**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**(Mark One)**

| **x** | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|-----------------------------------------------------------------------------------------------------|

 

**Forthe fiscal year ended December 31, 2006**

**Commissionfile number 0-21421**

**VCAMPUS CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                              |   | **54-1290319**       |
|-------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer     |
| incorporation or  organization)           |   | Identification  No.) |
|                                      |   |                 |
| **1850  Centennial Park Drive**           |   | ** **           |
| **Suite 200**                        |   |                 |
| **Reston,  Virginia**                     |   | **20191**            |
| (Address of  principal executive offices) |   | (Zip Code)           |

 

**Registrant’s telephonenumber, including area code: 703-893-7800**

**Securities registeredpursuant to Section 12(b) of the Act:**

**None**

**Securities registeredpursuant to Section 12(g) of the Act:**

**CommonStock ($0.01 par value per share)**

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes  o   No  x

Indicate by check mark if theRegistrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes  o   No  x

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

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

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large AcceleratedFiler  o      AcceleratedFiler  o      Non-AcceleratedFiler  x

The aggregate market value of thecommon stock held by non-affiliates of the registrant based upon the closingprice of the common stock of $0.16 per share on March 22, 2007 on theNasdaq OTC Bulletin Board was approximately $1,456,060 as of such date (andapproximately $2,394,789, based on $0.30 closing price, as of June 30,2006, the last business day of the registrant’s most recently completed secondquarter). Shares of common stock held by each executive officer and directorand by each person known by the registrant who owns 10% or more of theoutstanding common stock have been excluded in that such persons may be deemedto be affiliates. This determination of affiliate status may not be conclusivefor other purposes.

As of March 22, 2007, theregistrant had outstanding 10,925,423 shares of common stock.

 

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**NOTE REGARDING FORWARD-LOOKING STATEMENTS**

*Statementsin this Annual Report on Form 10-K that are not descriptions ofhistorical facts are forward-looking statements that are subject to risks anduncertainties. Actual events or results could differ materially from thosecurrently anticipated due to a number of factors, including those set forthherein and in VCampus’ other SEC filings, and including, in particular:uncertainties relating to our ability to continue as a going concern; ourhistory of losses and negative operating cash flows; future capital needs anduncertainty of additional funding; limited liquidity for our shares on the OTCBulletin Board; dependence on significant customers; substantial dependence oncourseware and third party courseware providers; substantial dependence onthird party technology; risks associated with acquisitions (including theintegration of Prosoft), dependence on online distribution; potential internetregulation;  our dependence on keypersonnel; intense and increasing competition; a developing market; and  rapid technological changes and new products.*

**PART I**

**Item 1.**                        Business

VCampus Corporation is a provider of comprehensive,outsourced e-Learning services. We develop courseware and manage and hostInternet-based learning environments that help professional credentialing andcertification organizations, corporations, government agencies and associationsunlock the value of their traditional branded course content. Our servicescover a broad range of e-Learning programs, from registration, enrollment andcourse delivery to custom course development, e-commerce and publishing, aswell as tracking of students’ progress, reporting of results and production ofcertificates of completion. VCampus was incorporated in Virginia in July 1984and reincorporated in Delaware in March 1985.

Through proprietary software, we provide customers withcomprehensive services on an outsourced, or hosted, basis. Our goal is to bethe leading service provider of integrated e-Learning services by helpingcustomers improve their performance and achieve their goals. We believe thatour outsourced hosting approach to web-based e-Learning services providessignificant business advantages to our customers, including lower life-cyclecosts compared to the cost for customers to provide it for themselves.

Beginning in 2004, we have shifted our emphasis to focus onour Select Partner program business model and away from our former, orLegacy, business model. Under the Select Partner program, we develop onlinecourses for Select Partners that provide professional credentials orcertifications or the training for such credentials and certifications that aredemanded by the markets served by their members or target audiences. We designand build courses based upon each Select Partner’s existing course materialsand/or content, which they have historically delivered or published in atraditional textbook or classroom-based manner, and convert them intointeractive, e-Learning courses. Some of our Select Partners advance funds tocover some or all of the development expenses. For others, we develop thecourses at our expense. In return, each Select Partner generally enters into anexclusive, long-term contract for VCampus to host and deliver the courses tothe Select Partner’s members or target audience. As part of this program, weshare the gross revenue generated from these courses with the Select Partner.

We also continue to maintain customers under our Legacybusiness model. Under this model, we charge customers a relatively low upfrontfee to establish a customized virtual campus, or “VCampus,” and then chargecustomers on either a subscription (set fee per period) or usage (charge foractual courses delivered) basis. We are in the process of leveraging ourexperience in the certification and certification-related fields, both throughour Select Partner model and through our Prosoft subsidiary, to create a strongpresence in the certification market. Approximately 19% of our revenue for theyear ended December 31, 2005 was derived from the Select Partner model and 81%from our Legacy business model. Approximately 55% of our revenue for the yearended December 31, 2006 was derived from our certification related business(through Select Partner online tuition and sales of Prosoft products) and 45% fromour Legacy business model (through learning portal revenues which consist ofonline hosting and tuition revenues for 

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third parties and development andother revenues which are derived from our delivery of professional services).We anticipate that the percentage of revenue derived from our certificationrelated business model will increase over time as we exploit the synergies withProsoft and as revenue from Legacy customers stabilizes.

Under the Select Partner model, we target the market forprofessional and technical credentials, certifications and continuing educationsupporting those certifications and credentials. Our primary marketing goalsare to identify and partner with certification and credentialing organizationswith: (1) 10,000 or more members; (2) a growing demand for theirsubject matter, body of knowledge or certification; (3) successfulinstructor-led education programs; and (4) minimal online educationpresence. We offer these organizations the opportunity to grow their revenuesby leveraging and scaling their existing instructor-led programs through ouroutsourced e-Learning offering. Under a typical Select Partner agreement, weenter into an exclusive e-Learning relationship with the partner for three tofour years, and we typically share the revenue from online sales equally with thepartner in return for our development of the courses from the partner’scontent. Historically, there has been no charge to the partner for the coursedevelopment except for the cost of providing subject matter experts to assistin design, development and review of the online course. However, we havetransitioned to a model where we expect our partner to contribute 50% or moreto the cost of their courseware development. This new expense-sharing modelhelps to ensure the partner has a vested interest in the success of the course.VCampus and the partner typically co-own the completed online course. TheSelect Partners can therefore repurpose their highly-demanded training coursesfor online delivery to enhance and support their professional development programs.The Select Partners benefit from our expert course development, publishing,hosting, e-commerce, reporting and account support and marketingservices. We enable these organizations to add online learning quickly,efficiently and relatively inexpensively. The Select Partner program enables usto reach these targeted markets through courses exclusively available on ourplatform. As of March 2007, we had 16 Select Partners, through which wehave released a total of 33 course titles and three exams and have alsoconverted 27 course titles from another hosting platform to ours. Under thisprogram, we have delivered more than 9,000 courses since completion of thepilot program in the fall of 2003.

Under our Legacy business model, our primary targets are thecorporate, government and association member training markets. Since we arephasing out the Legacy model, we no longer devote significant resources tomarketing to this market, except with respect to the U.S. government whichcontinues to offer attractive opportunities for, not only hosting, but also asa potential user of our Select Partner courses. We offer a full spectrum ofservices to federal government agencies through our Legacy business model andpackaged as “e-Learning Solutions” to reflect our comprehensive new approach toe-Learning in which our Legacy hosting has now become just one component. Inaddition, we offer course development, custom configurations, and integrationto third party offerings of content and services.

As of March 2007, under the Legacy model we offer morethan 3,900 online course titles and have delivered more than 3.2 millioncourses to more than 1.1 million desktops/users since inception of the programin 1997.

**Our ProsoftSubsidiary**

In June 2006, in furtherance of our long-standing planto develop a Select Partnership to target certifications in the Web-Technologyand Telecommunications Convergence areas, we acquired Prosoft LearningCorporation. The acquisition is a result of further refinement of our SelectPartner model, based on more than three years of experience. Under our revisedmodel, we concluded that, whenever possible, it is far more attractivefinancially to own and control the certifications rather than share revenueswith third parties who own them. This event is very important for VCampus, asnow we have become a certifying body in two of the most promising growth areas:(1) the Web, which is becoming increasingly sophisticated as a new medium;and (2) the convergence of voice, video and data over the Web. Through ouracquisition 

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of Prosoft, we have added, as asupplement to our portfolio of certifications, the market-leading CIW(Certified Internet Web Professional) certification and the CTP (ConvergenceTechnologies Professional) credential, which Prosoft manages for theTelecommunications Industry Association (TIA). The CIW program is the world’slargest and fastest-growing Internet Technology certification program. As of March 2007, wehave issued more than 86,000 CIW certifications to more than 45,000 individuals.

Through Prosoft, we offer content and certifications toenable individuals to develop and validate critical Information andCommunications Technology (ICT) workforce skills. We are active in theworkforce development arena, working with state and local governments andschool districts to provide ICT education solutions for high school andcommunity college students. We have created and distribute a comprehensivelibrary of classroom and e-learning courses. We distribute our content through Prosoft’sComputerPREP offerings to individuals, schools, colleges, commercial trainingcenters and corporations worldwide. We own the CIW job-role certificationprogram for Internet technologies and the CCNT (Certified in Convergent NetworkTechnologies) certificate program and manage the CTP (Convergence TechnologiesProfessional) vendor-neutral certification for telecommunications.

**MarketStrengths**

We believe our market strengths tobe:

·       our complete ownership and control of two major technologycertifications with global appeal with endorsements from major corporations;

·       our potential addressable market of millions of students inthe 15-25 age group, as well as adult learners in career transitions orthose seeking to refresh or validate their current skill set;

·       our course delivery as a service—information utility modelthat blends online delivery and supports traditional modes such as print andclassroom instruction;

·       our full service offering including publishing of highquality online and print materials for self study, as well as to complementclassroom instruction;

·       our presence in the U.S. government market;

·       significant revenues from outside of the U.S.;

·       our proven system performance and scalability, havingdelivered more than 3.2 million courses online;

·       our exceptional customer service and relationships; and

·       our system compliance with a wide variety of industrystandards.

We believe that we hold the following key advantages in thee-Learning marketplace:

***Diversifiedbusiness base.******  ***We serve customers from awide variety of market sectors—including corporations, government agencies,associations, professional credentialing and certification organizations, andindividuals. This diversification enables us to provide our customers with theopportunity and ability to participate in and market themselves to multiplecommunities of learning. The VCampus platform enables our customers to sharecontent, thereby creating cross-sale opportunities from customer to customer.Several of our customers successfully sell their content to other VCampuscustomers simply by offering their content on the advanced VCampus platform.

***Opentechnology.******  ***Our technology affordscustomers a number of advantages in terms of its ability to rapidly andcost-effectively implement a comprehensive and secure e-Learning and trainingenvironment. Our content-neutral, open architecture platform allows for accessto a wide range of aggregated content and the ability to quickly add newfunctionality, leverage new technology and to support a vast number of users.Our web services capabilities enable customers to easily integrate ourtechnology with other existing 

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systems (including enterprise resource planning, or ERP,systems and human resource information systems).

***Extensiveexperience.******  ***We have operated in thee-Learning space for more than ten years and have delivered more than3.2 million courses to more than 1.1 million desktops/users. We maintainsolid, long-term relationships with established customers and benefit from ahighly experienced and knowledgeable management team. Our management team hascombined over 60 years of experience in the e-Learning and related technologymarket.

***Expansivelibrary of content aggregated from leading sources.******  ***Ourexisting content library includes courses from many well known providers,including SkillSoft, ElementK, PureSafety and Coastal Technologies many ofwhich are publicly available. We also distribute some courseware that has beendeveloped by our customers, such as the New York Institute of Finance and otherSelect Partners, to other VCampus customers. Our wholly-owned library oftelecommunications courses is marketed under the Teletutor brand name. Finally,our Select Partner program enables our customers to sell or use recognizedbrand credentialing and certification courseware appropriate to their marketand/or employees or members.

***Courseware developmentexperience.******  ***We have significantcourseware development experience, built over the past ten years. We haveexperienced instructional designers and project managers on staff supplementedby courseware development firms. We develop high quality courseware,implementing the latest designs for optimization of adult learning, quickly andcost effectively. The scalability of our courseware development infrastructureenables us to meet the demands of our Select Partners.

***Flexibility.******  ***Theflexibility of our technology and implementation process enables us to respondto diverse customer needs. We offer rapid implementation on a content-neutralplatform that allows access to both off-the-shelf and proprietary courseware.We offer customization of our products and services for each customer, as wellas rapid incorporation of new technologies. Our technology and services aredesigned to be scaleable on demand to meet customer needs.

***Comprehensiveservices.******  ***We offer a completely hostedas well as behind-the firewall system, accessible by virtually any web browser.Our offerings include a leading edge Learning Management System, CourseManagement System and Courseware Delivery Engine. Our technology and servicehave been proven and tested through successful implementations for scores ofcustomers, through which thousands of students have experienced VCampus-basede-Learning for up to ten years. Additionally, we continue to introduce newtechnology to provide additional features for our customers.

**Business ofProsoft**

Through our integrated Prosoft operations, we are aprovider of information and communications technology (“ICT”) curriculum andcertifications to secondary, postsecondary, vocational training, and corporatetraining institutions. Prosoft’s operations have historically been organizedinto two business segments: (a) Content Development and Distribution, inwhich Prosoft, through its ComputerPREP division, publishes and/or distributesinstructor-led courseware in topics including CompTIA (A+, Network+), Adobe,Cisco, Microsoft Office, Microsoft Technical Certifications, Linux (LPI),Oracle, convergence technology and project management, amongst others; and (b) CertificationDevelopment and Management, through which Prosoft owns and manages twoproprietary job-role certifications, Certified Internet Web Professional (“CIW”)and Certified in Convergent Network Technologies (“CCNT”), and has developedand manages the Convergence Technology Professional (“CTP”) certification programfor the Telecommunications Industry Association (“TIA”). Management operates,evaluates and reports results for both its traditional VCampus operations andits now integrated Prosoft operations as one business segment for financialreporting purposes.

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Our curriculum and certifications help individuals develop,upgrade and validate critical ICT skills. We offer more than 1,500 ICT coursesand three proprietary certification programs to more than 2,800 activecustomers in over 60 countries, including the United States, Canada, Germany,Australia, Japan, India and China. Customers include a broad variety of 4-year,community, and technical colleges, commercial learning centers, as well asnumerous corporate clients. In late 2003, Prosoft launched an initiative(described in greater detail below) focused on integrating its CIWcertification program into the academic curricula for Career and TechnicalEducation (“CTE”) programs in secondary and post-secondary institutions. Prosoftcurrently has statewide endorsements from 12 states.

*ContentDevelopment and Distribution*

We develop content for and distribute a library of morethan 1,500 courses in the ICT and business skills curriculum. Content revenueis derived from the sale of course materials in the form of books, CD-ROMs,self-study kits, assessment products, quick-reference cards, e-Learning,royalties, content licenses and custom content development. We derive themajority of our content revenue from the formerly separate Prosoft business fromthe sales of books and related materials. Royalties and content licensesrepresent a minor portion of revenue from the formerly separate Prosoftbusiness and are sold either on a one-time fee or a fee-per-use basis.

Our Prosoft content is focused on education and trainingfor job-role and vendor-specific certifications. Other products we offer assistsin developing proficiency in specific computer programs, programming languagesor operating systems. As of March 2007, our library consisted ofapproximately 1,500 unique course titles covering business skills, software andhardware products, programming, and certification programs such as CompTIA (A+,Network+), Adobe, Cisco, Microsoft Office, Microsoft Computer Professional (“MCP”),Linux Professional Institute (“LPI”), Oracle and our proprietary certificationprograms including CIW, CCNT, and CTP. Many of these titles are produced inmultiple learning modalities such as instructor-led training (“ILT”),e-Learning, and often include supplementary practice tests and quick-referenceguides. Certain of these products are also combined into a “blended learning”offering that includes ILT, e-Learning and practice tests.

We develop academic-specific ILT textbooks for our proprietarycertification programs including CIW, CCNT and CTP. We have pursued a focusedinitiative to increase revenue from the academic channel. Our educationsolutions include a classroom-based assessment that allows teachers to deliverquizzes and tests as well as control questions and monitor scores. We provideessential instructor resources such as syllabi, extra labs and other teachingaids that meet the needs of this market.

*ContentDistribution*

Through our ComputerPREP offerings, we have built adistribution network with a wide range of customers, including academicinstitutions, commercial training centers, corporate clients, and individuals. Weprovide products to a diverse client list that includes New Horizons, ThomsonLearning, CompUSA, IBM, Safeco Insurance, SBC Communications, Toshiba, AT&T, Avaya, CALPERS, the New York Stock Exchange, and a broad variety ofcommunity colleges, technical colleges and high schools. In 2005 and 2006 thelearning center channel represented approximately 38% and 32%, respectively, offiscal year content revenues for the formerly separate Prosoft operations,followed by 36% and 32%, respectively, for the academic channel and 22% and36%, respectively, for corporate customers and other.

Under our CSG initiative, we have reached agreement with 12states for the endorsement and implementation of the CIW program in theirpublic education systems. These arrangements position us to provide states,school districts and workforce development agencies with education solutionsdesigned to integrate an industry-standard certification into statewideacademic curricula. We believe we are uniquely positioned to meet the needs ofthis growing market.

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Through Prosoft, we also distribute content outside theUnited States. Although the majority of our content revenues are from theUnited States and Canada (approximately 89% in 2006), the Europe, Middle Eastand Africa (“EMEA”) market accounts for approximately 10% in 2006. We maintaina direct sales and operations presence in the EMEA region through Prosoft’s wholly-ownedsubsidiary, based in Limerick, Ireland.

*ContentDevelopment*

We have built a sizable library of proprietary contentprimarily through our internal development process. Our content developmentteam is responsible for new product development and regular updates of existingtitles in its library. The team is comprised of instructional designers,project managers, editors, publishers, and subject matter experts.

We develop our proprietary content using our ProprietaryContent Architecture (“PCA”). This modular architecture allows us to createcomprehensive products for instructors and students in both the learning centerand academic channels from a single set of underlying content. We havedeveloped and own content for all of our major Prosoft product lines includingCIW, CTP and CCNT.

***Certification Development, Ownership and Management***

We own and manage two proprietary job-role certifications,CIW and CCNT, and have developed and manage the CTP certification program forthe TIA. We develop certification exams and provide candidates with access tothese exams through commercial testing sites in the Prometric and VUE networks,each of which has testing affiliates in over 100 countries. These are the sametesting services used by other leading certification providers such as Novell,Microsoft and Cisco. As the owner and manager of the certification programs, wealso create official preparatory courseware and maintains an authorized channelof official training centers.

We develop certification exams that validate a level ofknowledge related to a set of skills or topics. The CIW program focuses oncertification for job roles such as Site Designer, Web Developer and SecurityProfessional. The CCNT program targets basic data communications, basictelecommunications and telephony, while the CTP program focuses on datanetworking, telephone networking and convergence technologies. The exams arepublished electronically through the testing provider network and cost thecandidate between $25 and $125 in the United States. Entry-level certificationsgenerally require a single exam, while professional-level certificationstypically require between three and seven exams. Our certification programshave received the support and endorsement of non-profit, widely recognizedorganizations that have important visibility and credibility among policymakers, academic institutions and industry leaders.

We also offer certification management services to organizationsand associations that wish to develop and promote their own ICT certifications.Through our successful creation and development of the CIW and CCNTcertification programs, we have proven our ability to create certifications,develop supporting content to provide education in support of thosecertifications, establish and develop proprietary distribution channels,implement testing delivery networks, build and implement certified faculty andinstructor programs, and drive content demand through certification success. Asa result of these successes, we were chosen by the TIA to develop, manage andserve as the official content provider for the CTP certification program, whichlaunched in July 2002.

We also manage an authorized channel of more than 700Authorized Training Providers (“ATPs”) and Authorized Academic Partners (“AAPs”)for CIW and CTP worldwide. Commercial channel partners generally pay a smallmembership fee for the rights to sell and teach Official Curriculum whileacademic channel partners usually agree to place a minimum courseware orderwhen joining the authorized channel program.

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*CIW*

We own both the CIW certification and the Official CIWCurriculum. With over 86,000 certifications earned through March 2007, theCIW program has become one of the largest and most recognized programs amongthe more than 300 existing ICT certifications. The CIW certification covers jobroles in network administration, security, application development,programming, Web design and e-commerce. Candidates from more than 100 countrieshave earned a CIW certification.

We seek to expand the footprint of CIW by promotingvendor-neutral job-role standards in workforce development and academiccommunities. In the United States, CIW has received support and endorsementfrom the National Workforce Center for Emerging Technology, along with 12 statewideeducational agencies. Internationally, CIW has also received recognition orendorsement from numerous educational agencies, governmental andquasi-governmental organizations.

*CCNT*

In December 2000, Prosoft acquired Mastery PointLearning Systems. Mastery Point developed the CCNT certification program underthe direction of the TIA to serve the needs of telephone companies and networkservice providers. CCNT is a vendor-neutral credential program for theconvergence technology industry that validates an individual’s knowledge ofbasic data communications, basic telecommunications and telephony. Convergencetechnology is the merging of voice, video and data on a single network,integrating telecommunications and computer technologies. This six-test low-stakesprogram is supported by both classroom and Web-based e-learning courses. Our CCNTexams and curriculum are sponsored and endorsed by the TIA.

*CTP*

Prosoft began working with the TIA in 2001 to fulfill itsmembers’ need for a convergence certification for the customer-premiseequipment side of the telecommunications industry. The CTP CertificationAdvisory Council was formed in January 2002 with representatives fromCisco, Avaya, IBM, Siemens, Nortel, Mitel and First Communications to provide assistancein creating the CTP certification exam. Prosoft created Official CTP coursewareand a CTP authorized training channel. We share testing revenue from thisprogram with the TIA. To date, CTP has been endorsed by Vertical, Cisco, Avaya,Nortel, Mitel, Inter-Tel, Iwatsu, NEC America and Toshiba as a prerequisite tothose entities’ IP telephony certifications, product certifications, or dealernetwork certifications.

**CompanyStrategy**

Our goal is to be the leading provider of courses for professionaldevelopment and for valuable credentials through optimal blending of e-Learningto complement the traditional modes of print and classroom-based instructionworldwide. Our long term growth plans are primarily based on selling CIW andCTP certifications worldwide to institutional clients; assisting our leadingSelect Partners in deploying their online courses to prepare for credentialsworldwide using our e-Learning technology platform; and serving largeenterprises such as the US government in meeting the growing needs for onlineprofessional development requirements using our CIW course content.

