**UNITED
STATES**
 **SECURITIES
AND EXCHANGE COMMISSION**
 **WASHINGTON,
D.C. 20549**
 
 **FORM
10-QSB**
 
 **QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE**
 **SECURITIES
EXCHANGE ACT OF 1934**
 For the
quarterly period ended December 31, 2004
 
 **OR**
 
 **TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE**
 **SECURITIES
EXCHANGE ACT OF 1934**
 For the
Transition Period from ___________ to ___________
 
 **Commission
File Number: 333-116255**
 
 **VIVID
LEARNING SYSTEMS, INC.**
 (Exact
name of Registrant as specified in its charter)
 
 **Delaware**
      (State
      or other jurisdiction of
      incorporation
      or organization)
    **42-1623500**
      (I.R.S.
      Employer Identification No.)
 
 **723
The Parkway**
 **Richland,
Washington 99352**
 (Address
of principal executive offices, including zip code)
 
 **(509)
943-5319**
 (Registrant's
telephone number, including area code)
 
 
 Check
whether the Registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months, and (2) has been subject to such filing requirements for the past 90
days. Yes o No x
 
 The
number of shares of the Registrant's common stock issued and outstanding at
March 22, 2005, was 10,247,996.
 
 Transitional
Small Business Disclosure Format:  Yes o  No x
 
 
 
 ****
 **VIVID
LEARNING SYSTEMS, INC.**
 **DECEMBER
31** **,
2004 QUARTERLY REPORT ON FORM 10-QSB**
 
 **TABLE
OF CONTENTS**
  **PAGE**Special
      Note Regarding Forward Looking Statements
    3**PART
      I****FINANCIAL
      INFORMATION**Item
      1.
    Financial
      Statements
    4Item
      2.
    Management’s
      Discussion And AnalysisOf
      Financial Condition And Results Of Operations
    20Item
      3
    Controls
      and Procedures
    25**PART
      II****OTHER
      INFORMATION**Item
      4.
    Submission
      of Matters to a Vote of Security Holders
    26Item
      6.
    Exhibits
    26
  ****
 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 December 31, 2004, 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
    8-19
  4


**VIVID
      LEARNING SYSTEMS, INC.****CONSOLIDATED
      BALANCE SHEETS**December
      31,
    
    September
      30,2004
    
    2004(Unaudited)**ASSETS**CURRENT
      ASSETSCash
    
    $
    86,500
    
    $
    49,451Accounts
      and contracts receivable
    
    
    1,404,923
    
    
    1,933,573Accounts
      and contracts receivable, Fluor Hanford
    
    
    1,051
    
    
    59,035Accounts
      receivable, related party
    
    
    3,856
    
    
    3,894Employee
      advances
    
    
    20,139
    
    
    22,222Prepaid
      expenses
    
    
    96,958
    
    
    68,813Other
      current assets
    
    
    123,082
    
    
    72,179TOTAL
      CURRENT ASSETS
    
    
    1,736,509
    
    
    2,209,167PROPERTY,
      PLANT AND EQUIPMENTProperty
      and equipment
    
    
    1,161,893
    
    
    1,135,030Less:
      Accumulated depreciation and amortization
    
    
    (783,582
    )
    
    (764,914
    )TOTAL
      PROPERTY, PLANT AND EQUIPMENT
    
    
    378,311
    
    
    370,116OTHER
      ASSETSSoftware,
      net of amortization
    
    
    1,691,196
    
    
    1,684,406Intangibles,
      net of amortization
    
    
    762,410
    
    
    763,160Goodwill
    
    
    375,000
    
    
    375,000Long-term
      contracts receivable
    
    
    477,291
    
    
    —Deferred
      tax asset
    
    
    —
    
    
    3,853TOTAL
      OTHER ASSETS
    
    
    3,305,897
    
    
    2,826,419**TOTAL
      ASSETS**
    
    $
    5,420,717
    
    $
    5,405,702**LIABILITIES
      AND STOCKHOLDERS' EQUITY**CURRENT
      LIABILITIESAccounts
      payable
    
    $
    252,439
    
    $
    189,588Payable
      to related party
    
    
    888,501
    
    
    823,430Accrued
      contract labor
    
    
    145,803
    
    
    159,450Other
      current liabilities
    
    
    225,000
    
    
    271,950Unearned
      revenue
    
    
    130,152
    
    
    30,286Notes
      payable, related parties
    
    
    218,562
    
    
    250,000Current
      portion of long-term liabilites
    
    
    30,000
    
    
    30,000TOTAL
      CURRENT LIABILITIES
    
    
    1,890,457
    
    
    1,754,704LONG-TERM
      LIABILITIESOther
      long-term liability
    
    
    545,000
    
    
    545,000Related
      party payable
    
    
    255,327
    
    
    303,487TOTAL
      LONG-TERM LIABILITIES
    
    
    800,327
    
    
    848,487TOTAL
      LIABILITIES
    
    
    2,690,784
    
    
    2,603,191COMMITMENTS
      AND CONTINGENCIES
    
    
    —
    
    
    —STOCKHOLDERS'
      EQUITYPreferred
      stock, $0.0001 par value;5,000,000
      shares authorized, no shares issued and outstanding
    
