
              
              
              20,000
              
              
              20,910Changes
                  in assets and liabilities:Accounts
                  and contracts receivable
              
              
              389,750
              
              
              792,941Prepaid
                  expenses
              
              
              19,102
              
              
              (221
              )Other
                  current assets
              
              
              216,999
              
              
              (243,881
              )Accounts
                  payable
              
              
              (9,106
              )
              
              44,183Accrued
                  payroll and related expenses
              
              
              (147,197
              )
              
              164,143Related
                  party payables, net of line of credit
              
              
              -
              
              
              779,552Long-term
                  receivable contracts
              
              
              84,162
              
              
              (404,792
              )Other
                  current liabilities
              
              
              (180,248
              )
              
              (57,822
              )Net
                  cash provided by operating activities
              
              
              373,864
              
              
              634,179CASH
                  FLOWS FROM INVESTING ACTIVITIES:Acquisition
                  of property, equipment and intangible assets
              
              
              (14,336
              )
              
              (380,496
              )Acquisition
                  of software
              
              
              (71,800
              )
              
              (298,554
              )Net
                  cash used by investing activities
              
              
              (86,136
              )
              
              (679,050
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from stock issuances
              
              
              8,343
              
              
              -Payments
                  on notes payable, related party
              
              
              (220,297
              )
              
              (200,000
              )Payments
                  on line of credit
              
              
              (74,721
              )
              
              -Payments
                  on other long-term liabilities
              
              
              (8,282
              )
              
              -Proceeds
                  from related party line of credit
              
              
              -
              
              
              227,975Net
                  cash provided (used) by financing activities
              
              
              (294,957
              )
              
              27,975Net
                  increase (decrease) in cash
              
              
              (7,229
              )
              
              (16,896
              )Cash
                  at beginning of period
              
              
              16,622
              
              
              49,451Cash
                  at end of period
              
              $
              9,393
              
              $
              32,555SUPPLEMENTAL
                  CASH FLOW INFORMATION:Interest
                  paid
              
              $
              62,872
              
              $
              39,142Income
                  taxes paid
              
              $
              -
              
              $
              -NON-CASH
                  TRANSACTIONS:Common
                  stock and options issued for services
              
              $
              20,000
              
              $
              20,910Common
                  stock issued for related party debt
              
              $
              1,092,448
              
              $
              -Note
                  receivable for sale of equipment and intangible assets
              
              $
              45,000
              
              $
              -Capital
                  lease for equipment
              
              $
              46,483Leasehold
                  improvements financed
              
              $
              100,000




7





**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**


**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 Tec *Knowledge* y,
      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. 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
      Washington develops and provides computer-based training products and services,
      which are marketed nationally.





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 principles 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. These unaudited interim financial statements
      should be read in conjunction with the audited financial statements for the
      period ended September 30, 2005. 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, 2006 are not necessarily indicative of the results
      that may be expected for the fiscal year ending September 30, 2006. 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.




8





**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**





**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.





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 the calculation of “basic” and “diluted” earnings per share. Basic
      earnings per share includes no dilution and is computed by dividing net income
      available to common shareholders by the weighted average 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
      are
      595,440 common stock equivalents outstanding at June 30, 2006.





Guarantees
      and Line of Credit


In
      November 2002, the Financial Accounting Standards Board issued FASB
      Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for
      Guarantees, including Indirect Guarantees of Indebtedness of Others”
(hereinafter “FIN 45” or the “Interpretation”. FIN 45 expands the disclosure
      requirements to be made by a guarantor in its interim and annual financial
      statements about its obligations under certain guarantees that it has issued.
      The Interpretation also clarifies that a guarantor is required to recognize,
      at
      the inception of a guarantee, a liability for the fair value of the obligation
      undertaken in issuing the guarantee. Certain guarantees, including (i) an
      original lessee’s guarantee of the lease payments when the lessee remains
      secondarily liable in conjunction with being relieved from being the primary
      obligor and (ii) a parent’s guarantee of a subsidiary’s debt to a third party,
      and a subsidiary’s guarantee of debt owed to a third party by either its parent
      or another subsidiary of that parent, are excluded from the provisions related
      to liability recognition. These guarantees, however, are subject to the
      disclosure requirements of the Interpretation. The Company has adopted the
      disclosure requirements of FIN 45. Although there is a line of credit in place
      which was executed by Nuvotec, Vivid’s major shareholder, the Company, as a
      subsidiary guaranteeing this debt which is owed to a third party, in fact has
      a
      guarantee which is excluded from the disclosure requirements of the
      Interpretation, and is not required to be recognized as a liability for the
      guarantee.