To implement our strategy, we plan to do the following:

***Acquire and/or Create Partnerships with Leading CredentialingOrganizations***

The Select Partner program is our core focus for expandingour business. Under this strategy, we seek to partner with organizations thatprovide highly-sought credentialing or certification services to largeaddressable markets. Our target partners currently provide most, if not all, oftheir educational programs through instructor-led programs, thus leaving anunder-addressed market opportunity for end users who 

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seek the credentialing orcertification through an online course. By developing online courses under ourSelect Partner program, we are able to address this market opportunity jointlywith these partners.

In the past four years, we formednew relationships with 16 Select Partners, the majority of which offercredentials or training for learners interested in obtaining credentials. SelectPartner relationships formed in 2003 and 2004 include:

·       the Association for Financial Professionals, 

·       PCI Global, Inc., 

·       the National Council of State Boards of Nursing, 

·       the National Contract Management Association, 

·       the American College of Forensic Examiners International, 

·       the New York Institute of Finance and 

·       Kiplinger Washington Editors, Inc.

During 2005, 2006 and the firstquarter of 2007, we formed new relationships with the following six SelectPartners:

·       Regulatory Affairs Professionals Society,

·       Sourcefire, Inc., 

·       the CFA Institute, 

·       the Emergency Nurses Association and 

·       the Institute of Management Accountants and the InformationSystems Audit and Control Association.

During 2006, we acquired Prosoft, which positions us tosubstantially further our efforts in this area. We plan to pursue acquisitionsof similar leading certifying organizations in information technology andsecurity that would enable us to better control and exploit the full marketpotential over the life cycle of a certification and the opportunity to cross-sellcontent.

*DevelopHigh Quality Courseware Quickly for Select Partners*

Addressing the market opportunity swiftly is essential to asuccessful Select Partner strategy. With more than a decade experience in thebudding e-Learning industry, we have developed the capabilities and expertiseto fulfill the course development needs of our current and new partnersquickly, while delivering superior quality. As such, we are able to work with ourSelect Partners to transform their traditional, instructor-led content intohigh-quality online courses while the market opportunity is still ripe. We useboth in-house and off-shore resources to minimize costs of development.

*ProvideSuperior Customer Service*

Our core customer service principle is to deliver uniquelysuperior service through creative, committed and well-trained employees whowork as a team. Each VCampus employee has defined roles and responsibilitiesfor monitoring and supporting the health and growth of our customerrelationships. Furthermore, each team is responsible for continuous review ofits customers’ content needs, introduction of existing and new VCampusservices, recommendation of suitable additional content, identification of thepotential need for custom courseware development and recommendation of platformconfigurations for customer-specific business processes.

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*Develop andUpgrade Proprietary Technology*

We intend to maintain our market position in onlinecourseware delivery technology by continuing to develop and enhance thefeatures and functionality of our proprietary technology. Our system isdesigned to accommodate users on both low and high bandwidth connections.Additionally, our system is completely outsourced with little or no investmentin software or hardware required of customers or students (other than access tothe Internet via a web browser).

In 2005 we released a substantially upgraded version of ourCMS and Testing software to accommodate the needs our growing user base. Ourcontinuous improvement method of technology R&D has also improved thescalability of our systems to manage over a million students taking courses onour system.

**Courseware**

*ExistingCourseware Library*

We currently offer more than 3,000 courses real-time on oure-Learning system, the majority of which are publicly-available courses. Ourcourseware strategy involves the provision of the following three components: (1) strategically-developedcourses from VCampus based on Select Partner content; (2) COTS, orcommercial off-the-shelf, courses from a variety of leading third-party coursevendors; and (3) custom courseware development for the proprietarytraining needs of our customers.

*StrategicallyDeveloped Courses*

We invest in the development of courses which we deemstrategic in nature to attract customers with strong revenue prospects.Typically, this type of course is developed in partnership with a leadingexpert in the field, typically under the Select Partner program. Content consideredfor co-development must target a large, reachable audience and offer theaudience some compelling reason to attend the course (e.g., compliance withlaws, certification, CPEs or CEUs). Examples of strategically-developed coursesinclude Information Security and Project Management courses. Courses sodeveloped may be owned, at least partially, by us.

*COTSLibrary*

The majority of the online courses delivered from ourlibrary through our e-leaning system are commercial off-the-shelf, or COTS,courses. The current library was built from a combination of acquisitions, ourown development efforts and relationships with leading content providers suchas SkillSoft, Element K, Coastal Training Technologies, PureSafety, PCI Global,Course Technology Publications, Aztec Software and the New York Institute ofFinance. Although we do not provide accreditation or certification itself, anumber of our current courses provide either accreditation or certificationthrough our content providers.

*CustomLibrary*

Our existing custom courseware library consists of onlinecourses built by our legacy corporate, government agency, and associationcustomers for their own proprietary use. Approximately 80% of these legacycustomers have such custom courses ranging from a few courses to 50 or more percustomer. We believe these courses increase customer retention and provide morelong-term revenue potential than commercial off-the-shelf courses, which havebecome commoditized.

**Customers**

Our primary target markets for our Select Partner programare professional credentialing and certification organizations, corporations,government agencies, and associations. 

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Through our integrated Prosoft operation, we serve fourmajor customer groups:  commercial learning centers, academicinstitutions, corporate clients and individuals.

*Commercial Learning Centers.*   The commerciallearning center channel is comprised of entities that provide short-formatcourses in a commercial setting to individuals and corporations. Course lengthin this channel ranges from one day to two weeks. The primary end-user customerof our channel partners is a corporation seeking specialized training ontechnical topics. This channel is highly fragmented, with the largest companiesresponsible for a small percentage of the total market. Large chains in thischannel are New Horizons, Learning Tree, and CompUSA.

*Academic Institutions.*   The academic channelis comprised of high schools, community colleges, technical and vocationalschools and other diploma or degree-granting institutions. Course length inthis channel is tied to academic semesters or quarters. This channel alsoprovides “continuing education” in a format that competes directly withcommercial learning centers. The academic channel is highly fragmented.

*Corporations.*   Internal trainingdepartments and corporate universities represent the majority of customers inthis channel. These customers typically purchase the same products ascommercial learning centers.

*Individuals.*   A small amount ofcontent revenue is generated from sales directly to individuals. These salesgenerally occur through our ComputerPREP.com website. In addition, virtuallyall certification exams are sold directly to individuals. Individuals registerand pay for exams through an authorized Prometric or VUE testing center. Individualsare not required to complete training courses or buy content prior to taking anexamination.

**Sales andMarketing**

Our primary marketing goals are to identify and attractorganizations that offer the opportunity for developing significantrelationships with us. Our principal marketing and sales focus is the SelectPartner program. Our sales force and marketing efforts target organizationsthat offer highly-sought after professional credentials or certifications toorganizations with generally at least 10,000 members. We target organizationsthat, additionally, offer little to no online learning currently to theirmembers. In turn, under this program our Select Partners become a sales andmarketing channel for the courses we jointly introduce on the VCampus platform.

In the Legacy business, our sales and marketing efforts arelimited and focused. Our primary target markets are the corporate, governmentand association member training markets. Since we are phasing out of andultimately exiting the Legacy model, we no longer devote significant resourcesto marketing to this market broadly. Instead, we focus our sales efforts onexpanding revenue from our current Legacy customers.

In addition to direct sales efforts, we market our productsand services through a variety of means, including Select Partners, the Web,public relations, trade shows, direct mail, trade publications, resellers andstrategic partners. We believe that forming strategic marketing alliances withchannel partners who will sell, promote and market our products and serviceswill be important for growth.

We sell and market our certification exams, content andintegrated courses to students primarily through a channel of academicinstitutions and commercial learning centers. As of March 1, 2007, we had14 people directly involved in sales, marketing and customer support in theUnited States, Asia, and Europe. Our customer service organization in Phoenixaccepts, enters and reviews domestic and EMEA courseware orders. Because manyof our customers need to make last-minute adjustments or wait to order coursewareuntil a few days before a class starts, our quick-response capability is acompetitive advantage. In November 2004, Prosoft signed two distributionagreements with Thomson Course Technology 

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(“Thomson”). Under the terms of thefirst agreement, Thomson will distribute the CIW Official Curriculum toacademic institutions. This relationship, rolled out to the Thomson sales forcein January 2005, gives us the opportunity to leverage Thomson’s salesforce in its marketing to the academic channel. Under the terms of the secondagreement, ComputerPREP is able to distribute up to 600 Thomson coursewaretitles, thereby significantly expanding our courseware offerings.

**Competition**

The market for online educational and training products andservices is highly competitive and will likely intensify. Although we know ofno other company offering a program substantially similar to our Select Partnerprogram, there are no significant barriers to entry in the online education andtraining market. Competition in the market is based upon various factors,including technology, course offerings, pricing, quality, flexibility,reliability of delivery system, marketing and third party relationships.

A number of companies, including SkillSoft, SumTotal Systems,Saba and Pearson, compete in this market, as well as many others. In additionto traditional classroom and distance learning providers, other institutionssuch as Apollo Group (through University of Phoenix Online) offer their ownaccredited courses online. We face competition from many other companiesoffering training and certification services and products, including theinternal training departments of corporations and publishing units of largecorporations. We compete in general ICT skills courseware with ElementK,Thomson Learning and Pearson LLC, each of which has one or more subsidiariesthat sells courseware. The trade association CompTIA offers i-Net+, acertification that competes directly with our CIW Associate certification.Trade associations such as the World Organization of Webmasters have releasedcertification exams that compete with aspects of our certification programs.Individuals can and often do earn multiple certifications, and ourcertifications focus on job skills rather than product-specific curriculaoffered by Microsoft, Cisco and other large vendors. However, these vendorshave more resources to attract candidates to their programs than we do. Manyeducation providers use some of our methods, including e-mail, bulletin boards,threaded discussion and electronic conferencing, as well as other deliverymethods such as satellite communications and audio and videotapes.

We believe that it is becoming increasingly apparent thate-Learning providers must not only remain technologically advanced, but also,more importantly, offer “complete” service offerings. This “complete serviceoffering” approach includes offering customers: access to a large library ofhigh quality, off-the-shelf courses; the ability to produce customized courses quicklyand effectively; and value-added features that allow flexibility andscalability. Additionally, successful e-Learning services must be affordable,convenient and easy to use and administer.

**Trademarksand Proprietary Rights**

We regard our copyrights, trademarks, trade dress, tradesecrets and similar intellectual property as critical to our success, and werely upon federal statutory as well as common law copyright and trademark law,trade secret protection and confidentiality and/or license agreements with ouremployees, customers, partners and others to protect our proprietary rights. Weown registered trademarks in the United States for:  VCampus Youre-Learning Partner, VSurvey, Pointpage, Content Matters, V (& design),VCampus (& design), www.vcampus.com, Select Partner and Govlearn. We havefiled intent-to-use applications for the following: VCMP, Unlock the Value ofYour Branded Content, VCampus Test Portal and VCampus ProfessionalCertification & Development Center. We have licensed the right to usethe web address www.vcmp.com. We also own numerous registered trademarks for manyof the products, logos and taglines acquired by us from Prosoft.

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**Employees**

As of March 1, 2007, we had 57 employees, consistingof 15 full-time and one part-time employee in general business operations, 18full-time employees in sales and marketing, 14 full-time employees in productdevelopment, and six full-time and three part-time employees in finance andadministration. None of our employees is represented by a union and there havebeen no work stoppages. We believe that our employee relations are good.

**Where you can find additional information**

Our websiteaddress is www.vcampus.com. We make available free of charge through ourwebsite our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K, and allamendments to those reports as soon as reasonably practicable after suchmaterial is electronically filed with or furnished to the SEC.

**Item 1A.**                Risk Factors.

This reportcontains forward-looking statements that involve risks and uncertainties. Ouractual results could differ materially from those discussed in this report.Factors that could cause or contribute to these differences include, but arenot limited to, those discussed below and elsewhere in this report and in anydocuments incorporated in this report by reference.

If any ofthe following risks, or other risks not presently known to us or that wecurrently believe to not be significant, develop into actual events, then ourbusiness, financial condition, results of operations or prospects could bematerially adversely affected. If that happens, the market price of our commonstock could decline, and stockholders may lose all or part of their investment.

***Doubts about our ability to continue as a going concern.******  ***Inconnection with our 2006 financial statements our independent registered publicaccounting firm issued an unqualified opinion containing an explanatoryparagraph that states that we have suffered recurring losses and negative cashflows, which raise substantial doubt about our ability to continue as a goingconcern. Our financial statements have been prepared assuming we will continueas a going concern, which contemplates the realization of assets and thesatisfaction of liabilities and commitments in the normal course of business. Thefinancial statements do not include any adjustments relating to the recoverabilityand classification of recorded asset amounts and the amount and classificationof liabilities that might be necessary should we be unable to continue as agoing concern. The fact that this opinion has been issued could have materialadverse effects on our business, results of operations and cash flows, bycausing parties we deal with to question our financial ability to perform our obligations.For example, one or more of our content providers and/or suppliers could decidenot to sell to us or could impose restrictive transaction terms. Financialuncertainty also could negatively affect our relationships with customers,employees and others.

***We have incurred losses and anticipate future losses, whichcould have an adverse impact on the trading price of our common stock.***   We have incurred significant losses since our inception in1984, including net losses attributable to common stockholders of $6.6 million,$5.9 million and $12.8 million for the years ended December 31, 2004,2005 and 2006, respectively.  As of December 31,2006, we had an accumulated deficit of $115.7 million, stockholders’deficit of $0.7 million and a working capital deficit of $1.5 million.We expect losses from operations to continue until our Select Partner businessmodel matures and until we complete our integration of Prosoft. For these andother reasons, we cannot assure you that we will ever operate profitably, whichcould have an adverse impact on the trading price of the shares held by ourstockholders.

***If we do not have the resources to meet our businessobjective, we might not survive or be successful.******  ***Ourkey objective is to be one of the leading providers of outsourced e-Learningservices. Pursuing this objective may significantly strain our administrative,operational and financial resources. We cannot assure 

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you that we will have the operational, financial and otherresources to the extent required to meet our business objective, which means wemight not survive or be successful.

***Failure toraise additional capital, as and when needed, could prevent us from executingour business strategy.******  ***Becausewe are not currently able to generate sufficient cash for ongoing operations,we will need to raise additional funds in the near term through public orprivate sale of our equity or debt securities or from other sources for thefollowing purposes:

·       to execute on our Select Partner business model;

·       to fund our operating expenses, including the continued integrationof Prosoft; and

We cannotassure you that additional funds will be available if and when we need them, orthat if funds are available, they will be on terms favorable to us and ourstockholders. If we are unable to obtain sufficient funds or if adequate fundsare not available on terms acceptable to us, we may be unable to repay our debtobligations or meet our business objectives. A lack of sufficient funds couldalso prevent us from taking advantage of important opportunities or being ableto respond to competitive conditions. Any of these results could have amaterial adverse effect on our business, financial condition and results ofoperations.

Our need toraise additional funds could also directly and adversely affect stockholderinvestment in our common stock in another way. When a company raises funds byissuing shares of stock, particularly at a discount to the market price, thepercentage ownership of the existing stockholders of that company is reduced,or diluted. If we raise funds in the future by issuing additional shares ofstock (as we have in the past), stockholders may experience significant dilutionin the value of their shares. Additionally, certain types of equity securitiesthat we have issued in the past, including our currently outstandingconvertible debt and our Series A-1 and B-1 Preferred Stock,and may issue in the future could have rights, preferences or privilegessenior to the rights of the holders of our common stock.

We completeda $3.0 million convertible debt financing in September 2006. We must beginrepaying this new debt obligation in August 2007. We may in the future fundthe Company with additional debt obligations which typically require payment ofprincipal and interest in cash, therefore, reducing the cash we would haveavailable to meet operating requirements. We began making quarterly principaland interest payments in cash on our outstanding convertible debt from our March 2004financing in July 2005. Cash payments for principal under these notes are$99,000 per quarter through the maturity date in April 2009. Initial cashpayments for interest under these notes were approximately $36,000 per quarterbeginning July 2005 and have been gradually reduced as the principal ispaid down. Additionally, debt obligations may make additional financingofferings more difficult to enter into which may result in less favorable financingterms for us.

***We have limited cash resources and willl need to raiseadditional funds.******  ***We are operating withlimited cash resources. Our cash resources would not be sufficient to repay theprincipal of our existing long-term debt if it should be accelerated. Additionally,a moderate change to our revenue-generating capability or expense structurecould result in increased operating losses. Increased or continued operatinglosses would erode our liquidity by further reducing cash resources and wouldresult in the need to raise additional funds even sooner than we anticipate. Inaddition, a portion of our cash resources are held in bank accounts in foreigncountries, which accounts may be subject to local currency controls andrestrictions on withdrawal. Repatriation of these funds to the United Statescould result in delays or expense.

Over thenext approximately three years both the SIAR Capital Notes and the September 2006Notes will mature and all outstanding principal and capitalized interest thereuponwill become due and payable. Although these securities are convertible intocommon stock at any time the conversion price is significantly higher than ourcurrent market price as of the date of this report. Should they not beconverted into common stock by their holders prior to their maturity dates, wemight need to seek capital 

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to refinance these debt instruments. The holders of theSIAR Capital Notes could claim that we are in default based on our granting ofa subordinate lien on our assets in favor of the September 2006 noteinvestors. In the event of default, the holders of securities subject to thenote in default could choose to accelerate the repayment of the notes, and wewould be forced to seek alternative financing at that time.

Given our relativelysmall size and historical operating results, our access to capital is limited. Weneed to raise additional funds in the near term. We cannot be certain that wewill be able to obtain them on terms satisfactory to us. If we could not raiseadditional funds on terms satisfactory to us, we would be forced to raise fundson terms that we would not otherwise accept, seek funds through other meanssuch as a sale of some or all of our assets or operations, or otherwisesignificantly alter our operating plan, any of which could have a materialadverse effect on our business, financial condition, and results of operations.

***With our shares being traded only on the OTC BulletinBoard, the liquidity of our  shares may be limited.******  ***Ourshares trade on the OTC Bulletin Board. If we were unable to have and maintaina quotation of our shares on the OTC Bulletin Board System, our shares willonly be traded on the “pink sheet” market. Stocks in the OTC Bulletin Board orin the “pink sheet” market ordinarily have much lower trading volume than inother markets, such as the Nasdaq Capital Market or the Nasdaq Global Market. Alimited number of market makers take interest in shares tradedover-the-counter, and accordingly the markets for such shares are less orderlythan is usual for Nasdaq stocks. As a result of the low trading volumesordinarily obtained in OTC Bulletin Board and “pink sheet” markets, sales ofour shares in any significant amount might not be absorbed without a dramaticreduction in price. Moreover, thinly traded shares in the OTC Bulletin Boardand in the “pink sheet” markets are more susceptible to trading manipulationsthan is ordinarily the case for more actively traded shares.

***The large number of our shares eligible for future salecould have an adverse impact on the market price of our common stock.******  ***Alarge number of shares of common stock already outstanding, along with sharesissuable upon exercise of options or warrants or conversion of convertiblenotes, are eligible for resale, which may adversely affect the market price ofour common stock. As of December 31, 2006, we had 10,225,424 shares ofcommon stock outstanding, 7,664,583 shares of common stock were issuable uponconversion of Series A-1 Preferred Stock, 6,713,514 shares of commonstock were issuable upon conversion of Series B-1 Preferred Stock,another 10,607,122 shares were issuable upon conversion of convertible notesand another 10,952,257 shares were issuable upon exercise of outstandingwarrants and a total of 3,032,939 are issuable upon the exercise of outstandingoptions. Substantially all of the shares subject to outstanding warrants andoptions will, when issued upon exercise, be available for immediate resale inthe public market pursuant to currently effective registration statements underthe Securities Act of 1933, as amended, or pursuant to Rule 701 or Rule 144promulgated thereunder. Some of the shares that are or will be eligible forfuture sale have been or will be issued at discounts to the market price of ourcommon stock on the date of issuance. Resales or the prospect of resales of theshares issued or issuable in connection with our recent financings may have anadverse effect on the market price of our common stock.

***Our substantial dependence on third-party relationshipscould impair our ability to achieve our business objectives and serve ourcustomers.***   We rely on maintaining anddeveloping relationships with customers, Select Partners, professionalcredentialing and certification organizations and other businesses that providecontent for our products and services, corporations, government agencies, andassociations and with companies that provide Internet and relatedtelecommunications services used to distribute our products and services tocustomers.

We haverelationships with a number of customers, professional credentialing andcertification organizations and other businesses that provide us with coursecontent for our online products and services, as well as access to theirmembers who are the ultimate end users of our products. Some of the agreementswe have entered into with these content providers limit our use of their coursecontent, some 

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do not cover use of any future course content and most maybe terminated by either party upon breach of the agreement by the other partyor bankruptcy of the other party. Our ASP-based business model is not compatiblewith the business models of certain content providers which may lead them toterminate the future licensing of existing and new course content to us or failto make this content available to us at commercially reasonable rates or termsnecessary for success under our business model. Given our plans to introduceadditional online courses in the future, we will need to license new coursecontent from existing and prospective content providers. However we might notbe able to maintain and modify, if necessary, our existing agreements withcontent providers, or successfully negotiate agreements with prospectivecontent providers. If the fees we pay and/or the expenses we incur to acquireor distribute content increase, our operating costs and results of operationscould be adversely affected. We might not be able to license or otherwiseacquire course content at commercially reasonable rates or at all.

We havelicensed a Learning Management System from a third party provider under anagreement that expires on December 31, 2008. If the provider does notperform on the contract, does not continue to upgrade and maintain the LMS,does not renew the agreement with VCampus or in some other way impairs ourability to provide the LMS to our customers, our ability to compete would beadversely affected.

We dependheavily on third-party providers of Internet and related telecommunicationsservices. In order to reach customers, our products and services have to becompatible with the web browsers they typically use. Our customers have accessto us through their arrangements with Internet service providers. We alsodepend heavily on the third-party provider of our off-site data center and therelated utilities (electricity and HVAC), physical security and access, and Internetservices that it provides.

For our customers, the professional credentialing andcertification organizations and other businesses that provide content for ourproducts and services, the companies that provide the Internet and relatedtelecommunications services used to distribute our products and services tocustomers, and the web-site operators that provide links to our companyweb-sites, we cannot assure you that:

·       they regard their relationships with us as sufficientlyimportant to their own businesses and operations;

·       they will not reassess their commitment to our products orservices at any time in the future;

·       they will not develop their own competitive products orservices;

·       the products or services by which they provide access orlinks to our products or services will achieve market acceptance or commercialsuccess; or

·       our relationships with them will result in successfulproduct or service offerings or generate significant revenues.