    
    —
    
    
    —Common
      stock, $0.0001 par value;200,000,000
      shares authorized, 10,197,996shares
      issued and outstanding
    
    
    1,020
    
    
    1,020Additional
      paid-in capital
    
    
    2,490,536
    
    
    2,469,626Retained
      earnings
    
    
    238,377
    
    
    331,865TOTAL
      STOCKHOLDERS' EQUITY
    
    
    2,729,933
    
    
    2,802,511**TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY**
    
    $
    5,420,717
    
    $
    5,405,702
  5




**VIVID
      LEARNING SYSTEMS, INC.****CONSOLIDATED
      STATEMENTS OF INCOME**Three
      Months Ended
    
    Three
      Months EndedDecember
      31, 2004
    
    December
      31, 2003(Unaudited)
    
    (Unaudited)REVENUESTraining
      subscriptions
    
    $
    631,812
    
    $
    512,321Training
      subscriptions, Fluor Hanford
    
    
    147,338
    
    
    142,363Custom
      products and services
    
    
    339,674
    
    
    298,229Custom
      products and services, Fluor Hanford
    
    
    8,864
    
    
    32,3861,127,688
    
    
    985,299COST
      OF REVENUESTraining
      subscriptions
    
    
    82,472
    
    
    71,880Custom
      products and services
    
    
    316,716
    
    
    135,273399,188
    
    
    207,153GROSS
      PROFIT
    
    
    728,500
    
    
    778,146EXPENSESMarketing
      and related labor expenses
    
    
    237,244
    
    
    242,710Reseller
      commissions
    
    
    109,182
    
    
    149,713Depreciation
      and amortization
    
    
    19,338
    
    
    24,438Wages
      and contract labor
    
    
    212,667
    
    
    88,926Other
      operating expenses
    
    
    280,390
    
    
    154,134TOTAL
      OPERATING EXPENSES
    
    
    858,821
    
    
    659,921INCOME
      FROM OPERATIONS
    
    
    (130,321
    )
    
    118,225OTHER
      INCOME (EXPENSE)Interest
      income
    
    
    270
    
    
    —Interest
      expense
    
    
    (11,597
    )
    
    (2,188
    )TOTAL
      OTHER INCOME (EXPENSE)
    
    
    (11,327
    )
    
    (2,188
    )INCOME
      (LOSS) BEFORE INCOME TAXES
    
    
    (141,648
    )
    
    116,037INCOME
      TAX BENEFIT (EXPENSE)
    
    
    48,160
    
    
    (29,009
    )NET
      INCOME (LOSS)
    
    $
    (93,488
    )
    $
    87,028BASIC
      AND DILUTED NET INCOME (LOSS) PER SHARE
    
    $
    (0.01
    )
    $
    0.01BASIC
      AND DILUTEDWEIGHTED
      AVERAGE NUMBER OF SHARES
    
    
    10,197,996
    
    
    8,100,000
  ****
 6
 ****
 **VIVID
      LEARNING SYSTEMS, INC.****CONSOLIDATED
      STATEMENTS OF CASH FLOWS**Three
      Months Ended
    
    Three
      Months EndedDecember
      31,
    
    December
      31,2004
    
    2003(Unaudited)
    
    (Unaudited)**CASH
      FLOWS FROM OPERATING ACTIVITIES:**Net
      income (loss)
    
    $
    (93,488
    )
    $
    87,028Adjustments
      to reconcile net income (loss)to
      net cash provided by operating activities:Depreciation
      and amortization
    
    
    19,338
    
    
    24,438Amortization
      of capitalized software
    
    
    72,805
    
    
    65,921Options
      issued for services
    
    
    20,910
    
    
    —Changes
      in assets and liabilities:Accounts
      and contracts receivable
    
    
    586,634
    
    
    (130,029
    )Prepaid
      expenses
    
    
    (28,145
    )
    
    5,888Other
      current assets
    
    
    (48,820
    )
    
    22,972Accounts
      payable
    
    
    62,851
    
    
    14,261Accrued
      payroll and related expenses
    
    
    (13,647
    )
    
    (10,728
    )Related
      party payables, net
    
    
    (61,547
    )
    