9





**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**




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.





Recent
      Accounting Pronouncements


In
      March
      2006, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards No. 156, "Accounting for Servicing of Financial Assets,
      an
      Amendment of FASB Statement No. 140," (hereinafter "SFAS No. 156). This
      statement requires an entity to recognize a servicing asset or servicing
      liability each time it undertakes an obligation to service a financial asset
      by
      entering into a servicing contract in any of the following situations: a
      transfer of the servicer's financial assets that meets the requirements for
      sale
      accounting; a transfer of the servicer's financial assets to a qualifying
      special-purpose entity in a guaranteed mortgage securitization in which the
      transferor retains all of the resulting securities and classifies them as either
      available-for-sale securities or trading securities; or an acquisition or
      assumption of an obligation to service a financial asset that does not relate
      to
      financial assets of the servicer or its consolidated affiliates. The statement
      also requires all separately recognized servicing assets and servicing
      liabilities to be initially recorded at fair value, if practicable and permits
      an entity to choose either the amortization or fair value method for subsequent
      measurement of each class of servicing assets and liabilities. The statement
      further permits, at its initial adoption, a one-time reclassification of
      available-for-sale securities to trading securities by entities with recognized
      servicing rights, without calling into question the treatment of other
      available-for-sale securities under Statement No. 115, provided that the
      available-for-sale securities are identified in some manner as offsetting the
      entity's exposure to changes in fair value of servicing assets or servicing
      liabilities that a servicer elects to subsequently measure at fair value and
      requires separate presentation of servicing assets and servicing liabilities
      subsequently measured at fair value in the statement of financial position
      and
      additional disclosures for all separately recognized servicing assets and
      servicing liabilities. This statement is effective for fiscal years beginning
      after September 15, 2006, with early adoption permitted as of the beginning
      of
      an entity's fiscal year. Management believes the adoption of this statement
      will
      have no immediate impact on the Company's financial condition or results of
      operations.




10





**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**




In
      February 2006, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 155, "Accounting for Certain Hybrid Financial
      Instruments, an Amendment of FASB Standards No. 133 and 140," (hereinafter
      SFAS
      No. 155). This statement established the accounting for certain derivatives
      embedded in other instruments. It simplifies accounting for certain hybrid
      financial instruments by permitting fair value remeasurement for any hybrid
      instrument that contains an embedded derivative that would otherwise require
      bifurcation under SFAS No. 133 as well as eliminating a restriction on the
      passive derivative instruments that a qualifying special-purpose entity may
      hold
      under SFAS No. 140. This statement allows a public entity to irrevocably elect
      to initially and subsequently measure a hybrid instrument that would be required
      to be separated into a host contract and derivative in its entirety at fair
      value (with changes in fair value recognized in earnings) so long as that
      instrument is not designated as a hedging instrument pursuant to the statement.
      SFAS No. 140 previously prohibited a qualifying special-purpose entity from
      holding a derivative financial instrument that pertains to a beneficial interest
      other than another derivative financial instrument. This statement is effective
      for fiscal years beginning after September 15, 2006, with early adoption
      permitted as of the beginning of an entity's fiscal year. Management believes
      the adoption of this statement will have no immediate impact on the Company's
      financial condition or results of operations.