If one ormore of these entities fail to achieve or maintain market acceptance orcommercial success, or if one or more of the entities that do succeed decide toend their relationship with us, we might not be able to generate sufficientrevenues to be successful and stockholder investment would be impaired.

***We may beunable to effectively integrate Prosoft and any other acquisitions we mightmake, which could disrupt or have a negative impact on our business***.   Part of our growthstrategy includes pursuing acquisitions. Any integration process may be complexand time consuming, may be disruptive to the business and may cause aninterruption of, or a distraction of management’s attention from, the businessas a result of a number of obstacles, including but not limited to:

·       the loss of key customers of the acquired company;

·       the incurrence of unexpected expenses and working capitalrequirements;

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·       a failure of our due diligence process to identifysignificant issues or contingencies or to properly assess the value anddetermine an appropriate purchase price;

·       our inability to retain key personnel of acquired entities;

·       failure to maintain the quality of customer service; and

·       our inability to achieve the financial and strategic goalsfor the acquired and combined businesses.

Any of theforegoing obstacles, or a combination of them, could increase selling, generaland administrative expenses in absolute terms and/or as a percentage of netsales, which could in turn negatively impact our net income and cash flows.

As part ofour plans to grow our business, we periodically evaluate potential acquisitioncandidates that we believe would compliment our e-Learning business. We havelimited experience acquiring other businesses and there can be no assurancethat we will be successful completing acquisitions or integrating theoperations of acquired companies into our business. We cannot predict theeffect expansion may have on our core business. Regardless of whether we aresuccessful in completing any acquisitions, the negotiations could disrupt ourongoing business, distract our management and employees and increase ourexpenses.

***Ouracquisition of Prosoft presents many risks, and we may not realize thefinancial and strategic goals that were contemplated at the time of thetransaction.***   The Prosoft acquisition isthe only acquisition that we have undertaken in more than eight years. Weentered into this transaction with the expectation that it would result invarious benefits including, among other things, enhanced revenue and exposureto international markets and enhancements to our product portfolio and customerbase. Risks that we may encounter in seeking to realize these benefits include:

·       we may not realize the anticipated increase in our revenuesif Prosoft customers do not continue to pay for our services at the same orhigher levels as they have historically, if we are unable to sell Prosoft’sproducts and services to our customer base or if the acquired contracts do notallow us to recognize revenues on a timely basis;

·       we may not be able to successfully sell our products andservices to Prosoft customers;

·       we may be unable to effectively integrate the internationaloperations of Prosoft with our own;

·       we may have difficulty incorporating Prosoft’stechnologies, certifications or products with our existing product and servicelines and maintaining uniform standards, controls, procedures and policies;

·       we may have higher than anticipated costs in continuing supportand development of Prosoft’s products;

·       we may face contingencies related to intellectual property,financial disclosures, and accounting practices or internal controls; and

·       we may be unable to manage effectively the increased sizeand complexity of the combined company and our management’s attention may bediverted from our ongoing business by transition or integration issues.

Thesefactors could have a material adverse effect on our business, results ofoperations, financial condition or cash flows.

***Our sales cycle with international customers may be longerthan our historic U.S. sales cycle, which could cause us to incur greatercosts and could reduce our operating margins.***   As we target more of our sales efforts at internationalcustomers, we could face greater costs, longer sales cycles and lesspredictability in 

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completing some of our sales, which may harm our business. Inthat market, a potential client’s decision to use our products and services maybe a decision involving multiple institutions and, if so, these types of saleswould require us to provide greater levels of education to prospective clientsregarding the use and benefits of our products and services. In addition, weexpect that potential clients in some international markets may demand morecustomization, integration services and features. As a result of these factors,these sales opportunities may require us to devote greater sales support andprofessional services resources to individual sales, thereby increasing thecosts and time required to complete sales and diverting sales and professionalservices resources to a smaller number of international andU.S. transactions.

***Expansionof our business internationally, including the integration of Prosoft’s foreignoperations, will subject our business to additional economic and operationalrisks that could increase our costs and make it difficult for us to operateprofitably.***   One of our key growthstrategies is to pursue international expansion. Expansion of our internationaloperations, including the integration of Prosoft’s foreign operations, mayrequire significant expenditure of financial and management resources andresult in increased administrative and compliance costs. As a result of suchexpansion, we will be increasingly subject to the risks inherent in conductingbusiness internationally, including:

·       foreign currency fluctuations, which could result inreduced revenues and increased operating expenses

·       difficulty in collecting accounts receivable

·       the effect of applicable foreign tax structures, includingtax rates that may be higher than tax rates in the United States or taxes thatmay be duplicative of those imposed in the United States;

·       tariffs and trade barriers;

·       general economic and political conditions in each country;

·       inadequate intellectual property protection in foreigncountries;

·       uncertainty regarding liability for information retrievedand replicated in foreign countries;

·       the difficulties and increased expenses in complying with avariety of foreign laws, regulations and trade standards; and

·       unexpected changes in regulatory requirements.

***Operational failures in our network infrastructure coulddisrupt our remote hosting service, could cause us to lose current hostingclients and sales to potential hosting clients and could result in increasedexpenses and reduced revenues.***   Unanticipated problems affecting our network systems couldcause interruptions or delays in the delivery of the hosting service we provideto some of our clients. We provide remote hosting through computer hardwarethat is currently located in third-party co-location facilities in Virginia. Wedo not control the operation of these co-location facilities. Lengthyinterruptions in our hosting service could be caused by the occurrence of anatural disaster, power loss, vandalism or other telecommunications problems atthe co-location facilities or if these co-location facilities were to closewithout adequate notice. Although we have multiple transmission lines into theco-location facilities through telecommunications service providers, we haveexperienced problems of this nature from time to time in the past, and we willcontinue to be exposed to the risk of network failures in the future. Wecurrently do not have adequate computer hardware and systems to providealternative service for most of our hosted clients in the event of an extendedloss of service at the co-location facilities. If there are operationalfailures in our network infrastructure that cause interruptions, slowerresponse times, loss of data or extended loss of service for our remotely hostedclients, we may be required to issue credits or pay penalties, current hostingclients may terminate their contracts or elect not to renew them, and we maylose sales to potential hosting clients.

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***U.S. and foreign government regulation of the Internet couldcause us to incur significant expenses, and failure to comply with applicableregulations could make our business less efficient or even impossible.***   The application of existing laws and regulationspotentially applicable to the Internet, including regulations relating toissues such as privacy, defamation, pricing, advertising, taxation, consumerprotection, content regulation, quality of products and services andintellectual property ownership and infringement, can be unclear. It ispossible that U.S., state and foreign governments might attempt to regulateInternet transmissions or prosecute us for violations of their laws. Inaddition, these laws may be modified and new laws may be enacted in the future,which could increase the costs of regulatory compliance for us or force us tochange our business practices. Any existing or new legislation applicable to uscould expose us to substantial liability, including significant expensesnecessary to comply with such laws and regulations, and dampen the growth inuse of the Internet.

Specific federal laws that could also have an impact on ourbusiness include the following:

·       The Children’s Online Protection Act and the Children’sOnline Privacy Protection Act restrict the distribution of certain materialsdeemed harmful to children and impose additional restrictions on the ability ofonline services to collect personal information from children under the age of13; and

·       The Family Educational Rights and Privacy Act imposesparental or student consent requirements for specified disclosures of studentinformation, including online information.

Our clients’use of our software as their central platform for online education initiativesmay make us subject to any such laws or regulations, which could imposesignificant additional costs on our business or subject us to additionalliabilities.

***Our facilities, personnel and financial and managementsystems may not be adequate to effectively manage the future expansion webelieve necessary to increase our revenues and remain competitive.***   We anticipate that futureexpansion will be necessary in order to increase our revenues. In order toeffectively manage any future expansion, we may need to attract and hireadditional sales, administrative, operations and management personnel. Wecannot assure you that our facilities, personnel and financial and managementsystems and controls will be adequate to support the expansion of ouroperations, and provide adequate levels of service to our customers andpartners. If we fail to effectively manage our growth, our business could beharmed.

***We operate in a highly competitive industry and may not beable to compete effectively.*****  **The market for onlineeducational, certification and training products and services is highlycompetitive and we expect that competition will continue to intensify. Thereare no substantial barriers to entry into our business, and we expect thatestablished and new entities will enter the market for online educational,certification and training products and services in the near future.

A number ofour existing competitors, as well as a number of potential new competitors(including some of our strategic partners), have longer operating histories,greater name recognition, larger customer bases, more diversified lines ofproducts and services and significantly greater resources than we do. Suchcompetitors may be able to undertake more extensive marketing campaigns, adoptmore aggressive pricing policies and make more attractive offers to potentialcustomers. In the past few years, a number of our customers have demandedupgrades to our technology platform. Our relatively limited capital resourcesmight not afford us a full opportunity to meet these demands. Recently, we havenoticed that some of the more widely available online course offerings,particularly those targeted to the corporate training market, are increasinglycompeting primarily on price, which commoditization drives down margins for allcompetitors in our industry. In competing against us, our strategic partnerscould use information obtained from us to gain an additional competitiveadvantage over us. Our current and potential competitors might develop productsand services that are superior to ours or that achieve greater marketacceptance than 

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ours. We might not compete effectively and competitivepressures might prevent us from acquiring and maintaining the customer basenecessary for us to be successful.

As therevenue potential for online delivery of educational, certification andtraining courses continues to grow, the market is likely to attract a number oflarge, well-capitalized competitors seeking to diversify their revenue streamsinto this market. Not only will some of these potential competitors be wellcapitalized and be willing to operate in the market at a loss to build marketshare, they may also acquire and/or substantially fund our other competitorswhich could weaken demand for our products and make it more difficult for us toreach or even prevent us from reaching profitability.

***The loss or reduction of services of any member of our keypersonnel could prevent us from adequately executing on our business strategy.***   Our future success dependson the continued contributions of our key senior management personnel,consisting of Narasimhan Kannan, Chief Executive Officer, Christopher Nelson,our part-time Chief Financial Officer, Ronald Freedman, Senior Vice President,e-Learning Solutions, Laura Friedman, Vice President—Co-Publishing, LindsayMiller, Senior Vice President, and James Stanger, Vice President ofCertification. We do not maintain “key man” life insurance on any of ourexecutive officers. The term of Mr. Nelson’s new part-time employmentagreement is scheduled to expire in May 2007 and Mr. Hadjinicolaou,our former Vice President of Finance and Corporate Controller, terminated hisemployment to pursue other opportunities effective at the end of 2006. We havefilled Mr. Hadjinicolaou’s vacancy in the finance department and we arecurrently conducting a search for a full-time CFO candidate. The loss ofservices of any of our key management personnel, whether through resignation orother causes, the reduced services of our part-time Chief Financial Officerstarting in October 2006, or the inability to attract qualified personnelas needed, could prevent us from adequately executing our business strategy.

***Our results of operations have fluctuated significantlyfrom period to period, and a failure to meet the expectations of investors orthe financial community at large could result in a decline in our stock price.***   Our expense levels are based in part on our expectations asto future revenues. Quarterly sales and operating results generally depend onthe online revenues and development and other revenues, which are difficult toforecast. In addition, past results have shown our business to be subject to amaterial adverse seasonality associated with the large number of holidays inthe calendar fourth quarter. Our Prosoft division experiences seasonalityassociated with academic cycles resulting in relatively stronger financialperformance in the first and third calendar quarters and relatively weakerfinancial performance in the second and fourth quarters. We may not be able toadjust spending in a timely manner to compensate for any unexpected revenueshortfall. Accordingly, any significant revenue shortfall would have animmediate adverse impact on our business and financial condition.

Our operating results may fluctuate significantly in thefuture as a result of a variety of factors, some of which are outside of ourcontrol. These factors include:

·       demand for online education and especially the demand forprofessional certification and continuing education;

·       the budgeting cycles of customers, particularly in thegovernment and educational sectors;

·       seasonality of revenues corresponding to holidays in theUnited States;

·       capital expenditures and other costs relating to theexpansion of operations or the acquisition of complimentary businesses;

·       the introduction of new products or services by us or ourcompetitors;

·       the mix of the products and services sold and the channelsthrough which those products and services are sold;

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·       pricing or accounting changes; and

·       general economic conditions.

As astrategic response to a changing competitive environment, we may elect fromtime to time to make certain pricing, service or marketing decisions that couldhave a material adverse effect on us. We believe that period-to-periodcomparisons of our operating results should not be relied upon as an indicationof future performance. Due to all of the foregoing factors, it is possible thatin some future quarter, our operating results will be below the expectations ofpublic market analysts and investors. In such event, the price of our commonstock would likely decline. We also believe that the price of our shares hasbeen adversely affected, and may continue to be adversely affected, by shortsales by unknown groups and by the involuntary listing of our shares in theunregulated Berlin Stock Exchange. The Berlin Stock Exchange is known topermit “naked shorts” and creates an environment for the speculation in sharesthat is not permitted under U.S. law.

***We rely on significant customers, and if we fail tomaintain and develop relationships with such customers, we might not generaterevenues necessary to achieve our business objectives.***   A significant portion of our revenues is generated by alimited number of customers. For the year ended December 31, 2006, twocustomers, the U.S. Department of Veterans’ Affairs and a large insurancecompany, accounted for approximately 25% and 8% of our revenues, respectively. Becausethe large insurance company customer is migrating its testing and courses toanother platform, revenues from this customer have been decreasingsignificantly from and after June 30, 2006 and we do not expect furtherbusiness from this customer after their contract expired in December 2006.For the twelve months ended December 31, 2005, two customers, the U.S.Department of Veterans’ Affairs and a large insurance company, accounted forapproximately 36% and 20% of our revenues, respectively. We expect that we willcontinue to depend on large contracts with a limited number of significantcustomers at least through the near future. This situation can cause ourrevenue and earnings to fluctuate between quarters based on the timing ofcontracts. Most of our customers have no obligation to purchase additionalproducts or services from us. If we fail to maintain and develop relationshipswith significant customers, we might not be able to generate revenues necessaryto achieve our business objectives.

***We rely heavily on a limited number of contracts with theU.S. government, which are subject to termination for convenience by thegovernment at any time. While we have experienced no such terminations and havehad contracts with these agencies for a number of years, should suchterminations occur, they could cause a material adverse impact on ouroperations.***   During the years ended December 31,2006 and 2005, 25% and 39%, respectively, of our net revenues were derived fromperformance on a limited number of contracts with U.S. government agencies,primarily the Department of Veterans Affairs, which represented 25% and 36% ofour net revenues for the years ended December 31, 2006 and 2005,respectively. Therefore, any significant disruption or deterioration of ourrelationship with the U.S. government agencies with which we do business wouldsignificantly reduce our revenues. Our competitors continuously engage inefforts to expand their business relationships with the government and arelikely to continue these efforts in the future. Our contracts with thegovernment are generally multiyear contracts, however, they are subject tonon-renewal annually, as well as termination by the government for convenienceat any time. The government may choose to use contractors with competingtechnologies or it may decide to discontinue any of our programs altogether. Inaddition, the contracts that we do obtain require ongoing compliance withapplicable government regulations. Termination of our contracts, a shift ingovernment spending to other programs in which we are not involved, a reductionin government spending generally, or our failure to meet applicable governmentregulations could have a material adverse impact on our operations.

***System failures and capacity constraints could interferewith our efforts to attract customers and attain market acceptance of ourproducts and services.***   A key element of ourstrategy is to generate a high volume of online traffic to our products andservices. Accordingly, the performance of our products and services is 

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critical to our reputation, our ability to attractcustomers and attain market acceptance of our products and services. Any systemfailure that causes interruptions in the availability or increases responsetime of our products and services would result in less usage of our productsand services and, especially if sustained or repeated, would reduce theattractiveness of our products and services. For example, in early 2007 manylearners were unable to access the campus on four occasions for periods longerthan our standards require. Also, in September of 2006 we experiencedinstability in our internally developed course delivery application that causedmultiple “crashes” of the system over several weeks until the problem wascorrected. Such interruptions of service, if frequent or for sustained periods,could lead to increased customer dissatisfaction and discontinued use of ourservice and did contribute to the termination of our relationship with onecustomer. Also, in 2005 we experienced a number of “downtimes” with our datacenter provider that we consider unacceptable. Although we have taken actionsto remedy these failures, they might recur. In addition, our system has singlepoints of failure and requires a weekly maintenance window, both of whichincrease the time the system is unavailable to our users. An increase in thevolume of use of our products and services could strain the capacity of thesoftware or hardware we use or the capacity of our network infrastructure,which could lead to slower response time. Any failure to expand the capacity ofour hardware or network infrastructure on a timely basis or on commerciallyreasonably terms would reduce the attractiveness of our products and services.We also depend on web browsers and Internet service providers for access totheir products and services, and users may experience difficulties due tosystem failures unrelated to our systems, products and services.

***If the security of information stored in and transmittedthrough computer systems of VCampus and its end-users is not adequatelysecured, we could incur significant liability and potential customers might bedeterred from using our products and services.***   We include in our products certain security protocols thatoperate in conjunction with encryption and authentication technology. Inaddition, we monitor our system with intrusion detection devices. Despite thesetechnologies, our products may be vulnerable to break-ins and similardisruptive problems caused by online users. Such computer break-ins and otherdisruptions would jeopardize the security of information stored in and transmittedthrough our computer systems and the computer systems of end-users, which mayresult in significant liability for us and may also deter potential customers.For example, computer “hackers” could steal, remove or alter portions of ouronline courseware or customer payment and identification information.Persistent security problems continue to plague the Internet, the Web and otherpublic and private data networks. Alleviating problems caused by third partiesmay require us to make significant expenditures of capital and other resourcesand may cause interruptions, delays or cessation of service to our customersand to us. Moreover, our security and privacy concerns and those of existingand potential customers, as well as concerns related to computer viruses, mayinhibit the growth of the online marketplace generally, and our customer baseand revenues in particular. We attempt to limit our liability to customers,including liability arising from a failure of the security features containedin our products, through contractual provisions limiting warranties anddisallowing damages in excess of the price paid for the products and servicespurchased. However, these limitations might not be enforceable. We maintainliability insurance to protect against these risks. However, this insurance maybe inadequate or may not apply in some situations.

***We might not be successful in responding to the changingmarket for our products and services.******  ***Themarket for our products and services is evolving in response to recentdevelopments relating to online technology. The market is characterized byevolving industry standards and customer demands and an increasing number ofmarket entrants who have introduced or developed online products and services.It is difficult to predict the size and growth rate, if any, of this market. Asis typical in the case of a rapidly evolving industry, demand and marketacceptance for recently introduced products and services are subject to a highlevel of uncertainty. Our future success will depend in significant part on ourability to continue to improve the performance, features and reliability of ourproducts and services in response to both evolving demands of the marketplaceand competitive product offerings, and we cannot assure that we will besuccessful in developing, integrating or marketing such products or services.In addition, our new 

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product and courseware releases may contain undetectederrors that require significant design modifications, resulting in a loss ofcustomer confidence.

***We might not be able to adequately protect our intellectualproperty rights.******  ***We regard our copyrights,trademarks, trade secrets and similar intellectual property as critical to oursuccess, and we rely upon trademark and copyright law, trade secret protectionand confidentiality and/or license agreements with our employees, customers,partners and others to protect our proprietary rights.

We have hadcertain trademark applications denied and may have more denied in the future.We will continue to evaluate the need for registration of additional marks asappropriate. Despite our efforts to protect our proprietary rights,unauthorized parties may attempt to copy aspects of our products or services orto obtain and use information that we regard as proprietary. In addition, thelaws of some foreign countries do not protect proprietary rights to as great anextent as do the laws of the United States. Litigation may be necessary toprotect our proprietary technology. Any such litigation may be time-consuming andcostly, cause product release delays, require us to redesign our products orservices or require us to enter into royalty or licensing agreements, any ofwhich could have a material adverse effect upon us. For example, we were forcedto pursue legal action during 2006 to eliminate the unauthorized use of thedomain name www.vcampus.ch by a third party. These royalty or licensingagreements, if required, may not be available on terms acceptable to us or atall. Our means of protecting our proprietary rights might not be adequate andour competitors might independently develop similar technology, duplicate ourproducts or services or design around patents or other intellectual propertyrights we have. In addition, distributing our products through online networksmakes our software more susceptible than other software to unauthorized copyingand use. For example, online delivery of our courseware makes it difficult toensure that others comply with contractual restrictions, if any, as to theparties who may access such courseware. If, as a result of changing legalinterpretations of liability for unauthorized use of our software or otherwise,users were to become less sensitive to avoiding copyright infringement, wemight not be able to realize the full value of our intellectual propertyrights.

***Government regulation of business conducted on the Internetcould decrease the demand for our products and services or increase our cost ofdoing business.***   There are currently few lawsor regulations that directly apply to activities on the Internet. We believethat we are not currently subject to direct regulation by any government agencyin the United States, other than regulations that are generally applicable toall businesses. A number of legislative and regulatory proposals are underconsideration by federal and state lawmakers and regulatory bodies and may beadopted with respect to the Internet and/or online delivery of course content. Someof the issues that these laws and regulations may cover include user privacy,pricing and characteristics and quality of products and services. The adoptionof any such laws or regulations may decrease the growth of the Internet, whichcould in turn decrease the projected demand for our products and services orincrease our cost of doing business. The applicability to the Internet ofexisting U.S. and international laws governing issues such as propertyownership, copyright, trade secret, libel, taxation and personal privacy isuncertain and developing. For example, we recently settled an assessmentbrought by the Virginia Department of Taxation for use tax on third-partyroyalties paid by us to content providers for courses we delivered online. Anynew legislation or regulation, or application or interpretation of existinglaws, could decrease online demand for our products and services or increaseour costs.

***We could issue additional preferred stock and take otheractions that might discourage third parties from acquiring us.******  ***Ourboard of directors has the authority, without further action by thestockholders, to issue shares of preferred stock and to fix the rights,preferences, privileges and restrictions, including voting rights, of suchshares. In December 2005, we created and issued a new class of Series A-1Preferred Stock. The rights of the holders of the common stock will be subjectto, and may be adversely affected by, the rights of the holders of the Series A-1Preferred Stock and any other preferred stock that we may issue in the future,such as the new class of Series B-1 Preferred Stock we created andissued in March 2006. Issuing preferred stock could have the effect ofmaking it more difficult for a third party to acquire a 

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majority of our outstanding voting stock, thereby delaying,deferring or preventing a change in control of our company. Furthermore, thepreferred stock may have other rights, including economic rights, senior to ourcommon stock, and as a result, the existing or future preferred stock could decreasethe market value of our common stock.