    —Long-term
      receivable contracts
    
    
    (477,291
    )
    
    —Other
      current liabilities
    
    
    21,478
    
    
    39,944Net
      cash provided by operating activities
    
    
    61,078
    
    
    119,695**CASH
      FLOWS FROM INVESTING ACTIVITIES:**Acquisition
      of property, equipment and intangible assets
    
    
    (18,727
    )
    
    (25,748
    )Acquisition
      of software
    
    
    (70,373
    )
    
    (165,088
    )Net
      cash used by investing activities
    
    
    (89,100
    )
    
    (190,836
    )**CASH
      FLOWS FROM FINANCING ACTIVITIES:**Overdrafts
      payable
    
    
    —
    
    
    7,468Proceeds
      from related party line of credit
    
    
    65,071
    
    
    23,052Net
      cash provided by financing activities
    
    
    65,071
    
    
    30,520Net
      increase (decrease) in cash
    
    
    37,049
    
    
    (40,621
    )Cash
      at beginning of period
    
    
    49,451
    
    
    11,612Cash
      at end of period
    
    $
    86,500
    
    $
    (29,009
    )SUPPLEMENTAL
      CASH FLOW INFORMATION:Interest
      paid
    
    $
    11,597
    
    $
    2,188Income
      taxes paid
    
    $
    —
    
    $
    —NON-CASH
      TRANSACTIONS:Options
      issued for services
    
    $
    20,910
    
    $
    —
 ****
 7
 ****
 **VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**
   - **BUSINESS
ORGANIZATION**





Nature
of Operations


Vivid
Learning Systems, Inc. (hereinafter “Vivid Washington”) was incorporated in 1995
in the State of Washington under the name of Applied TecKnowledgey, and was
shortly thereafter renamed Vivid Concepts, Inc. Prior to December 23, 2003,
Vivid Washington was a wholly owned subsidiary of Nuvotec, Inc., a technology
commercialization corporation based in Washington State. On December 23, 2003,
Nuvotec, Inc., exchanged all of its 7,000,000 common stock shares in Vivid
Washington for 8,100,000 shares of common stock with a par value of $0.0001 in a
newly formed Delaware corporation also named Vivid Learning Systems, Inc. The
Delaware company (“Company” or “Vivid Delaware”) serves as the holding company
and parent and sole shareholder of the operating entity (“Vivid Washington”).
The common stock of the Delaware company was held 100% by Nuvotec, Inc., until
an additional 1,987,996 of the Company’s common stock was issued in a private
placement to approximately seventy individual shareholders at September 30,
2004. Vivid Washington develops and provides computer-based training products
and services, which are marketed nationally. The reorganization caused no change
in the accounting in the financial statements of Vivid Washington as Vivid
Washington continues to be the operating company and the financial information
provided is the historical financial information of Vivid Washington. Vivid
Delaware and its subsidiaries have a year end of September 30.





Basis
of Presentation


The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting priciples for interim financial
information and the instructions to Form 10-QSB and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a fair
presentation of interim results have been included. Operating results for the
three months ended December 31, 2004 are not necessarily indicative of the
results that may be expected for the fiscal year ending September 30, 2005. For
further information, refer to the Company’s consolidated audited financial
statements and footnotes thereto.





Certain
prior year amounts may have been reclassified to conform to the current period’s
presentation.




**NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





This
summary of significant accounting policies is presented to assist in
understanding the financial statements. The financial statements and notes are
representations of the Company’s management, which is responsible for their
integrity and objectivity. These accounting policies conform to accounting
principles generally accepted in the United States and have been consistently
applied in the preparation of the financial statements.





8





**VIVID
LEARNING SYSTEMS, INC.**


**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**


**December
31, 2004**




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 intercompany accounts and
transactions. The wholly owned subsidiaries of the Company are Vivid Washington,
Inc., and ImageWorks Media Group, Inc.





Earnings
Per Share


The
Company has adopted Statement of Financial Accounting Standards No. 128, which
provides for calculation of "basic" and "diluted" earnings per share. Basic
earnings per share for Vivid includes no dilution and is computed by dividing
net income available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted earnings per share reflect the
potential dilution of securities that could share in the earnings of an entity.
There were 716,834 and 882,353 common stock equivalents outstanding at December
31, and September 30, 2004, respectively. Earnings per share at December 31 and
September 30, 2004 reflect the forward stock split which occurred on November
25, 2003.