In
      May
      2005, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards (“SFAS No. 154”), “Accounting Changes and Error
      Corrections,” which replaces Accounting Principles Board Opinion No. 20,
“Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim
      Financial Statements -- An Amendment of APB Opinion No. 28”. SFAS No. 154
      provides guidance on accounting for and reporting changes in accounting
      principle and error corrections. SFAS No. 154 requires that changes in
      accounting principle be applied retrospectively to prior period financial
      statements and is effective for fiscal years beginning after December 15, 2005.
      The Company does not expect SFAS No. 154 to have a material impact on its
      consolidated financial position, results of operations, or cash
      flows.




11




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**





In
      March
      2005, the Financial Accounting Standards Board issued FASB Interpretation No.
      47
      (“FIN 47”), “Accounting for Conditional Asset Retirement Obligations.” FIN 47
      clarifies that the term “conditional asset retirement obligation,” which as used
      in SFAS No. 143, “Accounting for Asset Retirement Obligations,” refers to a
      legal obligation to perform an asset retirement activity in which the timing
      and
      (or) method of settlement are conditional on a future event that may or may
      not
      be within the control of the entity. The entity must record a liability for
      a
“conditional” asset retirement obligation if the fair value of the obligation
      can be reasonably estimated. FIN 47 also clarifies when an entity would have
      sufficient information to reasonably estimate the fair value of an asset
      retirement obligation. FIN 47 is effective no later than the end of fiscal
      years
      ending after December 15, 2005. Management is reviewing the impact of FIN 47
      on
      the financial statements of the Company.





Reclassifications


Certain
      prior year amounts in the accompanying financial statements have been
      reclassified to conform to the fiscal 2005 presentation. The reclassifications
      principally consists of reclassification of the fair market value of all
      outstanding options and warrants as paid-in-capital instead of a separate
      caption on the balance sheets and statement of stockholders’ equity. These
      reclassifications have resulted in no changes to the Company’s accumulated
      deficit or net losses presented





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,
      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. 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 three additional years, a material
      reseller agreement with Element K of Rochester, New York.




12




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**





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.





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 a 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 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. The Company’s amortization method assumes that sales of
      the Company’s existing software products will continue for at least the ensuing
      five years.





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





June
                30,
              2006,
            
            September
                30,
              2005Software
                development costs
            
            $
            3,439,413
            
            $
            $3,367,614Accumulated
                amortization
            
            
            (1,918,272
            )
            
            (1,713,309
            )$
            1,521,141
            
            $
            $1,654,305





The
      amount of software costs written down to net realizable value was zero during
      the nine months ended June 30, 2006 and 2005, 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.




13




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**


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 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.





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 entered into in the current period for the portion of the
      subscription contract that extends into future periods. At June 30, 2006 and
      September 30, 2005, 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.





**NOTE
      3 - RELATED PARTY TRANSACTIONS**





The
      Company was awarded a three-year contract renewal with a minimum value of
      $1,622,609 with Fluor Hanford, Inc., a Nuvotec, Inc. shareholder, for the period
      from October 2005 to September 30, 2008. The Company provides computer-based
      training monthly for the employees of Fluor Hanford, Inc. and its contractors.
      The account receivable due from Fluor Hanford at June 30, 2006 and September
      30,
      2005, was $43,298 and $81,272, respectively. Revenue from Fluor Hanford for
      the
      nine months ended June 30, 2006 and 2005 was $592,395 and $558,719,
      respectively.





At
      June
      30, 2006 and September 30, 2005, the recorded current related party payable
      consisted of $925,279 and $1,000,000, respectively, of borrowing from Nuvotec
      USA, Inc.’s line of credit and current amounts due to the former owners of
      ImageWorks of $75,000 in cash or stock. The long-term related party payable
      at
      June 30, 2006 and September 30, 2005, consists of borrowing from Nuvotec of
      $82,118 and $1,364,145, respectively, and amounts due to the former owners
      of
      ImageWorks of $350,000 and $389,000, respectively.




14





**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**




The
      total
      amount payable by Vivid on Nuvotec’s line of credit at June 30, 2006 and
      September 30, 2005 was $925,279 and $1,000,000, respectively. The portion of
      drawing on the line of credit attributed to Nuvotec as of June 30, 2006 and
      September 30, 2005 was $74,721 and $0, respectively, leaving $0 available for
      use by either company at June 30, 2006.