Certainprovisions of our certificate of incorporation and our bylaws could make itmore difficult for a third party to acquire, and could discourage a third partyfrom attempting to acquire, control of VCampus. Some of them eliminate theright of stockholders to act by written consent and impose various proceduraland other requirements which could make it more difficult for stockholders toundertake certain corporate actions. These provisions could limit the pricethat certain investors might be willing to pay in the future for shares of ourcommon stock and may have the effect of delaying or preventing a change incontrol of VCampus. We may in the future adopt other measures that may have theeffect of delaying, deferring or preventing a change in control of VCampus. Certainof these measures may be adopted without any further vote or action by thestockholders, although we have no present plans to adopt any such measures. Weare also afforded the protections of Section 203 of the Delaware GeneralCorporation Law, which could delay or prevent a change in control of VCampus,impede a merger, consolidation or other business combination involving ourcompany or discourage a potential acquirer from making a tender offer orotherwise attempting to obtain control of VCampus.

***Demand for our products is susceptible to adverse economicconditions and educational funding constraints.****  *Our business and financialperformance is influenced by adverse financial conditions affecting our targetcustomers and by general weakness in the economy. In the short run, manycorporations may not view Information and Communications Technology (“ICT”)skills training as critical to the success of their businesses. When thesecompanies experience poor operating results, whether as a result of adverseeconomic conditions, competitive issues or other factors, they may decrease ordelay spending on training and education. In addition, most of our academiccustomers are reliant on the availability of funding to pursue their existingeducational programs and new initiatives. If educational funding is limited,whether as a result of overall economic conditions, budgetary constraints, thepolitical environment or other factors, these institutions may delay or foregospending for our content and certification products.

***We might not be able to use net operating losscarryforwards.******  ***As of December 31,2006, we had net operating loss carryforwards for federal income tax purposesof approximately $75.6 million, which will expire at various dates through2026. Our ability to use these net operating loss and credit carryforwards to offsetfuture tax obligations, if any, may be limited by changes in ownership. Specifically,management believes that deemed changes in ownership resulting from our recentequity financings will likely prevent us from using part or all of the netoperating losses and credit carryforwards under the IRS change in ownershiprules. We have recognized a full valuation allowance against these deferred taxassets because we have determined that it is more likely than not thatsufficient taxable income will not be generated during the carryforward periodavailable under the tax law to utilize the deferred tax assets. Any limitationon the use of net operating loss carryforwards, to the extent it increases theamount of federal income tax that we must actually pay, may have an adverseimpact on our financial condition.

***We do not presently anticipate paying cash dividends on ourcommon stock.******  ***We intend to retain allearnings, if any, for the foreseeable future for funding our businessoperations. Consequently, we do not anticipate paying any cash dividends on ourcommon stock for the foreseeable future, which could deter some investors fromseeking to acquire our common stock.

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**SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS**

Some of the statements contained in this report discuss ourplans and strategies for our business and are “forward-looking statements” asthat term is defined in the Private Securities Litigation Reform Act. The words“anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends” andsimilar expressions are meant to identify these statements as forward-lookingstatements, but they are not the exclusive means of identifying them. Theforward-looking statements in this report reflect the current views of ourmanagement; however, various risks, uncertainties and contingencies could causeour actual results, performance or achievements to differ materially from thoseexpressed or implied by these statements, including:

·       our history of losses and negative operating cash flows;

·       we face uncertainties and risk relating to our ability tocontinue as a going concern;

·       the large number of our shares eligible for future salecould have an adverse impact on  the market price of our common stock;

·       our future capital needs and the uncertainty of additionalfunding;

·       our potential inability to compete effectively;

·       limited liquidity for our shares on the OTC Bulletin Board;

·       our dependence on significant clients;

·       our substantial dependence on courseware and third-partycourseware providers;

·       risks associated with acquisitions, including integrationof Prosoft;

·       our substantial dependence on third-party relationships;

We assume no obligation to update publicly anyforward-looking statements, whether as a result of new information, futureevents or otherwise. For a discussion of important risks of an investment inour common stock, including factors that could cause actual results to differmaterially from results referred to in the forward-looking statements, see the “RiskFactors” section of this report. In light of the risks and uncertaintiesdiscussed in “Risk Factors” and elsewhere in this report, events referred to inforward-looking statements in this report might not occur.

**Item 1B.**               Unresolved Staff Comments.

Not applicable.

**Item 2.**                        Properties.

Ourexecutive offices and principal administration, technical, marketing and salesoperations are located in Reston, Virginia. The Phoenix, Arizona location isthe headquarters for Prosoft which provides a location for administrativeoffices and serves Prosoft’s content development activities, sales, contentpublishing, IT, certification and customer service purposes. The Limerickfacility serves sales and customer service purposes, and is currently on amonth-to-month lease extension following the expiration of the base term inFebruary 2005. The Beijing office serves as our representative office inChina.

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As of March 2007, the Companyhad the following lease arrangements for commercial space in the followinglocations:

| **Location**      | ** ** | ** ** | ** ** | **Square  Footage** | ** ** | **Monthly  Cost** | ** **          | **Lease  Expiration** | ** ** |
|-------------------|------------|------------|------------|---------------------|------------|-------------------|---------------------|-----------------------|------------|
| Reston, Virginia  |       | 16,701     |       | $45,285             |       | February, 2010    |                |
| Phoenix, Arizona  |       | 13,375     |       | $                   | 26,220     |              | April 30, 2007 |                  |
| Limerick, Ireland |       | 1,166      |       | $                   | 1,755      |              | Month to Month      |                  |
| Beijing, China    |       | 1,711      |       | $                   | 1,270      |              | June 30, 2007  |                  |

 

We believe that our existing office space is sufficient toaccommodate our current needs and that suitable additional space will beavailable on commercially reasonable terms to accommodate any expansion needsthrough 2007 should the need arise.

**Item 3.****                       ****Legal Proceedings****.**

We areobligated to pay up to approximately $400,000 in back sales and use tax to theVirginia Department of Taxation pursuant to an audit and the Department’sinterpretation of local law regarding third-party royalties we pay to ourcontent providers for courses we deliver online. In May 2006, we submittedan application for an Offer in Compromise to the Virginia Department ofTaxation requesting partial relief from amounts assessed and post-audit salesand use tax liability as well as a payment plan for the remaining liabilities.The Company has received notice that the Virginia Department of Taxation hasagreed to accept our offer in compromise in regards to the Department’soutstanding assessment of sales and use tax liability against us. As previouslydisclosed in our SEC filings, this tax assessment and its offer in compromisecovered retail sales and use tax liabilities for the audit period August 1998through October 2001, as well as for the post-audit period November 2001through May 2006. As a result of the Department’s prior assessment, we hadpreviously recorded a reserve charge of $400,000 included in its first quarter2006 statement of operations. Upon formal confirmation of the settlementagreement, which is subject to the completion of the Department’s post-auditverification, we would agree to make total payments to the Commonwealth ofVirginia of $252,477 (which represents approximately 63% of the assessed andestimated tax liability amounts). Pursuant to the terms of the pendingsettlement, we would be entitled to make these payments in 36 monthlyinstallments of $7,013 each.

Although we are not currently involved in any othermaterial pending legal proceedings, we could be subject to legal proceedings andclaims in the ordinary course of our business or otherwise, including claimsrelating to license agreements, royalties or claims of alleged infringement ofthe trademarks and other intellectual property rights of third parties by usand our licensees.

**Item 4.**                        Submission of Matters to aVote of Security Holders.

No matters were submitted to a vote of security holdersduring the fourth quarter ended December 31, 2006.

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**ExecutiveOfficers**

Our executive officers and theirages as of March 1, 2007 are as follows: 

| **Name**              | ** ** | ** ** | ** ** | **Age**                                                     | ** ** | **Positions** |
|-----------------------|------------|------------|------------|-------------------------------------------------------------|------------|---------------|
| Nat Kannan            |       | 58         |       | Chief Executive Officer and Chairman                        |
| Christopher L. Nelson |       | 44         |       | Chief Financial Officer and Secretary                       |
| Ronald E. Freedman    |       | 58         |       | Senior Vice President, e-learning solutions                 |
| Laura B. Friedman     |       | 44         |       | Vice-President, Publishing                                  |
| Lindsay H. Miller     |       | 59         |       | Senior Vice-President and General Manager Prosoft  Learning |
| James A.  Stanger     |       | 42         |       | Vice-President  of Certification and Product Development    |

 

*Narasimhan “Nat”Kannan*hasserved as VCampus’ Chairman of the Board of Directors since he founded VCampusin 1984. He resumed the Chief Executive Officer position in December 2002,a position he formerly held from 1984 to 2000. Prior to founding VCampus, heco-founded Ganesa Group, Inc., a developer of interactive graphics andmodeling software, in 1981. He also served as a consultant to Booz Allen andHamilton, Inc., the MITRE Corporation, The Ministry of Industry of theFrench Government, the Brookhaven and Lawrence Livermore National Laboratories,the White House Domestic Policy Committee on Energy and Control DataCorporation. He holds a B.S. in Engineering from the Indian Institute ofTechnology in Madras, India, and he performed advanced graduate work inbusiness and engineering at Dartmouth College.

*Christopher L.Nelson*joinedVCampus as Chief Financial Officer and Chief Information Officer in June of2002. Through September 2006, Mr. Nelson oversaw the entiretechnology, operations and customer service areas of the business in additionto his finance and accounting department responsibilities. In October 2006,the role of Chief Financial Officer was changed to a part-time position.Mr. Nelson has agreed to continue as the part-time Chief Financial Officerfor the balance of his employment contract term (through May 2007). We arecurrently conducting a search for a full-time CFO. He currently also serves asChief Financial Officer of Qmobile Inc., a private mobile entertainment contentcompany. Prior to his appointment as our CFO, Mr. Nelson was a Principalof Monticello Capital LLC since 1998, where he advised high-growth technologybusinesses and their corporate boards on corporate finance, capitalizationtransactions, and mergers and acquisitions. Mr. Nelson held positions asCEO, COO and CFO of niche, high tech companies in the Internet space prior tojoining VCampus (including Kignet, Inc., Monumental Network Systems, andIMA Software, Inc.) during which he developed particular expertise inbringing companies to cash flow positive positions. Mr. Nelson also heldexecutive positions at NTT/Verio, as well as sales and marketing andmanufacturing positions at IBM Corporation. Mr. Nelson holds a Master ofBusiness Administration from The Wharton School at the University ofPennsylvania and a Bachelor of Science degree in Chemical Engineering from theUniversity of Delaware. Mr. Nelson also previously served as a GeorgeMason Fellow, acting as an advisor to start-up and early stage technologycompanies on a volunteer basis through the TechVenture Partnership at GeorgeMason University.

*Ronald E.Freedman*isresponsible for e-Learning Solution sales with a particular emphasis on thegovernment market. Mr. Freedman has more than 20 years of hands-onexperience in sales management, strategic planning, business development, andexecution of profit and loss responsibility. Mr. Freedman joined VCampusin 2001 from USinternetworking, Inc. (USi) where he was Vice President ofInformation Assurance and Chief Security Officer from 1999 through 2001. Whileat USi, he was responsible for the design, implementation and management of theUSi Total Security Architecture, a best-of-breed security portfolio. Prior tojoining USi, Freedman was Vice President of one of the business divisions atThe Netplex Group, Inc. for four years. There, he was responsible forsales, marketing and fulfillment of a wide range of technology-based productsand services. Previously, Mr. Freedman was Vice President, Systems andServices for COMSIS Corporation, where he managed the division of theprofessional services company providing contingency planning and informationsecurity services to commercial and government customers. He also served asExecutive Vice President of Advanced Information Management, Inc., where 

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he was responsible for marketing and delivering informationsecurity and contingency planning services to Fortune 500 customers. Mr. Freedmanworked for General Electric Company for fifteen years, most recently as GeneralManager, Disaster Recovery Services and Manager, Strategic Planning andBusiness Development. He also served as a Presidential appointee, on loan toThe White House from General Electric, responsible for developing contingencyplans as part of the Continuity of Government Program. Mr. Freedman holdsa BA in Economics from Northeastern University in Boston and an MBA inManagement from Babson College in Wellesley, MA. He currently serves asChairman of ITAA’s e-Learning Committee.

*Laura B.Friedman*isresponsible for developing and managing partnerships under the Select Partnerprogram and for our courseware production group, or Custom Design Studio.Ms. Friedman is an experienced professional publishing executive, havingserved for more than 17 years in a variety of marketing, editorial and contentdevelopment positions in both traditional and electronic publishing. Prior tojoining VCampus, she served as Vice President of Learning Services at Zoologic, Inc.from November 2002 to August 2004. A long time supporter ofe-Learning, she founded the e-Learning program at The New York Institute of Finance(NYIF), Pearson’s financial training division, where she was Vice President ofe-Learning from May 1996 to November 2002. In addition to creatingNYIF’s portfolio of online courses in financial training, Laura oversaw customdevelopment projects for clients such as Accenture, Arthur Andersen and theFinancial Times. She served as Director, International Marketing for Business,Professional and Reference products at Simon & Schuster. AtMcGraw-Hill and Time Warner’s Book-of-the-Month Club, Ms. Friedman held avariety of editorial and marketing positions in professional publishing. Sheholds a B.A. from the State University at Albany and a MBA from FordhamUniversity.

*Lindsay H.Miller.*As the Senior Vice President and General Manager of Prosoft, Mr. Miller isresponsible for managing all aspects of day-to-day business and operations atProsoft. Mr. Miller began his career with ComputerPREP in 1998 as an ITManager and soon thereafter took over the position of CIO. After Prosoft’sacquisition of ComputerPREP in 2000, Mr. Miller was promoted first to VicePresident of Information Technology, and thereafter to CIO, and in March of2003 he became Vice President of Operations. Prior to joining ComputerPREP, Mr. Millerowned and operated the largest independent electronics-servicing firm in thePhoenix metropolitan area for 10 years. Mr. Miller’s experience alsoincludes various sales and marketing positions, including Vice President ofMarketing for companies such as Gould, General Instrument, AMCable and Xerox. Mr. Millerearned a B.S. in Mathematics from Bradley University and an MBA from theUniversity of Chicago. He is past Chairperson of the Phoenix CIO Council. Mr. Millerwas an executive officer at Prosoft prior to and at the time of its voluntaryfiling in April 2006 for bankruptcy protection in connection with Prosoft’sacquisition by VCampus in June 2006.

*Dr. JamesStanger*leads Prosoft’s broad activities in certification as well as the company’swell-respected product development capabilities. Dr. Stanger joined thecompany in 1997. Following many years as a key leader in the company’s productdevelopment area, he was named Director of the group in May 2003. He waspromoted to Vice President, Certification and Product Development in December 2003.Dr. Stanger is very active in the certification community. He has helpeddevelop certifications for Symantec, the Linux Professional Institute (LPI),CompTIA, and the Telecommunications Industry Association (TIA). He is currentlyChair of the LPI Advisory Council and sits on the CompTIA Network+ and Linux+cornerstone committees. Dr. Stanger is a prolific author. A sample of thetitles he has either written or contributed to include The Windows to LinuxMigration Toolkit (Syngress), Security+ (ComputerPREP), Hack Proofing Linux(Syngress), The E-mail Virus Protection Handbook (Syngress), and The CIWSecurity Professional Study Guide (Sybex). An accomplished networkingconsultant, Dr. Stanger has advised customers such as Symantec, the TIA,Security, Fuelzone.com, and IBM concerning Internet security, convergencetechnology, and Windows to Linux migration. Prior to joining Prosoft, Dr. Stangerwas an educator and consultant, holding teaching positions at the University ofCalifornia at Riverside, the University of Redlands, and Crafton Hills College.Dr. Stanger earned a B.A. and a Masters degree in English from BrighamYoung University and a Ph.D. in English from the University of California atRiverside. He is a CIW Master Administrator, and also holds the Linux+,Security+, A+, and Convergence Technologies Professional (CTP) certifications.

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**PART II**

**Item 5.**                        Market for Registrant’sCommon Equity and Related Stockholder Matters.

(a)*          **Price Range of Common Stock*

Our common stock currently tradeson the Over-the-Counter Bulletin Board under the symbol “VCMP.OB.” Prior to July 5,2006 our common stock was traded on the Nasdaq Capital Market under the symbol “VCMP”.For each full fiscal quarter since the beginning of 2005, the high and low bidquotations for our common stock were as follows: 

| ** **      | ** ** | **High**   | ** ** | **Low**    | ** ** |
|-----------------|------------|------------|------------|------------|------------|
| **2006**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| First  quarter  |       | $          | 0.77       |       | $          | 0.51 |   |
| Second  quarter |       | $          | 0.75       |       | $          | 0.26 |   |
| Third  quarter  |       | $          | 0.45       |       | $          | 0.10 |   |
| Fourth  quarter |       | $          | 0.25       |       | $          | 0.09 |   |
| **2005**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| First  quarter  |       | $          | 2.33       |       | $          | 1.31 |   |
| Second  quarter |       | $          | 1.72       |       | $          | 0.85 |   |
| Third  quarter  |       | $          | 1.49       |       | $          | 0.71 |   |
| Fourth quarter  |       | $          | 1.00       |       | $          | 0.41 |   |

 

The foregoingbid quotations reflect inter-dealer prices, without retail mark-ups, mark-downsor commissions, and may not represent actual transactions.

In recent years, the public market for our common stock hasbeen characterized by low and/or erratic trading volume, often resulting inprice volatility. There can be no assurance that there will be an active publicmarket for our common stock in the future. The market price of the common stockcould be subject to significant fluctuations in response to future announcementsconcerning us or our partners or competitors, the introduction of new productsor changes in product pricing policies by us or our competitors, proprietaryrights or other litigation, general conditions in the e-Learning market,developments in the financial markets and other factors. In addition, the stockmarket has, from time to time, experienced extreme price and volumefluctuations that have particularly affected the market prices for technologycompanies and which have often been unrelated to the operating performance ofthe affected companies. Broad market fluctuations of this type may adverselyaffect the future market price of the common stock. See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Liquidityand Capital Resources.”

(b)*         **Approximate Number of Equity SecurityHolders*

As of March 13, 2007, the number of record holders ofour Common Stock was 96 and we believe that the number of beneficial owners wasapproximately 1,600.

(c)*          **Dividends*

We have never paid a cash dividend on our common stock andwe do not anticipate paying cash dividends in the foreseeable future. Moreover,the terms of our outstanding preferred stock and convertible debt does contain,and any preferred stock that we could issue in the future and any future creditfacilities might contain, restrictions on our ability to declare and paydividends on our common stock. We plan to retain all earnings, if any, for theforeseeable future for use in the operation of our business and to fund thepursuit of future growth. Future dividends, if any, will depend on, among otherthings, our results of operations, capital requirements and on such otherfactors as our Board of Directors, in its discretion, may consider relevant.

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**Item 6.**                        Selected Financial Data.

Thefollowing selected consolidated financial data should be read in conjunctionwith our consolidated financial statements and the related notes, and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”included elsewhere in this annual report. The statement of operations data forthe years ended December 31, 2004, 2005 and 2006, and the balance sheetdata for the years as of then ended, are derived from, and are qualified byreference to, our consolidated financial statements that have been audited byReznick Group, P.C., our independent registered public accounting firm. Thestatement of operations data for the years ended December 31, 2002 and2003, and the balance sheet data as of the years then ended, are derived fromfinancial statements not included in this report.

**Statement of Operations Data:**

| ** **                                      | ** ** | **2002**                                                        | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                      | ** ** | **In thousands except per share data** | ** ** |
| Revenues:                                       |       |                                                            |       |     |       |     |       |     |       |     |       |
| Certification  related revenues                 |       | $                                                               | —     |     | $          | 12       |       | $        | 199        |     | $          | 691 |   | $ | 4,116 |   |
| Learning  portal revenues                       |       | 5,330                                                           |       | 5,496    |       | 4,299    |       | 3,355    |       | 2,683    |       |
| Development  and other revenues                 |       | 595                                                             |       | 558      |       | 366      |       | 518      |       | 647      |       |
| Total net revenues                              |       | 5,926                                                           |       | 6,066    |       | 4,864    |       | 4,564    |       | 7,446    |       |
| Costs and  expenses:                            |       |                                                            |       |     |       |     |       |     |       |     |       |
| Cost of revenues                                |       | 1,462                                                           |       | 1,718    |       | 1,357    |       | 1,731    |       | 2,559    |       |
| Sales and  marketing                            |       | 2,689                                                           |       | 2,138    |       | 1,895    |       | 1,723    |       | 2,508    |       |
| Product  development and operations             |       | 2,536                                                           |       | 2,475    |       | 2,725    |       | 2,649    |       | 2,829    |       |
| General  and administrative                     |       | 1,693                                                           |       | 1,910    |       | 1,687    |       | 1,488    |       | 2,913    |       |
| Depreciation  and amortization                  |       | 1,356                                                           |       | 880      |       | 1,227    |       | 1,574    |       | 1,755    |       |
| Sales and  use tax assessment                   |       | —                                                          |       | —   |       | —   |       | —   |       | 400      |       |
| Impairment  of goodwill                         |       | —                                                          |       | —   |       | —   |       | —   |       | 328      |       |
| Reorganization  and other non-recurring charges |       | 192                                                             |       | 173      |       | —   |       | —   |       | —   |       |
| Stock-based  compensation                       |       | 76                                                              |       | 126      |       | 154      |       | 110      |       | 859      |       |
| Total costs and expenses                        |       | 10,004                                                          |       | 9,420    |       | 9,045    |       | 9,275    |       | 14,151   |       |
| Loss from  operations                           |       | (4,078                                                          | )          | (3,354   | )          | (4,181   | )          | (4,711   | )          | (6,705   | )          |
| Other income (expense):                         |       |                                                            |       |     |       |     |       |     |       |     |       |
| Other  income                                   |       | 422                                                             |       | 207      |       | 183      |       | —   |       | —   |       |
| Interest  income (expense)                      |       | (220                                                            | )          | (112     | )          | (2,581   | )          | (1,155   | )          | (920     | )          |
| Loss on  debt extinguishments                   |       | (503                                                            | )          | —   |       | —   |       | —   |       | —   |       |
| Net loss                                        |       | $                                                               | (4,379     | )        | $          | (3,259   | )          | $        | (6,579     | )        | $          | (5,866 | ) | $ | (7,625 | ) |
| Dividends to preferred stockholders             |       | (2,768                                                          | )          | (2,927   | )          | —   |       | (14      | )          | (5,186   | )          |
| Net loss attributable to common stockholders    |       | $                                                               | (7,147     | )        | $          | (6,186   | )          | $        | (6,579     | )        | $          | (5,880 | ) | $ | (12,812 | ) |
| Net loss per share                              |       | $                                                               | (4.79      | )        | $          | (1.81    | )          | $        | (0.97      | )        | $          | (0.63 | ) | $ | (1.30 | ) |
| Net loss per share—assuming dilution       |       | $                                                               | (4.79      | )        | $          | (1.81    | )          | $        | (0.97      | )        | $          | (0.63 | ) | $ | (1.30 | ) |

 

| ** **                                | ** ** | **2002**   | ** ** | **2003**   | ** ** | **2004**   | ** ** | **2005**   | ** ** | **2006**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **Balance Sheet Data:**                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Working capital (deficit)                 |       | $          | (828       | )          | $          | (1,187     | )          | $          | 1,820      |       | $          | 701 |   | $ | (1,467 | ) |
| Total assets                              |       | 4,373      |       | 4,864      |       | 7,119      |       | 5,478      |       | 5,176      |       |
| Total liabilities                         |       | 2,725      |       | 2,828      |       | 2,274      |       | 2,817      |       | 5,875      |       |
| Accumulated deficit                       |       | (84,207    | )          | (90,393    | )          | (96,972    | )          | (102,852   | )          | (115,664   | )          |
| Total stockholders’ equity (deficit) |       | 1,648      |       | 2,035      |       | 4,845      |       | 2,661      |       | (699       | )          |
|                                           |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |

 

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Per share amounts for all periods presented have beenadjusted to reflect the one-for-ten reverse stock split which occurred in July 2002.