Management
Services Provided by Nuvotec


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





Provision
for Taxes


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





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





9


****
**VIVID
LEARNING SYSTEMS, INC.**
**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
**December
31, 2004**





Recent
Accounting Pronouncements


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




In
December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 152, which amends FASB statement No. 66,
“Accounting for Sales of Real Estate,” to reference the financial accounting and
reporting guidance for real estate time-sharing transactions that is provided in
AICPA Statement of Position (SOP) 04-2, “Accounting for Real Estate Time-Sharing
Transactions.” This statement also amends FASB Statement No. 67, “Accounting for
Costs and Initial Rental Operations of Real Estate Projects,” to state that the
guidance for (a) incidental operations and (b) costs incurred to sell real
estate projects does not apply to real estate time-sharing transactions. The
accounting for those operations and costs is subject to the guidance in SOP
04-2. This statement is effective for financial statements for fiscal years
beginning after June 15, 2005. Management believes the adoption of this
statement will have no impact on the financial statements of the
Company.




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


****
10
****
**VIVID
LEARNING SYSTEMS, INC.**
**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
**December
31, 2004**





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





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







Reseller
Commissions


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





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





11


****
**VIVID
LEARNING SYSTEMS, INC.**
**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
**December
31, 2004**





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





Software
Development Costs


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





Production
costs incurred subsequent to the establishment of technological feasibility are
capitalized. Also capitalized are the component costs incurred associated with
the development of product templates in accordance with Statement of Financial
Accounting Standards No. 86, which consist primarily of labor related costs. As
revenue generation commences on specific training content, additional costs
incurred are classified as maintenance expense, or customer marketing expense,
in the period they are incurred. Hours expended via time sheets, and costs
incurred by production personnel on lesson content development on a per lesson
basis are maintained so that cost efficiency in software content development can
be analyzed on a lesson content by lesson content basis. Net realizable value is
determined by comparing the unamortized cost of each developed software lesson
content and the remaining available market (quantified by dollars) for that
content in the industry in which Vivid is selling the content. The unamortized
software development cost is then aggregated by lesson content and a grand total
is compared to the total remaining available aggregate market for the content to
determine if a write-down is required. The Company’s amortization method assumes
that sales of the Company’s existing software products will continue for at
least the ensuing five years. For the three months ended December 31, 2004 and
2003, $72,806 and $65,922 of amortization expense were recorded, respectively.





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





December
      30, 2004
    
    September
      30,2004Software
      development costs
    
    $
    3,182,387
    
    $
    3,101,164Accumulated
      amortization
    
    
    (1,491,161
    )
    
    (1,416,758
    )$
    1,691,196
    
    $
    1,684,406





12





**VIVID
LEARNING SYSTEMS, INC.**
**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
**December
31, 2004**





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





The
amount charged to amortization expense for the three months ending December 31,
2004 was $72,806. The amount written down to net realizable value during this
period was zero. The amount charged to amortization expense for the three months
ending December 31, 2003 was $65,922. The amount written down to net realizable
value during this period was zero.





Use of
Estimates


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





Revenue
and Cost Recognition


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





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





Training
revenues are recognized at the time of shipment of products or performance of
contracted services. Products are shipped FOB shipping point and title passes
upon shipment. Training contracts may contain elements of both custom contract
work (contracted services) and subscription arrangements (delivery of training
products). Training subscription revenues are recorded when collection of the
subscription is highly probable and no significant Company obligations remain
after the product has been delivered. The Company defers revenue recognition on
training contracts related to payments received during the current period for
the portion of the subscription contract that extends into future periods. At
December 31, 2004 and September 30, 2004, no subscription contracts were paid in
advance. In accordance with EITF 01-14, the Company’s reimbursable costs are
recorded as gross revenue, with the actual costs recorded as a direct
cost.





The
Company’s internet sales are less than .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.


****
13
****
**VIVID
LEARNING SYSTEMS, INC.**
**CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
**December
31, 2004**





The
Company does not offer warranties or returns.





Royalty
expenses


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




**NOTE
3 - RELATED PARTY TRANSACTIONS**





The
Company was awarded a three-year contract with a minimum value of $1,708,353
with Fluor Hanford, Inc., a Nuvotec, Inc. shareholder, for the period from
October 2002 to September 30, 2005. The Company provides computer-based training
monthly for the employees of Fluor Hanford, Inc. and its contractors. The
accounts receivable due from Fluor Hanford at December 31, and September 30,
2004, was $1,051 and $59,035 respectively. Revenue from Fluor Hanford for the
three months ended December 31, September 30, 2004 $156,202 and $174,749,
respectively.





The total
amount payable by Vivid on the line of credit at December 31 and September 30,
2004 was $854,718 and $772,025, respectively. The portion of drawing on the line
of credit attributed to Nuvotec as of December 31 and September 30, 2004 was
$144,884 and $227,577 leaving $398 available for use by either company at
December 31, 2004.