**NOTE
      4 - STOCKHOLDERS’ EQUITY**





Common
      Stock


During
      the nine months ended June 30, 2006 the Company converted $1,092,448 in related
      party long-term debt due to Nuvotec, USA, Inc., into 1,749,303 shares of common
      stock. In addition, 33,375 shares were issued when stock options were exercised
      at $0.25 per share.





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
      June
      30, 2006 and September 30, 2005, no preferred stock has been issued by the
      Company.





**NOTE
      5 - STOCK-BASED COMPENSATION**





During
      2004, the Company issued to executives a total of 866,334 common stock options,
      exercisable at $0.25 per share for four years and vesting at a rate of 25%
      per
      year.





During
      the year ended September 30, 2005, 318,792 options which had been issued in
      2004, were vested, with a fair value of $25,503.





During
      the year ended September 30, 2005, additional options totaling 87,500 were
      issued of which 21,875 vested with a fair value of $3,937. Also during the
      year
      ended September 30, 2005, 50,000 options were exercised and 399,500 options
      originally issued in 2004 expired or were terminated.





A
      total
      of 153,606 vesting options have been issued in the nine months ending June
      30,
      2006, which vesting commences after September 30, 2006.





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%, volatility is 0.3, and
      expected life is 3 to 4 years.




15




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**





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
            
            
            527,584
            
            $
            0.25
            
            
            1,822,416Total
            
            
            527,584
            
            
            
            
            
            1,822,416





WeightedNumber
                of
            
            Average
                ExerciseShares
            
            PriceOutstanding
                at October 1, 2004
            
            
            866,334
            
            $
            0.24Granted
            
            
            87,500
            
            
            0.25Exercised
            
            
            (50,000
            )
            
            0.10Expired
                or terminated
            
            
            (399,500
            )
            
            0.25Outstanding
                at September 30, 2005
            
            
            504,334
            
            $
            0.25Options
                exercisable at September 30, 2005
            
            
            138,584
            
            $
            0.25Outstanding
                at October 1, 2005
            
            
            504,334
            
            $
            0.25Granted
            
            
            153,606
            
            
            0.54Exercised
            
            
            (33,375
            )
            
            0.25Expired
                or terminated
            
            
            (29,125
            )
            
            0.25Outstanding
                at June 30, 2006
            
            
            595,440
            
            $
            0.32Options
                exercisable at June 30, 2006
            
            
            301,322
            
            $
            0.34








**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, 2006 and 2005, services
      provided to these contractors aggregated $698,071 and $569,965, representing
      24%
      and 20% of total revenue, respectively. At June 30, 2006 and 2005, amounts
      due
      from these contractors are included in accounts receivable in the amounts of
      $54,635 and $20,646, respectively.




16




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**





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
              Ending
              June
                30, 2006
            
            Nine
                Months
              Ending
              June
                30, 2005Revenues—
              FluorHanford
            
            $
            592,395
            
            $
            558,719Accounts
                Receivable
              Fluor
                Hanford
            
            $
            43,298
            
            $
            20,646





**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, 2006 and 2005, the
      Company incurred $53,616 and $20,021 in royalty obligations, respectively,
      which
      are recorded in marketing expense. At June 30, 2006 and September 30, 2005,
      the
      Company had $0 accrual in royalty obligations.





**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 two operating segments at June 30, 2006
      and 2005: corporate training subscriptions and custom products and
      services.




17




**VIVID
        LEARNING SYSTEMS, INC.**
 **CONDENSED
        NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **June
        30, 2006**




Segment
      information (after inter-company eliminations) for the nine months ended June
      30, 2006 and 2005 are as follows:





June
                30,
            
            June
                30,2006
            
            2005Revenues:Training
                subscriptions
            
            $
            1,902,661
            
            $
            1,818,910Custom
                products and services
            
            
            1,026,091
            
            
            1,086,623Total
                revenues
            
            $
            2,928,752
            
            $
            2,905,533Income
                (loss) before taxes:Training
                subscriptions
            