These financial statements for the years ended December 31,2006, 2005, 2004, 2003 and 2002 reflect a different classification of certainrevenues from classifications previously presented. Management determined thatthis reclassification was appropriate to provide a more meaningful presentationof our performance following the acquisition of Prosoft LearningCorporation in June 2006. The classification for prior periodcomparisons has likewise been revised to conform to the current periodclassifications. Management continues to view the company as one operatingsegment.

**Item 7.**                        Management’s Discussion andAnalysis of Financial Condition and Results of Operation.

The following discussion of financial condition and resultsof operations should be read in conjunction with VCampus’ consolidatedfinancial statements and related notes thereto included elsewhere in thisreport. The following discussion contains forward-looking statements thatinvolve risks and uncertainties. Our actual results could differ materiallyfrom those anticipated in the forward-looking statements as a result of variousfactors, including those discussed in “Risk Factors” and elsewhere in thisreport.

***Current Operating Conditions and Basis of Presentation***

The consolidated financial statements included in thisreport have been prepared on a going concern basis, which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business. As described more fully below, certain significant factors raisesubstantial doubt about our ability to continue to operate as a going concern.The financial statements do not include any adjustments relating to therecoverability and classification of recorded asset amounts or the amounts orclassification of liabilities that might be necessary should we be unable tocontinue as a going concern. A significant portion of the our assets consist ofintangibles related to courseware, customer relationships and goodwill, all ofwhich are primarily related to the ProSoft acquisition. Should we be unable tocontinue as a going concern, the amount at which these assets might berecovered in a forced sale could be significantly less than the amounts atwhich they are recorded in the accompanying balance sheet. As of December 31,2006, we had a $1.47 million working capital deficiency and have sustainedrecurring losses from operations. From inception, we have met our liquidity andcapital expenditure needs primarily through the proceeds from sales of commonstock, preferred stock and convertible debt in both public and privateofferings, and to a lesser extent from borrowings.

While we currently operate as a going concern, certainsignificant factors raise substantial doubt about our ability to continue tooperate as a going concern. We have incurred significant losses sinceinception. We continue to rely on additional financing to fund our continuingoperations. Management has found additional financings more challenging toarrange and with less desirable terms than in past financings. Managementexpects these challenges to remain and possibly increase until operating conditionsimprove. As such, management can provide no assurance that it will besuccessful in raising additional capital necessary to sustain operations. Weexpect negative cash flow from operations to continue until our revenue streamsmature. We have a significant unresolved tax liability described below. Pastfinancings require significant ongoing cash payments for dividends, interestand principal. Existing lenders have alleged certain defaults under our debtinstruments, which, if successfully pursued, could lead to the acceleration ofthe indebtedness due under those instruments. These factors, among others,raise substantial doubt about our ability to continue to operate as a goingconcern.

***Management’s Plans to Address Operating Conditions***

Management’s plans to address theseconditions consist of the following:

·       Raise up to $6 million or more in additional capital beforethe end of the third quarter of 2007. With the current demands on our cashbased on the operating conditions discussed above, we must 

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raise capital in the short term to continue operations andmeet our obligations. We are currently engaged in ongoing discussions withexisting and new investors  who haveexpressed an interest in, among other things, funding the internationalexpansion opportunities for our certification products.

·       Maintain tight cost controls and continue to operate undera closely monitored budget approved by the Board of Directors. We believes wehave exhausted most meaningful opportunities for cutting operating costs andmust now manage the company at the current operating cost level to sustainoperations. Management’s plan is to pursue opportunities to grow the businesswithout a proportional increase in operating expenses and overhead.

·       Increaseinternational sales of current Prosoft certification products. We have witnessed increasing demand forUS-based credentials in international markets. Specifically, we haveexperienced success in the adoption of the CIW certification through ourpartner in Japan. We intend to ramp-up our current sales and marketing effortsin China through a network of affiliates and in Europe and other Asian marketsthrough further development of our sales location in Limerick, Ireland, as wellas through an Asian market partner.

·       Opportunisticallygrow sales to theFederal Government. We now have one of the largest LMS installations in theFederal Government e-Learning market and we believe that the successfuloperation of this system represents an outstanding reference within the FederalGovernment for attracting more business in this market. We plan on leveragingthis success and attempting to replicate it in other departments and agenciesof the Federal Government using the existing account management team.

***Reclassification of Revenues***

This report includes financial statements for the yearended December 31, 2006 reflecting a different classification ofcertain revenues from classifications previously presented. Managementdetermined that this reclassification was appropriate to provide a moremeaningful presentation of the Company’s performance followingour acquisition of Prosoft Learning Corporation in June 2006.The classification for prior period comparisons has likewise been revised toconform to the current period classifications. This reclassification does notcause total revenues reported herein for the  years ended December 31,2005 and 2004 to vary from what had previously beenreported, and has no impact on our current or previously reported assets,liabilities or net loss. Management continues to view the Company as oneoperating segment.

***Overview***

Our revenues are derived from threeprimary sources:

·       Certification related revenues

·       Learning portal revenues

·       Development and other revenue

Certification related revenues are derived from sales ofonline courses (online tuition) and sales of course materials by certificationcandidates and from distribution through education partners. Learning portalrevenues are derived from sales of online courses to our government, corporateand higher education customers. Development and other revenues consistprimarily of fees paid to us for developing and converting courseware.

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**Prosoft Acquisition**

OnJune 12, 2006, we acquired Prosoft, a provider of information andcommunications technology (“ICT”) curriculum and certifications to secondary,postsecondary and vocational and corporate training institutions. Prosoft’soperations have historically been organized into two business segments:(a) Content Development and Distribution, in which Prosoft, through itsComputerPREP division, publishes and/or distributes instructor-led coursewareon topics including CompTIA (A+, Network+), Adobe, Cisco, Microsoft Office,Microsoft Technical Certifications, Linux (LPI), Oracle, convergence technologyand project management, amongst others; and (b) Certification Developmentand Management, through which Prosoft owns and manages two proprietary job-rolecertifications, Certified Internet Web Professional (“CIW”) and Certified inConvergent Network Technologies (“CCNT”), and has developed and manages theConvergence Technology Professional (“CTP”) certification program for theTelecommunications Industry Association (“TIA”). With more than 84,000certificates issued, the CIW program is the world’s largest and fastest-growingInternet Technology certification program. The CIW certification program hasbeen endorsed by Departments of Education and/or Departments of WorkforceDevelopment in 12 U.S. states, as well as by a growing number of governments,trade associations and schools around the world. We believe there issignificant potential for additional growth in both domestic and internationalmarkets given the growing trend of Internet skills being taught in secondaryand post-secondary classrooms. The CTP certification is a certification forprofessionals working with convergence technologies such as Voice over InternetProtocol (VOIP).

We paid for the cash portion of the Prosoft acquisitionprice from our existing cash reserves without raising additional funds forspecific acquisition purposes. In addition to the approximately $1.4 million incash paid for the purchase we incurred approximately $250,000 intransaction-related costs and assumed net liabilities of approximately $700,000(as adjusted from the original amount of approximately $400,000 at Closing),the majority of which were immediately due and payable. As such, wesubstantially depleted our working capital and increased our short-termliabilities. This decrease in liquidity has impacted our ability to continue asa going concern partially. .

**Critical Accounting Policies and Significant Judgment andEstimates**

Our management’s discussion and analysis of our financialcondition and results of operations is based on our financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and assumptions that affect the reported amounts of assetsand liabilities and the disclosure of contingent assets and liabilities at thedate of the financial statements, as well as the reported revenues and expensesduring the reporting periods. On an ongoing basis, we evaluate our estimatesand judgments related to revenue recognition and capitalized software andcourseware development costs. We base our estimates on historical experienceand on various other factors that we believe are reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying value of assets and liabilities that are not readily apparent fromother sources. Actual results may differ from these estimates under differentassumptions or conditions. Our accounting policies, which are significantlyaffected by management’s estimates and assumptions, are as follows:

*Revenue Recognition*

We deriveour revenues from the following sources—certification related revenues,learning portal revenues and development and other revenues. Certificationrelated revenues are derived from sales of online courses (online tuition) andsales of course materials such as books, CD-ROMs, Web-based course books,assessment products and content licenses, all of which prepare learners forcertifications in a variety of areas. Certification related revenues alsoinclude fees paid by certification candidates to take our certification testsand annual fees received from education partners, including CIW and CTP ATPs. 

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Learning portal revenues are derived from sales of onlinecourses to our government, corporate and higher education customers.Development and other revenues consist primarily of fees paid to us fordeveloping and converting courseware.

Onlinetuition revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 104,*Revenue Recognition* (SAB 104).SAB 104 generally requires that four basic criteria must be met before revenuecan be recognized: (1) persuasive evidence of an arrangement exists; (2) deliveryhas occurred or services rendered; (3) the fee is fixed and determinable;and (4) collectibility is reasonably assured. Determination of criteria (3) and(4) are based on management’s judgments regarding the fixed nature of thefee charged for services rendered and the collectibility of those fees. Shouldchanges in conditions cause management to determine these criteria are not metfor certain sales, revenue recognized for any reporting period could beadversely affected. Online tuition revenues are generated primarily through twotypes of contracts: (i) time-based subscriptions and (ii) usage-basedcontracts. Under subscription contracts, revenue is recognized ratably (on astraight-line basis) over the subscription period. For usage contracts, revenueis recognized upon enrollment in a course. Once a student has enrolled in acourse, he generally cannot cancel delivery of a course or receive a refund. Onrare occasions, we may extend the subscription length for a specific student’scourse at no charge. Initial set-up fees related to all online tuition servicesare recognized ratably (on a straight-line basis) over the contract term.

Developmentand other revenues consist primarily of fees paid to us for developing andconverting courseware. For arrangements that include more than one element, weallocate the total arrangement fee among each deliverable based onvendor-specific objective evidence (“VSOE”) of the relative fair value of eachdeliverable. VSOE is determined using the price charged when that element is soldseparately by us. Development and other revenues earned under coursewareconversion contracts are recognized relative to our proportionate performancebased on the ratio that total costs incurred to-date bear to total estimatedcosts. We use direct labor hours as the key criteria to measure progresstowards completion. We develop our estimates to complete a project based onbudgeted total costs and periodic assessment by our project managers.

Wesometimes recognize development and other revenues as a separate element of anarrangement with a customer that also contains an element to provide coursewaredelivery services. The SEC Staff believes that the best indicator that aseparate element exists is that a vendor sells or could readily sell thatelement unaccompanied by other elements. We have a history of sellingcourseware development and conversion services unaccompanied by other elements.Further, EITF 00-21 (“Revenue Arrangements with Multiple Deliverables”)states that a deliverable should be segmented and accounted for separately fromthe remainder of the arrangement if: (1) there is objective and reliableevidence of the fair value of the element and (2) the element does notaffect the quality of use or the value of the other elements and the elementcan be purchased from an unrelated vendor without effecting the quality of useor value of the other elements. We believe that the hourly rates charged fordevelopment revenues are consistent and represent the fair value of theseservices.

We havedemonstrated the ability for our developed and converted material to be used inthe absence of our platform. In addition, customers can use other vendors todevelop electronic course material or develop course material internally foruse on our platform. Accordingly, management believes that separate recognitionof development revenues for customers who have online tuition contracts isappropriate.

Contentrevenues include fees received from the sale of course materials such as books,CD-ROMs, Web-based course books, assessment products and content licenses. Werecognize content revenue from the sale of course books and other products whenthey are shipped. Shipping and handling charges are invoiced to the customerand are included in gross revenues, reduced by our actual shipping expenses.Content licenses are either purchased on a fee-per-use basis or for a one-timefee. Revenue is recognized 

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over the period in which we have a commitment forcontinuing involvement or obligation to provide services to the customer. Inmost cases, no such commitment exists, and revenue is recognized when contentis shipped.

Certificationrevenues include fees paid by certification candidates to take the Company’scertification tests and annual fees received from education partners, includingCIW and CTP ATPs. We recognize certification revenue when certification testsare administered, and partner fees over the period during which there is acommitment for continuing involvement or obligation to provide services to thepartner.

We account for cash received from customers as prepaymentsfor future services as deferred revenue. We recognize revenue associated withthose cash receipts in accordance with the above policies.

*Allowance for Doubtful Accounts*

We maintain allowances for doubtful accounts for estimatedlosses resulting from the inability of our customers to make required payments.If the financial condition of those customers were to deteriorate, resulting inan impairment of their ability to make payments, additional allowances may berequired in future periods.

*Capitalized Software and Courseware Development Costs*

Wecapitalize costs associated with internally developed software in accordancewith Statement of Position 98-1, “Accounting for the Costs of ComputerSoftware Developed or Obtained for Internal Use” (SOP 98-1). SOP 98-1provides guidance for the treatment of costs associated with computer softwaredevelopment and defines those costs to be capitalized and those to be expensed.Costs that qualify for capitalization are external direct costs, payroll,payroll-related costs, and interest costs. Costs related to general andadministrative functions are not capitalizable and are expensed as incurred. Wecapitalize software and courseware development costs when the projects underdevelopment reach technological feasibility. Many of our new courses leverageoff of proven delivery platforms and are primarily content, which has notechnological hurdles. As a result, a significant portion of our coursewaredevelopment costs qualify for capitalization due to the concentration of ourdevelopment efforts on the content of the courseware. Technological feasibilityis established when we have completed all planning, designing, coding, andtesting activities necessary to establish that a course can be produced to meetits design specifications. Capitalization ends when a course is available forgeneral release to our customers, at which time amortization of the capitalizedcosts begins. Amortization of such costs is based on the greater of (1) theratio of current gross revenues to the sum of current and anticipated grossrevenues, or (2) the straight-line method over the remaining economic lifeof the VCampus or courseware, typically two to three years. It is possible thatthose anticipated gross revenues, the remaining economic life of the products,or both, may be reduced as a result of future events.

Weevaluated capitalized software costs in accordance with the provisions ofStatement of Financial Accounting Standards No. 144 “Accounting for theImpairment or Disposal of Long-Lived Assets (as amended)”. In accessing whetherthere is an impairment issue with respect to capitalized software costs, wedetermined that there is no reliable basis for estimating future gross revenuesrelated to our capitalized software. However, our capitalized software isexpected to continue operations well into the future. As it represents amajority of our business, we do not expect the revenue stream relating toonline courses to end and, accordingly, we will continue to make modificationsin order for our capitalized software to remain viable. In estimating futureexpected cash flows (i.e. inflows less outflows) we use historical cash flowsthat are directly associated with the online tuition revenue and an estimate ofthe outflows that are expected to arise as a direct result of the use andeventual disposition of the asset.

We evaluatecapitalized courseware development costs typically every quarter or morefrequently if events or changes in circumstances indicate that the asset mightbe impaired, to determine if the 

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unamortized balance related to any given course exceeds theestimated net realizable value of that course. Estimating net realizable valuerequires us to estimate future revenues and cash flows to be generated by thecourse and to use judgment in quantifying the amount, if any, to be writtenoff. We consider courseware development costs impaired when the carrying amountis not recoverable and exceeds the asset’s fair value. The carrying amount isdeemed unrecoverable if it is greater than the sum of undiscounted cash flowsexpected to result form use and eventual disposition of the asset. We recognizean impairment charge equal to the excess of the carrying amount over the fairvalue of the asset.

In estimating future cash flows (i.e., inflows lessoutflows) we use only those directly associated with the use and ultimatedisposition of the underlying asset. In estimating future cash flows to testfor recoverability we take all available evidence into account based on ourplanned usage of the underlying asset and use assumptions consistent with thoseused to develop other information (i.e., internal projections, forecasts, andbudgets). The period over which cash flows are projected is based on theremaining useful life of the underlying asset. As a result of our analysis, werecorded provisions for impairment relating to capitalized coursewaredevelopment costs.

*Goodwilland Other Identifiable Intangibles*

Management assesses the recoverability of goodwill andother identifiable intangibles whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. When managementdetermines that the carrying value of goodwill or other identifiableintangibles is not recoverable, an impairment loss is recognized to the extentthe carrying value of the asset exceeds its fair value. Fair value can beestimated using a number of techniques including quoted market prices,valuations by third parties and discounted cash flow analysis. The fair valueof the asset could be different using different estimates and assumptions inthese valuation techniques.

In accordance with Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangibles,” goodwill and otherindefinite-lived intangibles are subject to an annual impairment review. Wemay determine through the impairment review process that goodwill or otherindefinite-lived intangibles have been impaired, resulting in an impairmentcharge in the periods the review is completed.

*Derivativefinancial instruments*

We do notuse derivative instruments to hedge exposures to cash flow, market, or foreigncurrency risks.

We reviewthe terms of convertible debt and equity instruments that we issue to determinewhether there are embedded derivative instruments, including the embeddedconversion option, that are required to be bifurcated and accounted forseparately as a derivative financial instrument. When the risks and rewards ofany embedded derivative instrument are not “clearly and closely” related to therisks and rewards of the host instrument, the embedded derivative instrument isgenerally required to be bifurcated and accounted for separately. If theconvertible instrument is debt, or has debt-like characteristics, the risks andrewards associated with the embedded conversion option are not “clearly andclosely” related to that debt host instrument. The conversion option has therisks and rewards associated with an equity instrument, not a debt instrument,because its value is related to the value of our common stock. Nonetheless, ifthe host instrument is considered to be “conventional convertible debt” (or “conventionalconvertible preferred stock”), bifurcation of the embedded conversion option isgenerally not required. However, if the instrument is not considered to beconventional convertible debt (or conventional convertible preferred stock),bifurcation of the embedded conversion option may be required in certaincircumstances. Generally, where the ability to physical or net-share settle theconversion option is deemed to be not within the control of us, the embeddedconversion option is required to be bifurcated and accounted for as aderivative financial instrument liability.

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In connectionwith the sale of convertible debt and equity instruments, we may also issuefreestanding options or warrants. Additionally, we may issue options orwarrants to non-employees in connection with consulting or other services theyprovide. Although the terms of the options and warrants may not provide fornet-cash settlement, in certain circumstances, physical or net-share settlementmay be deemed to not be within the control of the us and, accordingly, we maybe required to account for these freestanding options and warrants asderivative financial instrument liabilities, rather than as equity.

Derivativefinancial instruments are required to be initially measured at their fairvalue. For derivative financial instruments that shall be accounted for asliabilities, the derivative instrument is initially recorded at its fair valueand is then re-valued at each reporting date, with changes in the fair valuereported as charges or credits to income.

Incircumstances where the embedded conversion option in a convertible instrumentmay be required to be bifurcated and there are also other embedded derivativeinstruments in the convertible instrument that are required to be bifurcated,the bifurcated derivative instruments are accounted for as a single, compound derivativeinstrument.

If theembedded derivative instrument is to be bifurcated and accounted for as aliability, the total proceeds received will be first allocated to the fairvalue of the bifurcated derivative instrument. If freestanding options orwarrants were also issued and are to be accounted for as derivative instrumentliabilities (rather than as equity), the proceeds are next allocated to thefair value of those instruments. The remaining proceeds, if any, are thenallocated to the convertible instrument itself, usually resulting in thatinstrument being recorded at a discount from its face amount. In circumstanceswhere a freestanding derivative instrument is to be accounted for as an equityinstrument, the proceeds are allocated between the convertible instrument andthe derivative equity instrument, based on their relative fair values.

To theextent that the fair values of the bifurcated and/or freestanding derivativeinstrument liabilities exceed the total proceeds received, an immediate chargeto income is required to be recognized, in order to initially record thederivative instrument liabilities at their fair value. The discount from theface value of the convertible debt instrument is required to be amortized overthe life of the instrument through periodic charges to income, using theeffective interest method. When the instrument is convertible preferred stock,the periodic amortization of the discount is charged directly to retainedearnings.

We review the classification of derivative instruments,including whether such instruments should be recorded as liabilities or asequity, at the end of each reporting period. Derivative instrument liabilitiesare required to be classified in the balance sheet as current or non-currentbased on whether or not net-cash settlement of the derivative instrument couldbe required within 12 months of the balance sheet date. We currently do nothave any derivative instruments that are required to be bifurcated and recordedas liabilities.

*Stock-based Compensation*

Stock-based compensationexpense:  Effective January 1, 2006, we adopted the fair valuerecognition provisions of FASB Statement No. 123R, using the modifiedprospective transition methods, and therefore we have not restated priorperiods’ results. Under this method we recognize compensation expense forshare-based payments granted to employees after January 1, 2006 and forother grants made prior to but not yet vested as of January 1, 2006, inaccordance with Statement No. 123R. Under the fair value recognitionprovisions of Statement No. 123R, we recognize stock-based compensationnet of an estimated forfeiture rate and only recognize compensation cost forthose shares expected to vest on a straight-line basis over the requisiteservice period of the award. Prior to Statement No. 123R adoption, weaccounted for share-based payments to employees under Accounting PrinciplesBoard Option No. 25, Accounting for Stock Issued to Employees (“APB 25”),and accordingly, we generally recognized compensation expense only when wegranted options with a discounted exercise price below fair market value.

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Determining the appropriate fair value model andcalculating the fair value of share-based payment awards require the input ofhighly subjective assumptions, including the expected life of the share-basedpayment awards and stock price volatility. Management has determined thathistorical realized volatility calculated since our initial public offering isa reasonable indicator of expected volatility and future stock price trends.The assumptions used in calculating the fair value of share-based payment awardsrepresent management’s best estimates, but these estimates involve inherentuncertainties and the application of management judgment. As a result, iffactors change and we use different assumptions, our stock-based compensationexpense could be materially different in the future. In addition, we arerequired to estimate the expected forfeiture rate and only recognize expensefor those shares expected to vest. If our actual forfeiture rate is materiallydifferent from our estimate, the stock-based compensation expense could besignificantly different from what we have recorded in the current period. SeeNote 2 to the Consolidated Financial Statements for a further discussion onstock-based compensation.