At
December 31, and September 30, 2004, the recorded related party payable
consisted of $854,718 and $772,025 of borrowing from the line of credit and
$33,783 and $51,405 of management fees allocated and expenses paid on behalf of
Vivid, by the majority shareholder, Nuvotec, Inc.




**NOTE
4 - STOCKHOLDERS’ EQUITY**





The
Company has authorized 5,000,000 shares of $0.0001 par value preferred stock,
which may be issued in one or more series. The Company’s board of directors is
also authorized to determine or alter the rights, preferences, privileges and
restrictions granted to or imposed upon any series of preferred stock. At
December 31 and September 30, 2004, no preferred stock has been issued by the
Company.





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





14





**VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**





On
December 23, 2003, the Company’s board of directors authorized several
transactions. The maximum number of authorized common stock shares of the
Company was increased to 200,000,000. The Company authorized a forward split of
the Vivid Learning Systems, Inc. common stock, such that the major shareholder,
Nuvotec, Inc. had 8,100,000 (restated) shares at September 30, 2003. Finally, a
stock option plan was approved with an option pool of 2,400,000 common stock
shares. Those shares will be available to employees, consultants and others
under the plan. All references to authorized and issued common and preferred
stock have been changed to reflect these board actions. The stock option plan is
more fully described below.




**NOTE
5 -- STOCK-BASED COMPENSATION**





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





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





The
following is a summary of stock option activity:





Equity
      compensation plans not approved by shareholders
    
    Number
      of securities to be issued upon exercise of outstanding
      options
    
    Weighted-average
      exercise price of outstanding options
    
    Number
      of securities remaining available for future issuance under equity
      compensation plans2003
      Stock Option Plan
    
    
    716,834
    
    $
    0.25
    
    
    1,683,166Total
    
    
    716,834
    
    
    
    
    
    1,683,166




15




**VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**


Number
      of Shares
    
    Weighted
      Average Exercise PriceOutstanding
      at September 2003
    
    
    —
    
    $
    —Granted
    
    
    866,334
    
    
    0.25Exercised
    
    
    —
    
    
    —Outstanding
      at September 30, 2004
    
    
    866,334
    
    $
    0.25Options
      exercisable at September 30, 2004
    
    
    —
    
    $
    —Granted
      during the threeMonths
      ended December31,
      2004
    
    
    —Expired
      or Terminated
    
    
    149,500
    
    
    0.25Options outstanding
      at December
      31, 2004
    
    
    716,834
    
    
    0.25Options
      exercisable atDecember
      31, 2004
    
    
    —




**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, 2004 and 2003, services
provided to these contractors aggregated $157,517 and $280,261, **** representing
14% and 28% of total revenue, respectively. At December 31, 2004 and 2003,
amounts due from these contractors are included in accounts receivable in the
amounts of $11,680 and $85,275, respectively.





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:




16


****
 **VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**


3
      Months EndingDecember
      31,2004
    
    3
      Months EndingDecember
      31,2003Revenues—Fluor
      Hanford
    
    $
    152,300
    
    $
    174,749Revenues—ERG
      (State
      of PA)
    
    $
    31,104
    
    $
    115,360Accounts
      Receivable
      Fluor
      Hanford
    
    $
    1,051
    
    $
    51,108Accounts
      Receivable
      ERG
      (State of PA)
    
    $
    327,344
    
    $
    35,550


The
Company maintains cash in a money market account at a bank in Washington State.
The funds on deposit are not insured by the FDIC and, accordingly, a total of
$22 and $111 is at risk at December 31, and September 30, 2004,
respectively.




**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 2004 and 2003,
the Company incurred $8,315 and $366 in royalty obligations, respectively, which
are recorded in marketing expense. At December 31, and September 30, 2004 the
Company accrued $11,239 and $11,202, respectively, in royalty obligations which
are recorded in other current liabilities on the balance sheet.




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





The
Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
(hereinafter “SFAS No. 131”) **** during
the year ended September 30, 2002. SFAS No. 131 established standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports issued to stockholders. It also established standards for related
disclosures about products and services and geographic areas. Operating segments
are defined as components of an enterprise about which separate financial
information is available, evaluated regularly by the chief operating decision
makers, or a decision making group, in deciding how to allocate resources and in
assessing performance. The Company has three operating segments at December 31,
and September 30, 2004: corporate training subscriptions; custom products and
services; ImageWorks-related revenues.