            $
            1,469,394
            
            $
            1,562,660Custom
                products and services
            
            
            498,098
            
            
            164,969Corporate
            
            
            (2,220,415
            )
            
            (2,478,666
            )Total
                income (loss) before taxes
            
            $
            (252,923
            )
            $
            (751,037
            )Identifiable
                assets:Training
                subscriptions
            
            $
            1,521,141
            
            $
            1,654,305Custom
                products and services
            
            
            256,516
            
            
            261,565Corporate
            
            
            2,873,381
            
            
            3,808,899Total
                identifiable assets
            
            $
            4,651,038
            
            $
            5,724,769Depreciation
                and amortization:Training
                subscriptions
            
            $
            204,963
            
            $
            223,942Custom
                products and services
            
            
            9,206
            
            
            16,346Corporate
            
            
            37,106
            
            
            38,360Total
                depreciation and amortization
            
            $
            251,275
            
            $
            278,648





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,
      derives its revenue from custom products and services designed specifically
      for
      the end user.





**NOTE
      9 -**  **SALE
      OF PROTRAIN ASSETS**





Effective
      October 1, 2005, the assets of Protrain, a division of the Company, including
      computers, equipment and a customer list were sold to a former employee for
      a
      $45,000 note payable to the Company over three years commencing January 1,
      2006
      with payments of $1,349 monthly including interest at 5% per annum. The Company
      recognized a gain on this transaction of $30,276.





**NOTE
      10 - INCOME TAXES**





During
      the nine months ended June 30, 2006, the Company realized a loss before income
      taxes of $252,923. As a result, the Company has recognized $85,993 of federal
      income tax benefit, calculated at a rate of approximately 34%, and an increase
      in its deferred tax asset for this same amount. The Company’s deferred tax asset
      at June 30, 2006 principally consists of the tax benefit (at 34%) of net
      operating losses in 2005 and 2006.




18





**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, 2006 COMPARED WITH THREE MONTHS
      ENDED JUNE 30, 2005**





**Revenues:**





Overall
      revenues increased 29% to $990,018 in the third quarter of fiscal year 2006
      from
      $767,297 in the third quarter of fiscal year 2005. The increase was mainly
      due
      to the increase in revenues attributable to training subscriptions of $204,863
      during the third quarter of fiscal 2006.





Training
      subscription revenues increased by 55% to $579,763 in the third quarter of
      fiscal year 2006 from $374,900 in the third quarter of fiscal year 2005 because
      of an increase in subscription based customer sales generated from newly
      acquired customers





Custom
      products and services revenues increased overall by 5% to $410,255 in the third
      quarter of fiscal year 2006 from $392,397 in the third quarter of fiscal year
      2005. The increase is mainly attributable to an increase of non-federal custom
      work revenues within the business unit, ImageWorks during the third quarter
      of
      fiscal year 2006 partially offset by decreased custom work in the federal sector
      and other commercial business units within the Company. ImageWorks revenues
      increased during the third quarter of fiscal year 2006 by 20% to $295,340 from
      $245,361 in the third quarter of fiscal year 2005 because of increasing custom
      work contracted with existing and new customers.




**Operating
      Expenses**





Cost
      of
      Revenues:





Overall,
      cost of revenues decreased by 19% to $326,681 in the third quarter of fiscal
      year 2006 from $403,532 in the third quarter of fiscal year 2005. The decrease,
      in spite of the higher current period revenue levels in the comparison the
      two
      reporting periods, is due to lower costs incurred in labor and technical
      assistance expense categories resulting from a streamlining of the operation.
      The gross profit margin achieved on total revenues improved significantly to
      67%
      from 47% in comparing the third quarter of fiscal year 2006 to the third quarter
      of fiscal year 2005, mainly attributable to higher revenues generated combined
      with the reduction in the fixed cost components of cost of
      revenues.





Training
      subscription cost of revenues increased by 226% to $276,322 in the third quarter
      of fiscal year 2006 from $84,645 in the third quarter of fiscal year 2005.
      This
      increase is due to a year to date reclassification of direct costs incurred
      resulting from the use of discreet cost identification versus cost allocation
      on
      the basis of estimates.