*Purchase Accounting and Goodwill*

As the result of acquisitions, any excess purchase priceover the net tangible and identifiable intangible assets acquired are recordedas goodwill. A preliminary allocation of the purchase price to tangible andintangible net assets acquired is based upon a preliminary valuation and ourestimates and assumptions may be subject to change. We assess the impairment ofgoodwill in accordance with SFAS No. 142,*“Goodwill and Other Intangible Assets.”*Accordingly, we test our goodwill for impairmentannually on December 31, or whenever events or changes in circumstancesindicate an impairment may have occurred, by comparing its fair value to itscarrying value. Impairment may result from, among other things, deteriorationin the performance of the acquired business, adverse market conditions, adversechanges in applicable laws or regulations, including changes that restrict theactivities of the acquired business, and a variety of other circumstances. Ifwe determine that an impairment has occurred, we are required to record awrite-down of the carrying value and charge the impairment as an operatingexpense in the period the determination is made. Although we believe goodwillis appropriately stated in our consolidated financial statements, changes instrategy or market conditions could significantly impact these judgments andrequire an adjustment to the recorded balance.

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**Results of Operations**

The following table sets forthcertain statement of operations data as a percentage of total net revenues forthe periods indicated:

| ** **                          | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statement of Operations Data:       |       |     |       |     |       |     |       |
| Revenues:                           |       |     |       |     |       |     |       |
| Certification  related revenues     |       | 4.1      | %          | 15.2     | %          | 55.3     | %          |
| Learning  portal revenues           |       | 88.4     |       | 73.5     |       | 36.0     |       |
| Development  and other revenues     |       | 7.5      |       | 11.3     |       | 8.7      |       |
| Total net  revenues                 |       | 100.0    |       | 100.0    |       | 100.0    |       |
| Costs and expenses:                 |       |     |       |     |       |     |       |
| Cost of  revenues                   |       | 27.9     |       | 37.9     |       | 34.4     |       |
| Sales and  marketing                |       | 39.0     |       | 37.8     |       | 33.7     |       |
| Product  development and operations |       | 56.0     |       | 58.0     |       | 38.0     |       |
| General  and administrative         |       | 34.7     |       | 32.6     |       | 39.1     |       |
| Depreciation  and amortization      |       | 25.2     |       | 34.5     |       | 23.6     |       |
| Sales and  use tax assessment       |       | 0.0      |       | 0.0      |       | 5.4      |       |
| Impairment  of goodwill             |       | 0.0      |       | 0.0      |       | 4.4      |       |
| Stock  based compensation           |       | 3.2      |       | 2.4      |       | 11.5     |       |
| Total costs and expenses            |       | 186.0    |       | 203.2    |       | 190.0    |       |
| Loss from  operations               |       | (86.0    | )          | (103.2   | )          | (90.0    | )          |
| Other income (expense):             |       |     |       |     |       |     |       |
| Other  income                       |       | 3.8      |       | 0.0      |       | 0.0      |       |
| Interest  expense                   |       | (53.1    | )          | (25.3    | )          | (12.4    | )          |
| Net loss                            |       | (135.3   | )%         | (128.5   | )%         | (102.4   | )%         |

 

*2006Compared to 2005*

*Summary*

For the twelve months ended December 31, 2006, weincurred a net loss to common stockholders of $12,811,455 (or $1.30 per share)compared to a net loss to common stockholders of $5,880,639 (or $0.63 pershare) for the twelve months ended December 31, 2005. The net loss for thetwelve months ended December 31, 2006 includes $328,317 of goodwillimpairment charges, $858,507 of stock-based compensation, $828,759 of non-cashamortization of debt discount and deferred debt offering costs incurred inconnection with our March 2004 and September 2006 private placementsand dividends to preferred stockholders of $5,186,495 (of which $4,664,535 wasa non-cash deemed dividend representing the beneficial conversion feature ofthe Series A-1 and B-1 Preferred Stock and the incrementalvalue of the compensatory warrants issued in those financings in accordancewith Statement No. 123(R)). The net loss for the twelve months ended December 30,2005 includes $1,060,057 of non-cash amortization of debt discount and debtoffering costs. Applying the then-applicable accounting standard (APB No. 25),$109,493 of stock-based compensation expense was recorded for the twelve monthsended December 31, 2005.

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The following table sets forth selected financial data:

| ** **                                   | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                                     | ** ** | **2006** | ** ** |
| Revenues                                     |       | $                                                            | 4,564,463  |   | 100.0 | % | $ | 7,445,533 |   | 100.0 | % |
| Cost of revenues                             |       | 1,730,892                                                    |       | 37.9 |   | 2,559,289 |   | 34.4 |   |
| Sales and marketing                          |       | 1,723,313                                                    |       | 37.8 |   | 2,507,854 |   | 33.7 |   |
| Product development and operations           |       | 2,649,215                                                    |       | 58.0 |   | 2,829,243 |   | 38.0 |   |
| General and administrative                   |       | 1,488,240                                                    |       | 32.6 |   | 2,912,462 |   | 39.1 |   |
| Depreciation and amortization                |       | 1,574,242                                                    |       | 34.5 |   | 1,754,877 |   | 23.6 |   |
| Sales and use tax assessment                 |       | —                                                       |       | 0.0 |   | 400,000 |   | 5.4 |   |
| Impairment of goodwill                       |       | —                                                       |       | 0.0 |   | 328,317 |   | 4.3 |   |
| Stock-based compensation                     |       | 109,493                                                      |       | 2.4 |   | 858,507 |   | 11.5 |   |
| Loss from operations                         |       | (4,710,932                                                   | )          | (103.2 | ) | (6,705,016 | ) | (90.0 | ) |
| Interest expense                             |       | (1,155,395                                                   | )          | (25.3 | ) | (926,815 | ) | (12.4 | ) |
| Net loss                                     |       | (5,866,327                                                   | )          | (128.5 | ) | (7,624,960 | ) | (102.4 | ) |
| Dividends to preferred stockholders          |       | (14,312                                                      | )          | (0.3 | ) | (5,186,495 | ) | (69.7 | ) |
| Net loss attributable to common stockholders |       | $                                                            | (5,880,639 | ) | (128.8 | )% | $ | (12,811,455 | ) | (172.1 | )% |

 

| ** **                            | ** ** | **For the Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                                     | ** ** | **2006** | ** ** |
| Certification related revenues        |       | $                                                            | 691,171    |   | 15.1 | % | $ | 4,116,165 |   | 55.3 | % |
| Learning portal revenues              |       | 3,354,808                                                    |       | 73.5 |   | 2,682,706 |   | 36.0 |   |
| Online development and other revenues |       | 518,484                                                      |       | 11.4 |   | 646,662 |   | 8.7 |   |
| Total net  revenues                   |       | $                                                            | 4,564,463  |   | 100.0 | % | $ | 7,445,533 |   | 100.0 | % |

 

Certificationrelated revenues increased to $4,116,165 for the twelve months ended December 31,2006, compared to $691,171 for the same period in 2005. The increase isprimarily due to $3,440,000 of revenues derived from Prosoft customers in the2006 period following its acquisition by VCampus in June 2006.

Learningportal revenues decreased 20.0% to $2,682,706 for the twelve months ended December 31,2006, compared to $3,554,808 for the same period in 2005. The decrease is primarilydue to a reduction in online tuition revenues from our corporate clients($663,000) mainly as a result of reduced course usage by one of our largestcorporate clients.

Online development and other revenues increased 24.7% to$646,662 for the twelve months ended December 31, 2006, compared to$518,484 for the 2005 period. The increase is primarily due two largecourseware orders from two Select Partners and increased professional servicesrevenues under our renewed contract with the Department of Veterans’ Affairs.

*Cost of Revenues*

Cost of revenues increased 47.9% to $2,559,289 in 2006 ascompared to $1,730,895 in 2005. The increase is primarily due a $699,000increase in cost of certification-related revenues as a result of the June 2006Prosoft acquisition and $137,000 increase in cost of development revenues as aresult of the increased development revenues, partially offset by a $358,000decrease in cost of learning portal revenues primarily due to lower royaltycosts as a result of (i) the decrease in corporate online tuition revenues(ii) lower royalties per course incurred to one of our largest contentpartners as a result of more favorable terms under a renewed agreement withthem.

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*Operating Expenses*

*Sales and Marketing.**  *Sales and marketing expensesincreased 45.5% to $2,507,854 for the twelve months ended December 31,2006 as compared to $1,723,313 for the 2005 period. The increase in sales andmarketing costs is primarily due to a net increase in headcount and relatedcosts as well as increases in out-of-pocket costs in 2006 as a result ofintegrating our sales and marketing activities with those of Prosoft followingour combination.

*Product Development and Operations.**  *Product development andoperations expenses increased 6.8% to $2,829,243 for the twelve months ended December 31,2006 as compared to $2,649,215 for the 2005 period. The increase in productdevelopment and operations costs is primarily due to a net increase inheadcount and related costs in 2006 as a result of integrating our productdevelopment and operating activities with those of Prosoft following ourcombination, offset in part by a decline in these costs at VCampus.

*General and Administrative.**  *General and administrativeexpenses increased 95.7% to $2,912,462 in 2006 as compared to $1,488,240 forthe 2005 period. The increase is primarily due to headcount related expenses,out-of-pocket costs and $850,000 of G&A expenses primarily attributable togeneral and administrative costs related to our Phoenix, AZ and Limerick,Ireland locations, following our combinations with Prosoft, none of which areincluded in our 2005 results of operations.

*Depreciation and Amortization.**  *Depreciation andamortization increased 11.5% to $1,754,877 for the twelve months ended December 31,2006 as compared to $1,574,242 for the 2005 period. The increase is primarilydue to $285,000 of expense related to the amortization of Prosoft acquisitionrelated intangibles, which did not exist in the prior period. Depreciation andamortization expense for the twelve months ended December 31, 2006 and2005 includes impairment charges of $413,426 and $320,933, respectively—*see Note 2 to our financial statements included inthis report—Significant Accounting Policies—Impairment of Long-Lived Assets*.These increases were partially offset by decreases in fixed asset andcapitalized software and courseware depreciation and amortization expense. SinceMarch 2004, we have not been capitalizing software development costs dueto their nature, and since October 2005 we have also been capitalizingreduced amounts in courseware development costs compared to prior periods as aresult of new contracts with Select Partners which provide us withreimbursement for such costs.

*Impairment of Goodwill.*   Impairment ofgoodwill was $328,317 and $0 for 2006 and 2005, respectively. The write-off wasas a result of an impairment analysis we conducted in connection with thereview of our quarterly financial statements.

*Stock-based Compensation.**  *Stock-based compensationexpense was $858,507 and $109,493 for 2006 and 2005, respectively. The increaseis a result of the adoption of SFAS 123(R) effective January 1, 2006,using the “modified prospective” method in which compensation cost is recognizedbeginning with the effective date based on the requirements of SFAS 123(R) forall (a) share-based payments granted after the effective date and (b) forall awards granted to employees prior to the effective date of SFAS 123(R) thatremain unvested on the effective date. Accordingly, for the twelve months endedDecember 31, 2006, stock compensation is accounted for under FAS 123(R),which requires recording expense equal to the fair value of all awards. For thetwelve months ended December 31, 2005, stock-based compensation isaccounted for under APB 25, “Accounting for Stock Issued to Employees” and onlyincludes expense associated with the fair value of stock issued as customarypayment to our non-employee directors for their participation in Board ofDirectors and Board Committee meetings and the fair market value of stockissued to consultants.

*Interest Expense.**  *Interest expense for thetwelve months ended December 31, 2006 decreased 20.4% to $919,944 comparedto $1,155,395 for the twelve months ended December 31, 2005. Interestexpense primarily consists of amortization of debt discount and deferred debtoffering costs and accrual of interest 

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payable related to the $3,649,625 (as reduced to $989,565following mandatory and voluntary conversions and principal and interestrepayments through December 31, 2006) and $3,000,000 of convertible promissorynotes issued in March 2004 and September 2006, respectively . Thedecrease in interest expense between the two periods is primarily attributableto $360,000 in write-offs in 2005 of debt discount and deferred debt offeringcosts related to the 2004 private placement following voluntary conversions of$542,000 in principal under those notes. The decrease is also due to areduction in interest expense related to our 2004 private placements, asprincipal under those notes is being paid down as per their amortizationschedule. The decreases in interest expense were partially offset by thirdquarter 2006 interest expense related to our August 2006 bridge financingand September 2006 private placement. We expect interest expense toincrease significantly as we amortize debt discount and deferred debt offeringcosts and accrue interest payable related to our September 2006 privateplacement.

*2005 Compared to 2004*

*Summary*

We incurreda net loss attributable to common stockholders of $5,880,639 (or $0.63 pershare) in 2005 as compared to a net loss attributable to common stockholders of$6,579,416 (or $0.97 per share) in 2004. The net loss for the twelve monthsended December 31, 2005 includes $1,060,057 of non-cash amortization ofdebt discount and debt offering costs. The net loss for the twelve months endedDecember 31, 2004 includes $2,430,849 of non-cash amortization of debtdiscount and debt offering costs and $183,210 of other income as a result ofsettlements with a customer and two vendors. The decrease in the net loss in2005 as compared to 2004 was due primarily to a decrease in interest expenseand, to a lesser extent, operating costs, which were partially offset by a 6%decrease in revenues and a 28% increase in cost of revenues.

The following table sets forthselected financial data:

| ** **                                   | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2004**                                                     | ** ** | **2005** | ** ** |
|  Revenues                               |       | $                                                            | 4,863,859  |   | 100.0 | % | $ | 4,564,463 |   | 100.0 | % |
| Cost of revenues                             |       | 1,356,699                                                    |       | 27.9 |   | 1,730,892 |   | 37.9 |   |
| Sales and marketing                          |       | 1,895,340                                                    |       | 39.0 |   | 1,723,313 |   | 37.8 |   |
| Product development and operations           |       | 2,725,155                                                    |       | 56.0 |   | 2,649,215 |   | 58.0 |   |
| General and administrative                   |       | 1,686,940                                                    |       | 34.7 |   | 1,488,240 |   | 32.6 |   |
| Depreciation and amortization                |       | 1,227,089                                                    |       | 25.2 |   | 1,574,242 |   | 34.5 |   |
| Stock-based compensation                     |       | 153,973                                                      |       | 3.2 |   | 109,493 |   | 2.4 |   |
| Loss from operations                         |       | (4,181,337                                                   | )          | (86.0 | ) | (4,710,932 | ) | (103.2 | ) |
| Other income                                 |       | 183,210                                                      |       | 3.8 |   | — |   | 0.0 |   |
| Interest expense                             |       | (2,581,289                                                   | )          | (53.1 | ) | (1,155,395 | ) | (25.3 | ) |
| Net loss                                     |       | (6,579,416                                                   | )          | (135.3 | ) | (5,866,327 | ) | (128.5 | ) |
| Dividends to preferred stockholders          |       | —                                                       |       | 0.0 |   | (14,312 | ) | (0.3 | ) |
| Net loss attributable to common stockholders |       | $                                                            | (6,579,416 | ) | (135.3 | )% | $ | (5,880,639 | ) | (128.8 | )% |

 

| ** **                            | ** ** | **For the Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                                     | ** ** | **2005** | ** ** |
| Certification related revenues        |       | $                                                            | 198,991    |   | 4.1 | % | $ | 691,171 |   | 15.1 | % |
| Learning portal revenues              |       | 4,298,522                                                    |       | 88.4 |   | 3,354,808 |   | 73.5 |   |
| Online development and other revenues |       | 318,546                                                      |       | 6.5 |   | 518,484 |   | 11.4 |   |
| Other service revenues                |       | 47,890                                                       |       | 1.0 |   | — |   | 0.0 |   |
| Total net  revenues                   |       | $                                                            | 4,863,859  |   | 100.0 | % | $ | 4,564,463 |   | 100.0 | % |

 

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Certificationrelated revenues increased from $198,991 in 2004 to $691,171 in 2005. Theincrease is due to increases in agreements we signed with Select Partners andthe releases of new revenue-generating courses under those agreements in 2005compared to 2004.

Learningportal revenues decreased 28.1% to $3,354,808 in 2005, compared to $4,298,522in 2004. The decrease is primarily due to a decrease in revenue from highereducation customers (decrease of $1,220,000), and more specifically from ParkUniversity, which was partially offset by increases in revenues from corporateand government customers (increases of $265,000 and $11,000, respectively).

Onlinedevelopment and other revenues increased 62.8% to $518,484 in 2005, compared to$318,456 in 2004. The increase is primarily due to an increase in coursedevelopment and professional services orders including a large courseware orderfrom a Select Partner in 2005.

Other service revenues were $47,890 for twelve months endedDecember 31, 2004. Our contract with the U.S. Army, under which alllicensing and support revenues were generated, was completed in May 2004. Accordingly,we ceased recognizing licensing and support revenues after that date.

*Cost of Revenues*

Cost of revenues increased 27.6% to $1,730,892 in 2005 ascompared to $1,356,699 in 2004. The increase is primarily due to the fact thatas we continue to build our Select Partner courseware library, we replaced partof the former Park University revenues with revenues from readily availablethird-party content courses which carry royalty costs. The increase is also dueto the increase in costs associated with an increase in development and otherrevenues which increased in the twelve months ended December 31, 2005compared to the same period in 2004.

*Operating Expenses*

*Sales and Marketing.**  *Sales and marketing expensesdecreased 9.1% to $1,723,313 in 2005 compared to $1,895,340 in 2004. Thedecrease is primarily attributable to decreased headcount and related costsand, to a lesser extent, a decrease in out-of-pocket costs in sales andmarketing in the twelve months ended December 31, 2005 as we gain moreexperience in and streamline our marketing activities associated with ourSelect Partner program.

*Product Development and Operations.**  *Product development andoperations expenses decreased 2.8% to $2,649,215 in 2005 compared to $2,725,155in 2004. The decrease is primarily due to decreases in headcount and relatedcosts as well as out-of-pocket costs. The decrease was partially offset by thefact that following the release of our new course management system in thefirst quarter of 2004, we did not capitalize any software development costs(due to their nature) in the first quarter of 2005, whereas in the firstquarter of 2004, software development costs had been capitalized.

*General and Administrative.**  *General and administrativeexpenses decreased 11.8% to $1,488,240 in 2005 as compared to $1,686,940 in2004. The decrease is primarily due to the payment of incentive compensationamounts to employees in the second quarter of 2004 which did not occur in the2005 period. The decrease was also due to reductions in legal, accounting andother professional fees as well as other overhead costs due to reductions inheadcount and our efforts to monitor and reduce costs where possible.

*Depreciation and Amortization.**  *Depreciation andamortization expense increased 28.3% to $1,574,242 in 2005 as compared to$1,227,089 in 2004. The increase is primarily due to the release of ourenhanced Course Management System in the first quarter of 2004 as a result ofwhich we began amortizing costs we had capitalized for its development, therelease of new Select Partner courses and the resulting amortization ofcapitalized costs incurred for their development and the write off or writedown of capitalized costs incurred for the development of nine courses duringthe 2005 period to their estimated net realizable value as a result ofimpairment analyses.

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*Stock-based Compensation.**  *Stock-based compensationexpense for 2005 and 2004 consists of the fair value of stock issued ascustomary payment to our non-employee directors for their participation inBoard of Directors and Board Committee meetings and the fair market value ofstock issued to consultants. Under new accounting standards that becameeffective on January 1, 2006, we must record compensation expense in ourfinancial statements for stock options and other equity-based awards granted toemployees. Accordingly, we expect our stock-based compensation expense tomaterially increase in future periods.

*Interest Expense.**  *Interest expense for 2005and 2004 primarily consists of amortization of debt discount and deferred debtoffering costs and interest related to the $3,649,625 (as reduced to $1,385,390following mandatory and voluntary conversions and payments of principal throughDecember 31, 2005) of convertible promissory notes issued inMarch 2004.

*Other Income.**  *Other income for 2004consists of amounts recorded in connection with the settlements with ParkUniversity and two of our content providers which resulted in the write-off ofroyalty obligations.

**Liquidity and Capital Resources**

At December 31,2006, we had $539,105 in cash and cash equivalents, compared to $2,488,159 at December 31,2005. The decrease in cash and cash equivalents during 2006 is principally dueto the net loss recorded and the Prosoft acquisition, partially offset by thenet proceeds from the $2.3 million equity and $3.0 million convertible debtprivate placements completed in March 2006 and September 2006,respectively, and a large customer prepayment in May 2006. Since ourinception, we have financed our operating cash flow needs primarily throughofferings of equity and debt securities and, to a lesser extent, borrowings. Cashutilized in operating activities was $4,338,481 in 2006 and $2,188,886 in 2005.The increase in cash utilized in operating activities is primarily due to theincrease in our net loss in the 2006 period as compared to the 2005 period.

Cashutilized in investing activities was $1,665,644 in 2006 and $678,464 in 2005. Theuse of cash for investing activities in 2006 is primarily attributable to thecash portion of the Prosoft purchase price, and to a lesser extent in bothperiods, to courseware development costs that were capitalized and the purchaseof computer equipment. The decrease in cash utilized in capitalized softwareand courseware development costs in the 2006 period compared to the 2005 periodis primarily as a result of some of our Select Partners paying us to developcourses.

Net cashprovided by financing activities was $4,066,411 in 2006 and $2,723,005 in 2005.In March 2006, we completed a private placement of Series B-1convertible Preferred Stock. Under the terms of this financing, we raised$2,300,000 in gross proceeds through the issuance of 2,300 of Series B-1convertible Preferred Stock at a purchase price of $1,000 per share to twoaccredited investors. Under the terms of this financing, we also issuedten-year warrants to purchase 1,000,000 shares of common stock to the sameaccredited investors at an exercise price per share equal to the thenapplicable conversion price of the Series B-1 Preferred Stock. Thewarrants are immediately exercisable. The shares of Series B-1Preferred Stock are convertible, at the option of their holders, into commonstock based on a formula with a floor of $0.37 per share plus 2% of the amountby which the trading price of the common stock exceeds $0.37 per share on thedate of conversion. The shares of Series B-1 Preferred Stock areentitled to receive dividends paid quarterly at the greater of:  (a) anannual rate of 16%, or (b) 6.48% of the net sales proceeds from twoProsoft courses agreed upon by the parties. Each share of Series B-1Preferred Stock has a liquidation preference equal to 150% of the purchaseprice paid for the share.