Segment
information (after intercompany eliminations) for the three months ended
December 31, 2004 and 2003 are as follows:




17


****
 **VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**


December
      31,
    
    December
      31,2004
    
    2004Revenues:Corporate
    
    $
    -
    
    $
    -Training
      subscriptions
    
    
    779,150
    
    
    654,684Custom
      products and services
    
    
    68,291
    
    
    330,615**ImageWorks**
    
    
    280,247
    
    
    -**Total
      Revenues**
    
    $
    1,127,688
    
    $
    985,299Operatingincome
      (loss):Corporate
    
    $
    (755,212
    )
    $
    (662,109
    )Training
      subscriptions
    
    
    581,742
    
    
    582,804Custom
      products and services
    
    
    (152,396
    )
    
    195,342**ImageWorks**
    
    
    184,218
    
    
    -**Income
      before income taxes**
    
    $
    (141,648
    )
    $
    116,037


December
      31,
    
    September
      30,2004
    
    2004Identifiable
      assets:Corporate
    
    $
    5,214,785
    
    $
    5,127,797Training
      subscriptions
    
    
    -
    
    
    -Custom
      products and services
    
    
    -
    
    
    -ImageWorks
    
    
    205,932
    
    
    277,905**Total
      Identifiable Assets**
    
    $
    5,420,717
    
    $
    5,405,702Depreciation
      and amortization:Corporate
    
    $
    13,089
    
    $
    2,640Training
      subscriptions
    
    
    -
    
    
    -Custom
      products and services
    
    
    -
    
    
    -**ImageWorks**
    
    
    6,249
    
    
    21,798**Total
      Depreciation and Amortization**
    
    $
    19,338
    
    $
    24,438


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





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




18


****
 **VIVID
LEARNING SYSTEMS, INC.**
 **CONDENSED
NOTES TO THE CONSOLIDATED FINANCIALS STATEMENTS**
 **December
31, 2004**


**NOTE
9- SUBSEQUENT EVENTS**





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




19




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





**Critical
Accounting Policies**





The
preparation of our consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires us to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The estimates and assumptions are evaluated
on an ongoing basis and are based on historical experience and on various other
factors that are believed to be reasonable. Accounts significantly impacted by
estimates and assumptions include, but are not limited to, fixed asset lives,
recovery of long-lived assets and income taxes. If we had made different
estimates or assumptions, our results of operations would have been affected.





We
believe that the following items, although not exclusive, represent our more
critical accounting policies and estimates used in the preparation of our
consolidated financial statements.





Below is
a summary of the Company’s major accounting policies.





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





Accounts
Receivable—The Company carries its accounts receivable at net realizable value.
On a periodic basis, the Company evaluates its accounts receivable and considers
the need for an allowance for doubtful accounts, based on the Company’s past and
expected collections, and current credit conditions. Most receivables result
from contracted subscriptions and services with large, established customers,
including the federal and state governments. As of September 30, 2004 all
Company receivables are considered collectible and no valuation allowance is
deemed necessary.





Advertising—Advertising
costs are charged to operations in the year incurred.





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. See Note 4 to the Financial
Statements.




Reseller
Commissions—These Commissions are recorded as an expense if the cumulative
affirmative impact of indicators of gross revenue reporting, as outlined in EITF
99-19, Indicators 7-14, are met by the Company in the transaction. The Company
pays each of the channel partners a commission, or a referral fee, recorded as a
selling expense, strictly on a success basis as a result of selling the
Company’s products and services to third party customers. The Company has
contractual arrangements with each of these partners that range from one to two
years. The Company pays these partners a referral fee, or a commission, of
between five and fifty percent of net revenue depending upon their annual sales
levels and other criteria. None of these U.S.-based contracts is exclusive, or
restricts the Company from selling directly or through other channel partners
into any markets. The Company does have one contract in place with a European
reseller that is country-specific, exclusive, and has a duration of two years.
Such expenses paid to resellers are recorded as a reduction to the underlying
selling price if the cumulative affirmative impact of indicators of net revenue
reporting, as outlined in EITF 99-19, Indicators 15-17 are present in the
transaction. The Company does not provide any consideration to end-users other
than negotiated price discounts for subscriptions based on the size of the
contract. Contract size is defined by the number of employees (seats), number of
lessons and length of the contract.





20





Royalty
Expenses—Royalty payments are recorded as an expense if ownership of the
training content does not reside with the Company in a licensing fee arrangement
between the Company and the owner of the content.





Compensated
Absences—The Company leases all of its employees from Human Resource Novations,
Inc., a professional employer organization. Leased employees are entitled to
paid personal time, which is accrued in the accounts as a current expense and
liability, dependent upon the length of service.





Software
Development Costs—Costs incurred for the internal development of software
training content and enhancements, after technological feasibility has been
established for the related content, are capitalized and stated at the lower of
cost or net realizable value. Amortization is provided based on the
straight-line method over the remaining economic life of the software training
content, not to exceed five years.