19





Custom
      products and services cost of revenues decreased by 84% to $50,359 in the third
      quarter of fiscal year 2006 from $318,887 in the third quarter of fiscal year
      2005. The decrease is due to a year to date reclassification of direct costs
      incurred resulting from use of discreet cost identification versus cost
      allocation on the basis of estimates.





The
      effect of the reclassification in the third quarter of fiscal year 2006 was
      to
      increase training subscription cost of revenues and decrease custom products
      and
      services cost of revenues by $200,225.





Marketing/Reseller
      Commissions:





Marketing
      and reseller commission expenses increased by 30% to $349,411 in the third
      quarter of fiscal year 2006 from $267,897 in the third quarter of fiscal year
      2005. The reason for the increase is the increased internal investment made
      in
      marketing related labor expenses.





Depreciation
      and Amortization:





Depreciation
      and amortization was $17,246 in the third quarter of fiscal year 2006 compared
      to $17,595 in the third quarter of fiscal year 2005.





General
      and Administrative Expenses:





General
      and Administrative expenses decreased by 23% to $350,157 in the third quarter
      of
      fiscal year 2006 from $453,020 in the third quarter of fiscal year 2005. The
      significant expense categories of decrease in comparing the third quarters
      of
      fiscal year 2006 to 2005 are the costs of labor and professional fees. The
      labor
      decrease ($145,550 in the third quarter of fiscal year 2006 compared to $233,923
      in the third quarter of fiscal year 2005) is due to management and staff
      reductions to align the infrastructure of the Company with revenues. The
      decrease in professional fees ($45,888 in the third quarter of fiscal year
      2006
      compared to $58,849 in the second quarter of fiscal year 2005) is the result
      of
      the absence of non-recurring costs of outside counsel related to initial
      regulatory reporting incurred in the prior year.





**Income
      from Operations**





Income
      from Operations increased by $321,270 to ($53,477) in the third quarter of
      fiscal year 2006 from ($374,747) in the third quarter of fiscal year 2005.
      The
      increase is due principally to significant increases in training subscription
      revenues and reductions in overall operating expenses resulting from a
      streamlined production operation.





**Other
      Income (Expense)**





The
      increase in Other Expenses is attributable to the increase in interest expense
      resulting from rising interest rates on outstanding debt in the third quarter
      of
      fiscal year 2006 compared to 2005. Interest expense on debt was $24,617 in
      the
      quarter ended June 30, 2006 compared to $15,027 in the quarter ended June 30,
      2005.




20




**Net
      Income (Loss)**





The
      operation sustained a net loss of $51,179 in the third quarter of fiscal year
      2006 compared to a loss of $257,182 in the third quarter of fiscal year 2005.
      The decrease in net loss of $206,003 is due mainly to increases in revenues
      and
      reductions in cost of revenues partially offset by a reduction in accrued income
      tax benefits.





**Seasonality
      and Other Factors Affecting Quarterly Results**





The
      revenues of the Company may fluctuate during the holiday season of the year.
      Training subscription revenues are typically higher in December because many
      subscription renewals occur at the end of each calendar year. 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**





Cash
      flows used by operating activities amounted to $16,143 in the third quarter
      of
      fiscal year 2006 compared to $440,872 provided by operating activities in the
      same period of fiscal year 2005. The main reason for the decrease in cash flows
      provided by operations is attributable to the reduction in related party
      payables.





Cash
      flows used in investing activities amounted to $36,918 in the third quarter
      of
      fiscal year 2006 compared to $333,660 in the third quarter of fiscal year 2005.
      The decrease is attributable to lower expenditures related to the acquisition
      of
      software, costs associated with internally developed software, and property
      and
      equipment.





Cash
      flows provided by financing activities amounted to $8,178 in the third quarter
      of fiscal year 2006 compared to cash flows used by financing activities of
      $75,000 in the third quarter of fiscal year 2005. The increase is attributable
      to reductions in payments on notes payable, related parties.