In September 2006we completed a $3.0 million private placement of convertible notes andwarrants. Under the terms of this financing we issued a Senior SecuredConvertible Note to the investor for $3.0 million. The Note bears interest at10% per annum and matures 30 months from the date of issuance. We must beginmaking monthly installment payments of principal beginning in August 2007.The indebtedness 

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represented by the Note is secured by a blanket lien onsubstantially all of our assets and our subsidiary Prosoft Learning Corporation.The new indebtedness is senior to all of our existing indebtedness except forthe our remaining senior indebtedness of approximately $1.0 million owed toSIAR Capital and the other holders of notes issued in our March 2004financing. The indebtedness due under the Note can be accelerated upon a changeof control or following an event of default, which includes customary eventssuch as nonpayment of interest, failure to satisfy SEC registration obligationsand breach of restrictive covenants. We may prepay or redeem the Note at anytime upon repayment of 120% of the outstanding principal and accrued interest.The Note is convertible, at the election of the investor, into shares of ourcommon stock at $0.30 per share. The Note was issued at 94% of par, resultingin gross proceeds to us (before deduction of placement agent fees and othertransaction-related expenses) of $2.82 million.  As an additional inducement to the investor,we also issued a 5-year warrant to the investor to purchase up to2,500,000 shares of common stock at $0.30 per share. We agreed to file, andhave filed, a registration statement with the SEC to cover the resale of theshares of common stock issuable upon conversion of the Note and exercise of thewarrants issued in the financing. We paid the placement agent for the financinga fee of 7% of the gross cash proceeds received by us in the financing,together with a warrant to purchase 940,000 shares of common stock at $0.30 pershare. Pursuant to antidilution protection provisions applicable to theinvestors in our Series A-1 preferred stock financing closed in December 2005,the conversion price for the Series A-1 preferred stock and theexercise price of the related warrants issued in connection therewithautomatically adjusted to $0.30 per share upon completion of the September 2006Financing. The securities issued in the this financing likewise haveantidilution protection that would cause the conversion price or exercise priceof such securities to automatically adjust to any lower price applicable to afuture financing of VCampus.  TheTransaction Documents limit the investor’s beneficial ownership of VCampus tono more than 4.99% at any given time, subject to the investor’s waiver of suchrestrictive covenant upon giving at least 61 days’ notice to us.

We haveincurred significant losses since inception and had an accumulated deficit of$116 million as of December 31, 2006. We expect negative cash flowfrom operations to continue until the revenue streams mature. Our plans toaddress these conditions are to increase sales of current and future products,including those from Prosoft, and obtain additional financing. We have alsoinstituted cost cutting measures and operate under an approved budget which isclosely monitored. If additional capital is not obtained and revenues do notincrease significantly in the near future, we would have to institutesignificant cost cutting measures in order to sustain the business and suchcost cutting could impair our ability to continue as a going concern. Managementis committed to continuing to reduce expenses to the extent possible whilestill allowing for sufficient resources to meet projected sales levels.  If cash flows of the combined companies do notmeet management expectations, then our operations would be materially adverselyaffected and the company may be unable to continue as a going concern.

We have anobligation to repay principal and interest under our March 2004convertible notes that began in July 2005. The total outstanding principalremaining under these convertible notes as of December 31, 2006 amountedto $989,565. Cash payments for principal under these notes are approximately$99,000 per quarter through the maturity date in April 2009, unless suchnotes are sooner converted to common stock or restructured. Initial cashpayments for interest under these notes were approximately $36,000 per quarterbeginning July 1, 2005 and have gradually been decreasing as the principalis paid down (i.e. $21,770 for the most recent installment). In February 2006,holders of a majority of these notes notified us that they believe an event ofdefault exists under the notes based on our failure to acknowledge theiralleged right to have the conversion price on their notes reduced from $1.63per share to $0.50 per share, which is the lowest potential reset conversionprice for the Series A-1 Preferred Stock we issued to otherinvestors in the December 2005 financing. We believe the note holders’allegations are without merit. The note holders could also claim we are indefault based on our granting of a subordinate lien on our assets in favor ofthe September 2006 note investors. In addition, in March 2007, theholders of the September 2006 convertible notes notified us that theybelieve that grounds exist for 

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declaring multiple defaults under their notes based on,among other things, non-payment of interest to date and our securing of$380,000 of working capital financing in February 2007. Although we believethese claims are without merit, we are negotiating with the note holders in aneffort to resolve these issues. If we are unable to resolve these issues and inthe event either or both groups of note holders were successful in pursuingtheir claims, they would thereafter be entitled to formally declare a defaultand immediately accelerate the entire amount of the indebtedness and pursuetheir rights as the senior secured creditors with respect to our assets. In theevent of default, the interest rate on the notes would automatically beadjusted from 8% to 13% per year, in the case of the March 2004 notes, andfrom 10% to 15% in the case of the September 2006 notes. We do notcurrently have cash resources available to repay the principal on these notes.

We areobligated to pay a quarterly cash dividend at an annual rate of 10% on the Series A-1Preferred Stock so long as it is outstanding. Based on the 2,299 shares of Series A-1Preferred Stock that remain outstanding through the date of this report, we areobligated to pay $230,000 per year in cash dividends to our Series A-1Preferred Stockholders.

We areobligated to pay cash dividends to our Series B-1 PreferredStockholders so long as the Series B-1 Preferred Stock isoutstanding. Cash dividends are due quarterly at the greater of:  (a) anannual rate of 16%, or (b) 6.48% of the net sales proceeds from twoProsoft courses. Series B-1 Preferred Stockholders have agreedto accept their cash dividends in the form of additional shares of Series B-1Preferred Stock for the period beginning April 1, 2006 and ending June 30,2007. In exchange for the right to pay the Series B-1 dividends instock for the periods above, in October 2006, we agreed to modify theconversion price applicable to the shares of Series B-1 PreferredStock and the exercise price applicable to the related warrants. We also agreedto issue to the Series B-1 investors additional warrants to purchasea total of 450,000 shares of common stock at an exercise price equal to theconversion price applicable to the Series B-1 Preferred Stock. Themodified conversion price for the Series B-1 Preferred Stock is thesum of $0.37 per share plus 2% of the amount, if any, by which the closing saleprice of the common stock on the date of conversion exceeds $0.37. As part ofthe repricing transaction, the shares of Series B-1 Preferred Stockand the related warrants can hereafter be immediately exercised or convertedinto common stock at any time in the discretion of the holder. As of the datehereof, there is approximately $2.5 million of Series B-1 PreferredStock outstanding.

We areobligated to pay up to approximately $400,000 in back sales and use tax to theVirginia Department of Taxation pursuant to an audit and the Department’sinterpretation of local law regarding third-party royalties we pay to ourcontent providers for courses we deliver online. In May 2006, we submittedan application for an Offer in Compromise to the Virginia Department ofTaxation requesting partial relief from amounts assessed and post-audit salesand use tax liability as well as a payment plan for the remaining liabilities.In August 2006, the Virginia Department of Taxation accepted our offer incompromise, thus reducing the amount of the liability to $252,477, payable in36 monthly installments of $7,013, subject however, to the Department’spost-audit verification of our calculation of additional sales and use tax fromOctober 2001 to March 2006. The department’s verification proceedingsare currently under way.

If we arenot able to address our funding needs and repayment obligations or if we arenot successful in defending against or settling the claims of default under ouroutstanding notes, we will be materially adversely affected. Our future capitalrequirements will depend on many factors, including, but not limited to,acceptance of and demand for our products and services, including our CIW andCTP certifications and our Select Partner business model, capital requirementsassociated with acquisitions, market demands for technology upgrades, possiblerestructuring or early repayment of our indebtedness, the types of arrangementsthat we may enter into with customers and agents, and the extent to which thewe invest in the conversion of our CIW and CTP certification courseware to anonline format, Select Partner courseware development, new technology andresearch and development projects. While we believe we 

45

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have the ability to raise additional capital, our abilityto raise capital in the near term is uncertain. However, additional capital, ifneeded and available, may not have terms favorable to us or our currentstockholders.

As of December 31,2006, we had net operating loss carryforwards of approximately $ 75.6 millionfor federal income tax purposes, which will expire at various dates through2025. Our ability to utilize all of our net operating loss and creditcarryforwards may be limited by changes in ownership. Specifically, managementbelieves that deemed changes in ownership resulting from our recent equityfinancings will likely prevent us from using part or all of the net operatinglosses and credit carryfowards under the IRS change in ownership rules. We haverecognized a full valuation allowance against these deferred tax assets becausewe have determined that it is more likely than not that sufficient taxableincome will not be generated during the carryforward period available under thetax law to utilize the deferred tax assets.

In February 2007, we raised $380,000 in cash proceedsthrough the issuance of short-term working capital notes to threeaccredited investors, including Nat Kannan, our Chief Executive Officer andChairman, who personally invested $50,000 in the financing. The notes bearinterest at 10% and are due and payable on the earlier of June 30, 2007 orwithin three days of the date that we receive the approximately $1.5 millionpayment we are entitled to be paid under our subcontract with the primecontractor to the U.S. Department of Veterans’ Affairs (the “VA”). We expect toreceive this payment under the VA contract in the second quarter of 2007.

*Contractual Obligations*

Our future liquidity and capitalresources will be affected by our contractual obligations. Our significantcontractual obligations as of December 31, 2006 are for debt, operatingleases, capital leases and purchase obligations. These obligations aresummarized as follows:

| ** **                       | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **2007** | ** ** | **2008 – 2010** | ** ** | **2011 – 2013** | ** ** | **2014 and  Thereafter** | ** ** |
| Notes payable(1)(2)              |       | $                                         | 4,113,776  |   | $ | 1,270,037 |   | $ | 2,843,739 |   |   | $ | — |   |   |   | $ | — |   |   |
| Operating lease obligations      |       | 1,887,818                                 |       | 670,860 |   | 1,216,958 |   |   | — |   |   |   | — |   |   |
| Capital lease obligations        |       | 63,449                                    |       | 30,456 |   | 32,993 |   |   | — |   |   |   | — |   |   |
| Purchase obligations             |       | 150,000                                   |       | 75,000 |   | 75,000 |   |   | — |   |   |   | — |   |   |
| Total contractual obligations    |       | $                                         | 6,215,043  |   | $ | 2,046,353 |   | $ | 4,168,690 |   |   | $ | — |   |   |   | $ | — |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          In March 2004, we raised $5,000,000 in gross cashproceeds through the private placement of 20 units, at a purchase price of$200,000 per unit, and Series B senior secured convertible notes in theaggregate principal amount of $1,000,000. Each unit consisted of 50,000 sharesof common stock (initially priced at $1.63 per share), a Series A seniorsecured convertible note in the original principal amount of $118,500 and afive-year warrant to purchase 61,350 shares of common stock. We issued anadditional $250,000 of Series B senior secured notes in exchange forcancellation of existing short-term indebtedness in that amount. Upon approvalof the private placement by VCampus’ stockholders at our annual meeting in May 2004,$18,500 of principal of each of the Series A notes was converted intocommon stock at $1.63 per share and $100,000, or 50%, in principal of each ofthe Series B notes was converted into common stock at $1.63 per share. Thetotal principal amount for both Series converted upon approval of thestockholders was $999,625. Therefore, following stockholder approval, a totalof $2,650,000 of the placement was recorded as equity and $2,650,000 as seniordebt. The notes mature in April  2009 and bear interest at the rate of 8%per annum payable quarterly in cash or stock (valued at the conversion price)at our option for the first year. Principal and interest on the notes arepayable in cash over the following four years in quarterly installments. During2004, an additional $512,500 of Series A and Series B senior securedconvertible note principal 

46

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was converted into 314,420 shares of common stock,resulting in $1,512,125 of aggregate principal from this financing converted asof the end of 2004. During 2005, an additional $541,809 of Series A and Series Bsenior secured convertible note principal was converted into 332,398 shares ofcommon stock, resulting in $2,053,934 of aggregate principal from thisfinancing converted as of the end of 2005.

(2)          In September 2006 wecompleted a $3.0 million private placement of convertible notes and warrants.Under the terms of this financing we issued a Senior Secured Convertible Noteto the investor for $3.0 million. The Note bears interest at 10% per annum andmatures 30 months from the date of issuance. We must begin making monthlyinstallment payments of interest and principal beginning ten months from thedate of issuance. The indebtedness represented by the Note is secured by ablanket lien on substantially all of our assets and our subsidiary ProsoftLearning Corporation. The new indebtedness is senior to all of our existingindebtedness except for the our remaining senior indebtedness of approximately$1.0 million owed to SIAR Capital and the other holders of notes issued in our March 2004financing. The indebtedness due under the Note can be accelerated upon a changeof control or following an event of default, which includes customary eventssuch as nonpayment of interest, failure to satisfy SEC registration obligationsand breach of restrictive covenants. We may prepay or redeem the Note at anytime upon repayment of 120% of the outstanding principal and accrued interest.The Note is convertible, at the election of the investor, into shares of ourcommon stock at $0.30 per share. The Note was issued at 94% of par, resultingin gross proceeds to us (before deduction of placement agent fees and othertransaction-related expenses) of $2.82 million.  As an additional inducement to the investor,we also issued a 5-year warrant to the investor to purchase up to2,500,000 shares of common stock at $0.30 per share.

*Recent Accounting Pronouncements*

In June 2006,the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty inIncome Taxes—an interpretation of FAS 109. This interpretation clarifiesthe accounting for uncertainty in income taxes recognized in a company’sfinancial statements in accordance with FASB Statement No. 109, Accountingfor Income Taxes. This interpretation prescribes a recognition threshold andmeasurement attribute for the financial statement recognition and measurementof a tax position taken in a tax return. It also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. Interpretation No. 48 is effective forfiscal years beginning after December 15, 2006. Earlier application isencouraged if we have not yet issued financial statements, including interimfinancial statements, in the period in which Interpretation No. 48 isadopted. We are currently evaluating the impact the adoption of thisinterpretation will have on our consolidated results of operations andfinancial position

**Item 7A.     Quantitative and Qualitative DisclosuresAbout Market Risk.**

Our exposure to market risk forchanges in interest rates is currently very minimal and relates primarily toany investments we may hold at various times. When investing, our purchasesconsist of highly liquid investments with maturities at the date of purchasegenerally no greater than 90 days and rarely ever more than twelve months,thus, due to the short-term nature of such investments and our usual intentionto hold these investments until maturity, the impact of interest rate changeswould not have a material impact on our results of operations. In addition,essentially all of our debt obligations are at fixed interest rates. Given thefixed rate nature of the debt, the impact of interest rate changes also wouldnot have a material impact on our results of operations.  As a result of the Prosoft acquisition, we arecurrently exposed to currency translation risks. While this risk was immaterialin the second quarter of 2006 due to the late date of the acquisition (June 12,2006), we expect to be exposed to a moderate level of currency translation riskin the future. For the six months ended December 31, 2006, approximately11% of our revenues were denominated in Euros, exposing us to translation risksfor this currency. An insignificant 

47

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amount ofrevenue is currently denominated in pounds sterling and renmenbi, but this maybecome material in the future. We maintain no derivatives or other contracts tohedge or mitigate this risk.

**Item 8.**                        Financial Statements andSupplementary Data.

The information required by thisitem is included in this Report at pages F-1 through F-31. SeeIndex to Consolidated Financial Statements on page F-1.

**Item 9.**                        Changes In and DisagreementsWith Accountants on Accounting and Financial Disclosure.

Not applicable.

**Item 9A.**                Controls and Procedures.

(a)   Disclosure Controls and Procedures:   Disclosurecontrols and procedures (as defined in Exchange Act Rule 13a-15(e))are designed only to provide reasonable assurance that they will meet theirobjectives. As of the end of the period covered by this report, the Companycarried out an evaluation, under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andChief Financial Officer, of the effectiveness of the Company’s disclosurecontrols and procedures pursuant to Exchange Act Rule 13a-15. Basedupon that evaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer have concluded that the Company’s disclosure controls and proceduresare effective to provide the reasonable assurance discussed above.

(b)   Internal ControlOver Financial Reporting:   No change in the Company’s internal controlover financial reporting occurred during the Company’s last fiscal quarter thathas material affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

**Item 9B.**               Other Information.

None.

48

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**PART III**

Certain information required by Part III is omittedfrom this report because the Registrant intends to file either:  (a) an amendment to this Form 10-Kwithin 120 days after the end of its fiscal year; or (b) a definitiveproxy statement for its 2007 Annual Meeting of Stockholders (the “ProxyStatement”) within 120 days after the end of its fiscal year pursuant toRegulation 14A promulgated under the Securities Exchange Act of 1934, asamended, and the information included therein is incorporated herein byreference to the extent provided below.

**Item 10.**                 Directors and ExecutiveOfficers of the Registrant.

The information required by Item 10 of Form 10-Kconcerning the Registrant’s executive officers is set forth under the heading “ExecutiveOfficers” located at the end of Part I of this Report.

The Board of Directors has determined that the members ofthe Audit Committee are independent as defined in Rule 4200(a)(15) of theNational Association of Securities Dealers’ listing standards. The Board of Directorshas determined that Martin Maleska is an “audit committee financial expert” asdefined in Item 407(d)(5) of Regulation S-K.

The Board of Directors has adopted a code of conduct thatapplies to all of our directors and employees. Our Board has also adopted aseparate code of conduct for our Chief Executive Officer, Chief FinancialOfficer and Controller, or persons performing similar functions. We willprovide copies of our codes of conduct without charge upon request. To obtain acopy of our codes of conduct, please send your written request to VCampusCorporation, 1850 Centennial Park Drive, Suite 200, Reston, VA 20191,Attention: Chief Financial Officer.

The other information required by Item 10 of Form 10-Kconcerning the Registrant’s directors is incorporated by reference to theinformation under the headings “Proposal No. 1—Election of Directors” and “OtherInformation—Section 16(a) Beneficial Ownership Reporting Compliance”in the Proxy Statement.

**Item 11.**                 Executive Compensation.

The information required by Item 11 of Form 10-Kis incorporated by reference to the information under the heading “Proposal No. 1—Electionof Directors—Corporate Governance Matters”, “Other Information—ExecutiveCompensation”, “—Compensation of Directors”, “—Employment Agreements”, “—CompensationCommittee Report” and “—Compensation Committee Interlocks and InsiderParticipation” in the Proxy Statement.

**Item 12.**                 Security Ownership ofCertain Beneficial Owners and Management and Related Stockholder Matters.

The information required by Item 12 of Form 10-Kis incorporated by reference to the information under the heading “OtherInformation—Principal Stockholders” and “Other Information—Equity CompensationPlan Information” in the Proxy Statement.

**Item 13.**                 Certain Relationships andRelated Transactions.

The information required by Item 13 of Form 10-Kis incorporated by reference to the information under the heading “OtherInformation—Certain Transactions” and “Proposal No. 1—Election ofDirectors—Corporate Governance Matters” in the Proxy Statement.

**Item 14.**                 Principal Accounting Feesand Services

The information required by Item 14 of Form 10-Kis incorporated by reference to the information under the heading “PrincipalAccounting Fees and Services” in the Proxy Statement.

49

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**PART IV**

**Item 15.**                 Exhibits and FinancialStatement Schedules.

(a)   Thefollowing Financial Statements, Financial Statement Schedules and Exhibits arefiled as part of this report or incorporated herein by reference:

(1)          Financial Statements.

See Indexto Consolidated Financial Statements on page F-1.

(2)          Financial Statement Schedules.

Thefollowing financial statement schedule is filed with this report: Schedule II—Valuationand Qualifying Account and Reserve

All otherfinancial statement schedules for which provision is made in Regulation S-X areomitted because they are not required under the related instructions, areinapplicable, or the required information is given in the financial statements,including the notes thereto and, therefore, have been omitted.

(b)   Exhibits.

| Exhibit No.                 | ** ** | ** **                                                                                                                                | ** ** | ** ** | **Description** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|-----------------|------------|
|     3.1(p)   |       | Amended  and Restated Certificate of Incorporation, as currently in effect.                                                               |
|     3.2(a)   |       | Amended  and Restated Bylaws, as currently in effect.                                                                                     |
|     3.3(e)   |       | Certificate of Amendment of Amended and Restated  Certificate of Incorporation, as filed in Delaware on September 13, 2006           |
|     4.1(a)   |       | Form of Common Stock certificate.                                                                                                    |
|     4.2(b)** |       | 2006 Equity Incentive Plan                                                                                                                |
|   10.9(a)**            |       | 1996 Stock Plan                                                                                                                           |
|   10.90(c)             |       | Form of warrant issued in connection with the  conversion of VCampus preferred stock.                                                |
|   10.91(k)             |       | Purchase Agreement dated March 23, 2004 for the $5.3  million private placement                                                      |
|   10.92(k)             |       | Form of Series A Senior Secured Convertible  Note issued on March 23, 2004                                                 |
|   10.93(k)             |       | Form of Series B Senior Secured Convertible  Note issued on March 23, 2004                                                 |
|   10.94(k)             |       | Form of Warrant issued on March 23, 2004 in  connection with the $5.3 million private placement                                 |
|   10.95(k)             |       | Registration Rights Agreement dated March 23, 2004  entered into in connection with the $5.3 million private placement               |
|   10.96(k)             |       | Security Agreement dated March 23, 2004 entered into  in connection with the $5.3 million private placement                          |
|   10.97(d)*            |       | Content Client License Agreement between VCampus and Net  Dimensions Limited dated February 24, 2004                                 |
|   10.98(d)             |       | Settlement Agreement and Release between VCampus and Park  University dated May 3, 2004                                              |
|   10.99(g)             |       | VCampus’ standard form of Online Content Conversion and  Distribution Agreement (also known as the form of Select Partner Agreement) |
|   10.100(g)            |       | Form of Subscription Agreement, dated March 30,  2005, between VCampus and each of the Purchasers                               |

50

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|   10.101(g) |   | Registration Rights Agreement, dated March 30, 2005,  among VCampus and the Purchasers.                                                                |
|-----------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.102(g)             |   | Form of Warrant issued by VCampus to each of the  Purchasers on March 30, 2005.                                                                   |
| 10.103(h)             |   | Form of Subscription Agreement for  December 2005 financing                                                                                       |
| 10.104(h)             |   | Form of Warrant for December 2005 financing                                                                                                       |
| 10.105(h)             |   | Registration Rights Agreement for December 2005  financing                                                                                             |
| 10.106(h)             |   | Certificate of Designations of the Series A-1  Convertible Preferred Stock                                                                             |
| 10.107(i)**           |   | Employment Agreement with Narasimhan P. Kannan dated  December 30, 2005.                                                                               |
| 10.109(j)             |   | Amendment to Certificate of Designations of the  Series A-1 Convertible Preferred Stock                                                                |
| 10.110(j)             |   | Certificate of Designations of the Series B-1  Convertible Preferred Stock                                                                             |
| 10.111(j)             |   | Form of Subscription Agreement for the Series B-1  Preferred Stock financing                                                                      |
| 10.112(j)             |   | Registration Rights Agreement for the Series B-1  Preferred Stock financing                                                                            |
| 10.113(j)             |   | Form of Warrant issued in the Series B-1  Preferred Stock financing                                                                               |
| 10.114(j)*            |   | Agreements representing the registrant’s renewal of its  subcontract to continue performing services for the Department of Veterans’ Affairs.     |
| 10.115(l)             |   | Acquisition and Reorganization Agreement dated  April 11, 2006 between Prosoft Learning Corporation,  ComputerPREP, Inc., and VCampus Corporation |
| 10.116(l)             |   | Letter Agreement dated April 11, 2006 regarding  Reorganization and Acquisition of Capital Stock of Prosoft Learning  Corporation                      |
| 10.117(l)             |   | Transition Services Agreement dated April 10, 2006  between Prosoft Learning Corporation and Benjamin M. Fink                                          |
| 10.118(m)             |   | Securities Purchase Agreement for September 2006  Financing                                                                                            |
| 10.119(m)             |   | Registration Rights Agreement for September 2006  Financing                                                                                            |
| 10.120(m)             |   | Form of Warrant issued in the September 2006  Financing                                                                                           |
| 10.121(m)             |   | Form of Senior Secured Convertible Note issued in  the September 2006 Financing                                                                   |
| 10.122(m)             |   | Security Agreement for the September 2006 Financing                                                                                                    |
| 10.123(n)**           |   | Amended and Restated Employment Agreement with  Christopher L. Nelson dated effective as of October 1, 2006                                            |
| 10.124(o)             |   | Amended and Restated Certificate of Designation of the  Series B-1 Preferred Stock dated October 31, 2006                                         |
| 21.1                  |   | List of Subsidiaries                                                                                                                                        |
| 23.1                  |   | Consent of Reznick Group, P.C., Independent Registered  Public Accounting Firm                                                                              |
| 31.1                  |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a).                                                                                  |
| 31.2                  |   | Certification of Chief Financial Officer pursuant to Rule 13a-14(a).                                                                                   |
| 32.1                  |   | Chief Executive Officer Certification pursuant to  Section 906 of the Sarbanes/Oxley Act of 2002.                                                      |
| 32.2                  |   | Chief Financial Officer Certification pursuant to  Section 906 of the Sarbanes/Oxley Act of 2002.                                                      |
| 99.7(f)               |   | Audit Committee Charter.                                                                                                                                    |

 

51

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*                    The registrant has requestedand/or received confidential treatment with respect to certain portions of thisexhibit. Such portions have been omitted from this exhibit and have been filedseparately with the SEC.