Property
and Equipment—Property and equipment are stated at cost. Depreciation is
provided using the straight-line method over the remaining useful live of the
assets, ranging from three to ten years. The Company evaluates the
recoverability of property and equipment when events and circumstances indicate
that such assets might be impaired. The Company determines impairment by
comparing the undiscounted future cash flows estimated to be generated by these
assets to their respective carrying amounts. Maintenance and repairs are
expensed as incurred. Replacements and betterments are capitalized. The cost and
related reserves of assets sold or retired are removed from the accounts, and
any resulting gain or loss is reflected in results of operations.




Principles
of Consolidation—The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries, after elimination of the
intercompany accounts and transactions.





Provision
for Taxes—Current tax provisions represent the federal income tax the Company
would have incurred on a separate, stand-alone 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.” 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.


****


21


****


**Results
of Operations:**





**Three
Months Ended December 31, 2004 as compared to the Three Months Ended December
31, 2003:**





**Revenues:**





Overall
revenues increased 14% to $1,127,688 in the first quarter of fiscal year 2005
from $985,299 in the first quarter of fiscal year 2004. The increase was due to
the revenues attributable to subsidiary, ImageWorks Media Group, Inc.
(“ImageWorks”) of $280,247 during the first quarter of fiscal 2005, which
revenue stream was not available to the Company during the same quarter in 2004
because the subsidiary was not acquired until May, 2004. If the revenues from
the subsidiary ImageWorks are excluded for comparison purposes, overall revenues
decreased by 14% in comparing the two quarters due to a reduction in custom
products and services revenue.





Training
subscription revenues increased by 19% to $779,150 in the first quarter of
fiscal year 2005 from $654,684 in the first quarter of fiscal year 2004 because
of increasing subscription based customers in the comparison of the two
quarters.





Custom
products and services revenues increased overall by 5% to $348,538 in the first
quarter of fiscal year 2005 from $330,615 in the first quarter of fiscal year
2004. However, custom products and services revenues decreased during the first
quarter of fiscal year 2005 if the revenues from ImageWorks are excluded,
because of reduced custom revenue earned from a large east coast customer, ERG,
and the reduction of contracted federal custom work on the Hanford Site in
Richland, WA from the Department of Energy and their subcontractors.





**Operating
Expenses**





Cost of
Revenues:





Overall,
cost of revenues increased by 92% to $399,188 in the first quarter of fiscal
year 2005 from $207,153 in the first quarter of fiscal year 2004. The increase
is due to a larger proportionate share of lower margin custom products and
services revenues as compared to training subscription revenues in comparing the
first quarter of fiscal 2005 to the first quarter of fiscal year 2004. Much of
the proportionate increase in custom products and services revenue in the first
quarter of fiscal year 2005 is attributable to the newly acquired subsidiary,
ImageWorks.





Training
subscription cost of revenues increased by 15% to $82,472 in the first quarter
of fiscal year 2005 from $71,880 in the first quarter of fiscal year 2004. This
increase is due to increased training subscription revenues in comparing the two
quarters. The increased expenses associated with cost of training subscription
revenues translated into no reduction in the gross profit margin of 89% of
training subscription revenues in comparing the two quarters due to the increase
in training subscription revenues in the first quarter of fiscal year 2005
compared to the first quarter of fiscal year 2004.





22





Custom
products and services cost of revenues increased by 134% to $316,716 in the
first quarter of fiscal year 2005 from $135,273 in the first quarter of fiscal
year 2004. The increase is partially due to the new costs of revenue
attributable to the ImageWorks operation of $96,029 in the first quarter of
fiscal 2005. Also, significant expenses were incurred in building the
infrastructure of the custom products and services operating segment, which had
the effect of increasing the direct costs attributable to custom products and
services revenues in the first quarter of fiscal year 2005. These infrastructure
expenses included increased salaries of newly acquired production personnel and
technical assistance support for custom projects.





Marketing/Reseller
Commissions:





Marketing
and reseller commission expenses decreased by 12% to $346,426 in the first
quarter of fiscal year 2005 from $392,423 in the first quarter of fiscal year
2004. The decrease is mainly attributable to a 27% reduction in commissions paid
to resellers to $109,182 in the first quarter of fiscal year 2005 from $149,713
in the first quarter of fiscal year 2004. The reduction in commissions paid to
resellers is the result of an increase in the proportion of direct sales to
total sales in the first quarter of fiscal year 2005.





Depreciation
and Amortization:





Depreciation
and amortization decreased by 21% to $19,338 in the first quarter of fiscal year
2005 from $24,438 in the first quarter of fiscal year 2004 due to an increase in
fully depreciated assets in comparing the two quarters.