**RESULTS
      OF OPERATIONS - NINE MONTHS ENDED JUNE 30, 2006 COMPARED WITH NINE MONTHS ENDED
      JUNE 30, 2005**





**Revenues:**





Overall
      revenues increased 1% to $2,928,752 in the nine months year to date of fiscal
      year 2006 from $2,905,533 in the nine months year to date of fiscal year 2005.
      The slight increase was mainly due to an increase in revenues attributable
      to
      training subscriptions of $83,751 offset by a slight decrease in custom products
      and services revenues of $60,532 during the nine months year to date of fiscal
      2006 as compared to the same period in fiscal 2005.





Training
      subscription revenues increased by 5% to $1,902,661 in the nine months year
      to
      date of fiscal year 2006 from $1,818,910 in the nine months year to date of
      fiscal year 2005 because of a high level of subscription renewals and an
      increase in new subscription based sales.




21





Custom
      products and services revenues decreased overall by 6% to $1,026,091 in the
      nine
      months year to date of fiscal year 2006 from $1,086,623 in the nine months
      year
      to date of fiscal year 2005. The decrease is partially attributable to a year
      to
      date reduction in ImageWorks revenues. Overall ImageWorks revenues decreased
      5%
      to $681,232 in the nine months year to date of fiscal year 2006 from $716,660
      in
      the nine months year to date of fiscal year 2005. Custom products and services
      revenues within the federal sector increased by 44%% to $167,970 in the nine
      months year to date of fiscal year 2006 from $116,706 in the nine months year
      to
      date of fiscal year 2005. Custom products and services revenues in other
      commercial business units of the Company decreased by 30% to $176,889 in the
      nine months year to date of fiscal year 2006 from $253,257 in the nine months
      year to date of fiscal year 2005.





**Operating
      Expenses**





Cost
      of
      Revenues:





Overall,
      cost of revenues decreased by 18% to $961,260 in the nine months year to date
      of
      fiscal year 2006 from $1,177,904 in the nine months year to date of fiscal
      year
      2005. The decrease, in spite of the similar revenue levels in the two reporting
      periods, is due to lower costs incurred in labor and technical assistance
      expense categories resulting from a streamlining of the operation. The gross
      profit margin achieved on total revenues improved to 67% in comparing the nine
      months year to date of fiscal year 2006 to 59% achieved in the nine months
      year
      to date of fiscal year 2005 mainly attributable to a reductions in the fixed
      cost components of costs of revenues.





Training
      subscription cost of revenues increased by 69% to $433,267 in the nine months
      year to date of fiscal year 2006 from $256,250 in the nine months ended June
      30,
      2005. This increase is due to a reclassification of direct costs incurred from
      using discreet cost identification versus cost allocation on the basis of
      estimates. The gross profit margin realized on training subscription revenues
      in
      the nine months ending June 30, 2006, after the year to date analysis and
      reclassification, was 77% versus 86% in the reporting period of one year ago.





Custom
      products and services cost of revenues decreased by 43% to $527,993 in the
      nine
      months year to date of fiscal year 2006 from $921,654 in the nine months ended
      June 30, 2005. The decrease is due to a reclassification of direct costs
      incurred from using discreet cost identification versus cost allocation on
      the
      basis of estimates. The gross profit percentage realized from this business
      segment in the nine months year to date of fiscal year 2006, after the year
      to
      date analysis and reclassification, was 49% versus 15% in the reporting period
      of one year ago.





The
      effect of the reclassification in the nine months year to date of fiscal year
      2006 was to increase training subscription cost of revenues and decrease custom
      products and services cost of revenues by $200,225.




22





Marketing/Reseller
      Commissions:





Marketing
      and reseller commission expenses increased by 11% to $1,036,950 in the nine
      months year to date of fiscal year 2006 from $931,337 in the nine months year
      to
      date of fiscal year 2005. The increase is mainly attributable to increased
      labor
      related expenses. Increased labor related expenses ($505,457 in the nine months
      year to date of fiscal year 2006 compared to $402,747 in the nine months year
      to
      date of fiscal year 2005) are as a result of an increasing internal investment
      to more effectively manage our various industry segments.





Depreciation
      and Amortization:





Depreciation
      and amortization decreased by 15% to $46,312 in the nine months to date of
      fiscal year 2006 from $54,706 in the comparable period of fiscal year 2005
      due
      to an increase in fully depreciated assets in comparing the two
      quarters.





General
      and Administrative Expenses:





General
      and Administrative expenses decreased by 24% to $1,106,278 in the nine months
      year to date of fiscal year 2006 from $1,454,017 in the nine months year to
      date
      of fiscal year 2005. The significant expense categories of decrease in comparing
      the nine months year to date of fiscal year 2006 to 2005 are the costs of labor
      and an overall reduction in infrastructure general and administrative expenses.
      The labor decrease ($476,078 in the nine month year to date of fiscal year
      2006
      compared to $670,789 in the same period of fiscal year 2005) is due to
      management and staff reductions to align the infrastructure of the Company.
      The
      overall reduction in infrastructure general and administrative expenses
      ($630,200 in the nine months year to date of fiscal year 2006 compared to
      $783,228 in the same period of fiscal year 2005) is the result of overhead
      efficiencies achieved.





**Income
      from Operations**





Income
      from Operations increased by $490,383 to ($222,048) in the nine months year
      to
      date of fiscal year 2006 from ($712,431) in the nine months year to date of
      fiscal year 2005. Principally, the increase is due to decreases in cost of
      revenues and the realization of cost efficiencies in administrative expenses.





**Other
      Income (Expense)**





The
      main
      increase in other income is attributable to the gain of $30,276 realized in
      the
      sale of Protrain assets, partially offset by an increase attributable to
      interest expense resulting from rising interest rates on debt in the nine months
      year to date of fiscal year 2006 compared to 2005. Interest expense on debt
      was
      $62,872 in the nine months year to date of fiscal year 2006 compared to $39,142
      in the nine months year to date of fiscal year 2005.




23





**Net
      Income (Loss)**





The
      operation sustained a net loss of $166,930 in the nine months year to date
      of
      fiscal year 2006 compared to a net loss of $495,685 in the nine months year
      to
      date of fiscal year 2005. The decrease in net loss of $328,755 is due mainly
      to
      reductions in cost of revenues and infrastructure expenses to align more
      directly with revenues, and partially offset by a reduction in the resulting
      federal income tax benefits.





**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, 2006,
      the
      Company had cash and cash equivalents of $9,393 as compared to $16,622 as of
      September 30, 2005.





Cash
      flows provided by operating activities amounted to $373,864 in the nine months
      year to date of fiscal year 2006 compared to $634,179 in the same period of
      fiscal year 2005. The main reasons for the decrease are attributable to a
      decrease in net loss generated by the operation of $328,755, a net decrease
      in
      current and long-term accounts and contracts receivable of $85,763, and a
      decrease in other current assets of $460,880, offset by decreases in accrued
      payroll related expenses of $311,340, related party payables of $779,552, and
      other current liabilities of $122,426 in the comparison of the same period
      of
      the two fiscal years.





Cash
      flows used in investing activities decreased by $592,914 to $86,136 in the
      nine
      months year to date of fiscal year 2006 from $679,050 in the same period of
      fiscal year 2005. The decrease is attributable to lower expenditures related
      to
      the acquisition of software, costs associated with internally developed
      software, and property and equipment.





Cash
      flows used in financing activities increased by $322,932 to $294,957 in the
      nine
      months year to date of fiscal year 2006 compared to cash flows provided by
      financing activities of $27,975 in the same period of fiscal year 2005. The
      increase is attributable mainly to a reduction in borrowings on the line of
      credit. It should also be noted that the Company converted $1,092,448 of related
      party debt into additional paid in capital in a non-cash transaction with its
      parent company.





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.





**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 period ended
      June 30, 2006. 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.




24




**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






25




**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.




Dated:
                August 11, 2006
            Vivid
                Learning Systems, Inc.By:/s/
                Christopher L.
                BrittonChristopher
                L. BrittonChief
                Executive Officer







26