General
and Administrative Expenses:





General
and Administrative expenses increased by 103% to $493,057 in the first quarter
of fiscal year 2005 from $243,060 in the first quarter of fiscal year 2004. The
significant expense categories of increase in comparing the first quarters of
fiscal year 2005 to 2004 are labor, professional fees, rents, and insurance. The
labor increase ($212,038 in the first quarter of fiscal year 2005 compared to
$88,926 in the first quarter of fiscal year 2004) is due to additional labor
support via the hiring of new employees, especially in management, to meet the
internal administrative needs of a growing operation. The increase in
professional fees ($56,597 in the first quarter of fiscal year 2005 compared to
$17,766 in the first quarter of fiscal year 2004) is related to increased
auditing, board, and legal fees associated with becoming a publicly traded
entity. The increase in rents ($57,245 in the first quarter of fiscal year 2005
compared to $14,143 in the first quarter of fiscal year 2004) is due to the
expiration of rent abatement from the landlord, Port of Benton, in the current
fiscal year. The increase in insurance (112% increase to $14,041 in the first
quarter of fiscal year 2005 compared to $6,613 in the first quarter of fiscal
year 2004) is due to new premiums for directors and officers liability coverage
and an overall increase in liability coverage requirements for becoming a
publicly traded entity.


****


23


****


**Income
from Operations**





Income
from Operations decreased by $248,546 to ($130,321) in the first quarter of
fiscal year 2005 from $118,225 in the first quarter of fiscal year 2004.
Principally, the decrease is due to increased direct and general and
administrative expenses in the comparison of the two quarters.





**Other
Income (Expense)**





The main
increase in other expenses is attributable to interest expense on the line of
credit in the first quarter of fiscal year 2005 compared to 2004. Interest
expense on the line of credit was $11,597 in the quarter ended December 31, 2004
compared to $2,188 in the quarter ended December 31, 2003. The line of credit
was utilized more frequently to finance the timing of expenses incurred in the
expansion of the operation in the first quarter of fiscal year 2005 compared to
fiscal year 2004.





**Net
Income (Loss)**





The
operation sustained a loss of $93,488 in the first quarter of fiscal year 2005
compared to a profit of $87,028, or 9% of revenues, in the first quarter of
fiscal year 2004. The decrease in net income of $180,516 is due to increased
infrastructure expenses to meet the needs of an expanding
operation.





**Seasonality
and Other Factors Affecting Quarterly Results**





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





**Liquidity
and Capital Resources**





Historically,
the Company has financed its cash flow requirements through the management of
its line of credit and cash generated from operations. As of December 31, 2004,
the Company had cash and cash equivalents of $86,500 as compared to $49,451 as
of September 30, 2004.





Cash
flows provided by operating activities amounted to $61,078 in the first three
months of fiscal year 2005 compared to $148,704 in the same period of fiscal
year 2004. The main reason for the reduction is attributable to the net loss of
$93,488 sustained by the Company in the first quarter of fiscal year 2005.





Cash
flows used in investing activities decreased by $101,736 to $89,100 in the first
quarter of fiscal year 2005 from $190,836 in the first quarter of fiscal year
2004. The decrease is attributable to lower expenditures related to the
acquisition of software and internally developed software as a result of a
reduction in cash resources generated by the operation.





24





Cash
flows provided by financing activities increased by $34,551 to $65,071 in the
first quarter of fiscal year 2005 compared to $30,520 in the first quarter of
fiscal year 2004. The increase is attributable to a greater reliance upon the
line of credit to assist in financing the operation.





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





**ITEM
3. CONTROLS AND PROCEDURES**





Our chief
executive officer and chief financial officer evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934) as of the end of the three month period ended
December 31, 2004. 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.


****


25


****


**PART
II - OTHER INFORMATION**





**ITEM
4.** **SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HO** **LDERS.**





(a)
    On
      January 26, 2005, the annual meeting of shareholders took
      place.





(b)
    The
      meeting involved the election of directors. The following directors were
      elected at the meeting. These individuals represent all of the directors
      of the Company.





Robert L.
Ferguson [three year term]  8,744,000
votes


William
N. Lampson [one year term]  8,748,000
votes


Steven
Katz [two year term]   8,744,000
votes


Kevin A.
Smith [three year term]   8,748,000
votes


Andrew A.
Thoresen [one year term]  8,744,000
votes


Robert J.
Turner [two year term]   8,748,000
votes





(c)
    The
      additional matter voted on at the January 26, 2005 annual meeting was the
      “2003 Vivid Learning Systems Stock Option Plan.” The Plan was approved
      with 8,630,000 votes. There were no votes cast against approval of the
      Plan. There were 1,567,996 votes that were not
cast.





**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





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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:
      March 24, 2005
    **Vivid
      Learning Systems, Inc.**By:
    /s/ Kevin A. SmithKevin
      A. SmithPresident
      andChief
      Executive Officer




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