**             Management contract orcompensatory plan or arrangement required to be filed as an exhibit to thisAnnual Report on Form 10-K.

(a)           Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Registration Statementon Form S-1 (File No. 333-12135).

(b)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Quarterly Report forthe quarter ended June 30, 2006.

(c)           Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Quarterly Report on Form 10-Qfor the quarter ended June 30, 2003.

(d)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Quarterly Report on Form 10-Qfor the quarter ended March 31, 2004.

(e)           Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Quarterly Report on Form 10-Qfor the quarter ended September 30, 2006.

(f)             Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s current report on Form 8-Kfiled on June 1, 2001.

(g)           Incorporated by reference tothe similarly numbered exhibit to the Registrant’s current report on Form 8-Kfiled on April 4, 2005.

(h)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s current report on Form 8-Kfiled December 14, 2005.

(i)             Incorporated by reference tothe Exhibits to the Registrant’s current report Form 8-K filed January 6,2006.

(j)              Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2005.

(k)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Annual Report on Form 10-Kfor the year ended December 31, 2003.

(l)             Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s current report on Form 8-Kfiled April 18, 2006.

(m)      Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s current report on Form 8-Kfiled September 26, 2006.

(n)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s current report on Form 8-Kfiled October 27, 2006.

(o)          Incorporated by reference tothe Exhibits to the Registrant’s current report on Form 8-K filed October 31,2006.

(p)          Incorporated by reference tothe similarly numbered Exhibit to the Registrant’s Post-EffectiveAmendment No. 1 to Registration Statement No. 333-108380 filedon July 19, 2004.

52

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**SIGNATURES**

Pursuant to the requirements of Section 13or 15(d) of the Securities and Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

|        |   | VCAMPUS  CORPORATION |
|--------|--------|----------------------|
|   |   | By:                  |   | /s/ Narasimhan P. Kannan |
|   |   |                 |   | Narasimhan  P. Kannan, Chief Executive Officer |

 

Date: April 12,2007

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing person on behalf of the Registrant and in the capacities and on thedates indicated.

|                           | **Signature** | ** **                                   | ** ** | ** **                 | **Capacity** | ** ** | ** ** | ** ** | **Date** | ** ** |
|---------------------------|---------------|----------------------------------------------|------------|----------------------------|--------------|------------|------------|------------|----------|------------|
| /s/ Narasimhan P. Kannan  |          | Chairman and Chief Executive Officer         |       | April 12,  2007       |
| Narasimhan P. Kannan      |          | (Principal Executive Officer)                |       |                       |
| /s/ Christopher L. Nelson |          | Chief Financial Officer                      |       | April 12,  2007       |
| Christopher L. Nelson     |          | (Principal Financial and Accounting Officer) |       |                       |
| /s/ Edson D. deCastro     |          | Director                                     |       | April 11,  2007       |
| Edson D. deCastro         |          |                                         |       |                       |
| /s/ Martin E. Maleska     |          | Director                                     |       | April 10,   2007 |
| Martin E. Maleska         |          |                                         |       |                       |
| /s/ John Birdsong         |          | Director                                     |       | April 10,   2007 |
| John  Birdsong            |          |                                         |       |                       |

 

53

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**VCAMPUS CORPORATION**

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

| Report of Reznick Group,  P.C., Independent Registered Public Accounting Firm                                             |   | F-2  |
|---------------------------------------------------------------------------------------------------------------------------|--------|------|
| Consolidated Balance Sheets as of December 31,  2005 and 2006                                                        |   | F-3  |
| Consolidated Statements of Operations for the years  ended December 31, 2004, 2005 and 2006                          |   | F-4  |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the years ended December 31, 2004, 2005 and 2006 |   | F-5  |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2004, 2005 and 2006                          |   | F-7  |
| Notes to Consolidated Financial Statements                                                                                |   | F-8  |
| Schedule II—Valuation and Qualifying Account and  Reserve                                                            |   | F-38 |

 

F-1

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To Board of Directors and Stockholders ofVCampus Corporation

We have audited the accompanying consolidated balancesheets of VCampus Corporation and subsidiaries as of December 31, 2005 and2006, and the related consolidated statements of operations, stockholders’equity (deficit) and cash flows for each of the years in the three-year periodended December 31, 2006. Our audits also included the financial statementschedule listed in the Index at Item 15(a)2. These financial statementsand schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our audits.

We conducted our audits in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged to perform, anaudit of its internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of VCampus Corporation and subsidiaries at December 31, 2005 and2006, and the consolidated results of their operations and their cash flows foreach of the years in the three-year period ended December 31, 2006, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,present fairly in all material respects the information set forth therein.

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 1 to the consolidatedfinancial statements, the Company has experienced significant operating lossesand negative cash flows from operations. These matters raise substantial doubtabout the Company’s ability to continue as a going concern. Management’s plansin regard to these matters are also described in Note 1. The consolidatedfinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

/s/ Reznick Group, P.C.

Vienna, VirginiaApril 11, 2007

F-2

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**VCAMPUSCORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                                                                                         | ** ** | **December 31,  2005** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                                                                                             |       |                        |       |                        |       |
| Current assets:                                                                                                                                                                                                                                    |       |                        |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                          |       | $                           | 2,488,159  |                        | $          | 539,105 |   |
| Accounts receivable, less allowance of $5,000 and $70,000  at December 31, 2005 and 2006, respectively                                                                                                                                        |       | 209,338                     |       | 686,360                     |       |
| Loans receivable from related party                                                                                                                                                                                                                |       | 15,453                      |       | —                      |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                          |       | 325,818                     |       | 832,053                     |       |
| Total current  assets                                                                                                                                                                                                                              |       | 3,038,768                   |       | 2,057,518                   |       |
| Property and  equipment, net                                                                                                                                                                                                                       |       | 313,880                     |       | 325,741                     |       |
| Capitalized  software costs and courseware development costs, net                                                                                                                                                                                  |       | 1,308,577                   |       | 223,965                     |       |
| Other assets                                                                                                                                                                                                                                       |       | 231,859                     |       | 326,632                     |       |
| Other intangible  assets, net                                                                                                                                                                                                                      |       | 257,006                     |       | 1,399,525                   |       |
| Goodwill                                                                                                                                                                                                                                           |       | 328,317                     |       | 842,186                     |       |
| Total assets                                                                                                                                                                                                                                       |       | $                           | 5,478,407  |                        | $          | 5,175,567 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                         |       |                        |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                               |       |                        |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                   |       | $                           | 1,182,585  |                        | $          | 1,223,058 |   |
| Accrued expenses                                                                                                                                                                                                                                   |       | 479,316                     |       | 907,576                     |       |
| Notes payable                                                                                                                                                                                                                                      |       | 191,796                     |       | 266,050                     |       |
| Accrued sales and use tax liability                                                                                                                                                                                                                |       | —                      |       | 400,000                     |       |
| Capital lease obligation                                                                                                                                                                                                                           |       | —                      |       | 26,873                      |       |
| Deferred revenues                                                                                                                                                                                                                                  |       | 469,280                     |       | 544,630                     |       |
| Accrued dividends payable to preferred stockholders                                                                                                                                                                                                |       | 14,312                      |       | 156,844                     |       |
| Total current liabilities                                                                                                                                                                                                                          |       | 2,337,289                   |       | 3,525,031                   |       |
| Long-term  liabilities:                                                                                                                                                                                                                            |       |                        |       |                        |       |
| Notes payable—less discount and current portion                                                                                                                                                                                               |       | 479,489                     |       | 2,317,968                   |       |
| Capital lease obligation—net of current portion                                                                                                                                                                                               |       | —                      |       | 31,550                      |       |
| Total liabilities                                                                                                                                                                                                                                  |       | 2,816,778                   |       | 5,874,549                   |       |
| Commitments and  contingencies:                                                                                                                                                                                                                    |       | —                      |       | —                      |       |
| Stockholders’  equity:                                                                                                                                                                                                                        |       |                        |       |                        |       |
| Series A-1 convertible Preferred Stock,  $0.01 par value per share; aggregate liquidation preference of $2,356,859;  5,000 shares authorized; 2,342 and 2,299 shares issued and outstanding at  December 31, 2005 and 2006, respectively |       | 23                          |       | 23                          |       |
| Series B-1 convertible Preferred Stock,  $0.01 par value per share; aggregate liquidation preference of $3,825,360;  5,000 shares authorized; 0 and 2,484 shares issued and outstanding at  December 31, 2005 and 2006, respectively     |       | —                      |       | 25                          |       |
| Common Stock, $0.01 par value per share; 50,000,000  shares authorized; 9,592,074 and 10,225,424 shares issued and outstanding at  December 31, 2005 and 2006, respectively                                                                   |       | 95,921                      |       | 102,254                     |       |
| Additional paid-in capital                                                                                                                                                                                                                         |       | 105,418,644                 |       | 114,874,543                 |       |
| Accumulated deficit                                                                                                                                                                                                                                |       | (102,852,959                | )          | (115,664,417                | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                               |       | —                      |       | (11,410                     | )          |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                          |       | 2,661,629                   |       | (698,982                    | )          |
| Total liabilities  and stockholders’ equity (deficit)                                                                                                                                                                                         |       | $                           | 5,478,407  |                        | $          | 5,175,567 |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

F-3

----

**VCAMPUSCORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:                                     |       |                                        |       |   |   |   |   |
| Certification related revenues                |       | $                                           | 442,250    |   | $ | 691,171 |   | $ | 4,116,165 |   |
| Learning portal revenues                      |       | 4,055,265                                   |       | 3,354,808 |   | 2,682,706 |   |
| Development and other revenues                |       | 366,344                                     |       | 518,484 |   | 646,662 |   |
| Net revenues                                  |       | 4,863,859                                   |       | 4,564,463 |   | 7,445,533 |   |
| Operating expenses:                           |       |                                        |       |   |   |   |   |
| Cost of revenues                              |       | 1,356,699                                   |       | 1,730,892 |   | 2,559,289 |   |
| Sales and marketing                           |       | 1,895,340                                   |       | 1,723,313 |   | 2,507,854 |   |
| Product development and operations            |       | 2,725,155                                   |       | 2,649,215 |   | 2,829,243 |   |
| General and administrative                    |       | 1,686,940                                   |       | 1,488,240 |   | 2,912,462 |   |
| Depreciation and amortization                 |       | 1,227,089                                   |       | 1,574,242 |   | 1,754,877 |   |
| Sales and use tax assessment                  |       | —                                      |       | — |   | 400,000 |   |
| Impairment of goodwill                        |       | —                                      |       | — |   | 328,317 |   |
| Stock-based compensation                      |       | 153,973                                     |       | 109,493 |   | 858,507 |   |
| Total operating  expenses                     |       | 9,045,196                                   |       | 9,275,395 |   | 14,150,549 |   |
| Loss from  operations                         |       | (4,181,337                                  | )          | (4,710,932 | ) | (6,705,016 | ) |
| Other income                                  |       | 183,210                                     |       | — |   | — |   |
| Interest expense,  net                        |       | (2,581,289                                  | )          | (1,155,395 | ) | (919,944 | ) |
| Net loss                                      |       | (6,579,416                                  | )          | (5,866,327 | ) | (7,624,960 | ) |
| Dividends to  preferred stockholders          |       | —                                      |       | (14,312 | ) | (5,186,495 | ) |
| Net loss  attributable to common stockholders |       | $                                           | (6,579,416 | ) | $ | (5,880,639 | ) | $ | (12,811,455 | ) |
| Basic and diluted net  loss per share         |       | $                                           | (0.97      | ) | $ | (0.63 | ) | $ | (1.30 | ) |

 

The accompanying notes are an integral part of the consolidated financial statements.

F-4

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**VCAMPUS CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)**

| ** **                                                    | ** ** | **Series B-1  Convertible** | ** ** | **Series A-1  Convertible** | ** ** | ** **            | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------------|------------|------------|------------|
| ** **                                                    | ** ** | **Preferred Stock**         | ** ** | **Preferred Stock**         | ** ** | **Common Stock** | ** ** |
| ** **                                                    | ** ** | **Shares**                       | ** ** | **Amount**                       | ** ** | **Shares**            | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Balance at  December 31, 2003                            |       |                             | —     |                             |       |                  | $          | —     |       |   |   | — |   |   |   | $ | — |   |   | 5,167,000 |   | $ | 51,670 |   |
| Issuance of Common Stock                                      |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 1,012,500 |   | 10,125 |   |
| Issuance of  Common Stock in connection with debt conversions |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 1,076,772 |   | 10,766 |   |
| Exercises of options  and warrants                            |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 1,132,617 |   | 11,326 |   |
| Compensatory  stock, stock options and warrants               |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 72,197 |   | 724 |   |
| Net loss                                                      |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Balance at  December 31, 2004                            |       |                             | —     |                             |       |                  | $          | —     |       |   |   | — |   |   |   | $ | — |   |   | 8,461,086 |   | $ | 84,611 |   |
| Issuance of Series A-1 convertible  Preferred Stock      |       |                             | —     |                             |       |                  | —     |       |       |   | 2,342 |   |   |   | 23 |   |   | — |   | — |   |
| Issuance of  Common Stock                                     |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 611,012 |   | 6,110 |   |
| Issuance of  Common Stock in connection with debt conversions |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 386,152 |   | 3,862 |   |
| Exercises of  options and warrants                            |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Compensatory  stock, stock options and warrants               |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 133,824 |   | 1,338 |   |
| Net loss                                                      |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Dividends on  convertible Preferred Stock                     |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Balance at  December 31, 2005                            |       |                             | —     |                             |       |                  | $          | —     |       |   |   | 2,342 |   |   |   | $ | 23 |   |   | 9,592,074 |   | $ | 95,921 |   |
| Issuance of Series B-1 convertible  Preferred Stock      |       |                             | 2,484      |                             |       |                  | 25         |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Issuance of  Common Stock                                     |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 284,000 |   | 2,840 |   |
| Issuance of  Common Stock—conversion of Preferred Stock  |       |                             | —     |                             |       |                  | —     |       |       |   | (67 | ) |   |   | — |   |   | — |   | — |   |
| Exercises of  options and warrants                            |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Compensatory  stock, stock options and warrants               |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | 349,350 |   | 3,493 |   |
| Issuance of  Series A-1 convertible Preferred Stock      |       |                             | —     |                             |       |                  | —     |       |       |   | 24 |   |   |   | — |   |   | — |   | — |   |
| Net loss                                                      |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Dividends on  convertible Preferred Stock                     |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Foreign currency  translation                                 |       |                             | —     |                             |       |                  | —     |       |       |   | — |   |   |   | — |   |   | — |   | — |   |
| Balance at  December 31, 2006                            |       |                             | 2,484      |                             |       |                  | $          | 25         |       |   |   | 2,299 |   |   |   | $ | 23 |   |   | 10,225,424 |   | $ | 102,254 |   |

 

F-5

----

**VCAMPUS CORPORATION ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) (Continued)**

| ** **                                                    | ** ** | **Additional  Paid in  Capital** | ** **  | **Accumulated   Deficit** | ** ** | **Other   Comprehensive  Loss** | ** ** | **Total   Stockholders’   Equity** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------|-------------|--------------------------------|------------|--------------------------------------|------------|---------------------------------------------------|------------|
| Balance at  December 31, 2003                            |       | $                                     | 92,376,579  |                           | $          | (90,392,904                          | )          |                                              | $          | — |   |   |   | $ | 2,035,345 |   |   |
| Issuance of Common Stock                                      |       | 1,520,209                             |        | —                         |       |                                 | —     |                                              |       |   | 1,530,334 |   |   |
| Issuance of Common Stock  in connection with debt conversions |       | 1,808,808                             |        | —                         |       |                                 | —     |                                              |       |   | 1,819,574 |   |   |
| Exercises of options and  warrants                            |       | 1,932,957                             |        | —                         |       |                                 | —     |                                              |       |   | 1,944,283 |   |   |
| Compensatory stock,  stock options and warrants               |       | 4,093,685                             |        | —                         |       |                                 | —     |                                              |       |   | 4,094,409 |   |   |
| Net loss                                                      |       | —                                |        | (6,579,416                     | )          |                                 | —     |                                              |       |   | (6,579,416 | ) |   |
| Balance at  December 31, 2004                            |       | $                                     | 101,732,238 |                           | $          | (96,972,320                          | )          |                                              | $          | — |   |   |   | $ | 4,844,529 |   |   |
| Issuance of  Series A-1 convertible Preferred Stock      |       | 2,032,833                             |        | —                         |       |                                 | —     |                                              |       |   | 2,032,856 |   |   |
| Issuance of Common Stock                                      |       | 894,340                               |        | —                         |       |                                 | —     |                                              |       |   | 900,450 |   |   |
| Issuance of Common Stock  in connection with debt conversions |       | 625,579                               |        | —                         |       |                                 | —     |                                              |       |   | 629,441 |   |   |
| Exercises of options and  warrants                            |       | —                                |        | —                         |       |                                 | —     |                                              |       |   | — |   |   |
| Compensatory stock,  stock options and warrants               |       | 133,654                               |        | —                         |       |                                 | —     |                                              |       |   | 134,992 |   |   |
| Net loss                                                      |       | —                                |        | (5,866,327                     | )          |                                 | —     |                                              |       |   | (5,866,327 | ) |   |
| Dividends on convertible  Preferred Stock                     |       | —                                |        | (14,312                        | )          |                                 | —     |                                              |       |   | (14,312 | ) |   |
| Balance at December 31,  2005                            |       | $                                     | 105,418,644 |                           | $          | (102,852,959                         | )          |                                              | $          | — |   |   |   | $ | 2,661,629 |   |   |
| Issuance of  Series B-1 convertible Preferred Stock      |       | 2,413,975                             |        | —                         |       |                                 | —     |                                              |       |   | 2,414,000 |   |   |
| Issuance of Common Stock                                      |       | 42,160                                |        | —                         |       |                                 | —     |                                              |       |   | 45,000 |   |   |
| Issuance of Common  Stock—conversion of Preferred Stock  |       | —                                |        | —                         |       |                                 | —     |                                              |       |   | — |   |   |
| Exercises of options and  warrants                            |       | —                                |        | —                         |       |                                 | —     |                                              |       |   | — |   |   |
| Compensatory stock,  stock options and warrants               |       | 6,975,390                             |        | (4,664,536                     | )          |                                 | —     |                                              |       |   | 2,314,347 |   |   |
| Issuance of  Series A-1 convertible Preferred Stock      |       | 24,374                                |        | —                         |       |                                 | —     |                                              |       |   | 24,374 |   |   |
| Net loss                                                      |       | —                                |        | (7,624,960                     | )          |                                 | —     |                                              |       |   | (7,624,960 | ) |   |
| Dividends on convertible  Preferred Stock                     |       | —                                |        | (521,962                       | )          |                                 | —     |                                              |       |   | (521,962 | ) |   |
| Foreign currency  translation                                 |       | —                                |        | —                         |       |                                 | (11,410    | )                                                 |       |   | (11,410 | ) |   |
| Balance at  December 31, 2006                            |       | $                                     | 114,874,543 |                           | $          | (115,664,417                         | )          |                                              | $          | (11,410 | ) |   |   | $ | (698,982 | ) |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

F-6

----

**VCAMPUSCORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                                         | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Operating Activities**                                                                           | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                                           |       | $                                           | (6,579,416 | ) | $ | (5,866,327 | ) | $ | (7,624,960 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:                       |       |                                        |       |   |   |   |   |
| Depreciation                                                                                       |       | 290,050                                     |       | 300,067 |   | 245,074 |   |
| Amortization                                                                                       |       | 937,039                                     |       | 1,025,199 |   | 1,125,922 |   |
| Bad debt expense                                                                                   |       | —                                      |       | — |   | (1,586 | ) |
| Impairment of capitalized software and courseware  development costs                               |       | —                                      |       | 248,976 |   | 294,856 |   |
| Impairment of other intangible assets                                                              |       | —                                      |       | — |   | 26,077 |   |
| Impairment of goodwill                                                                             |       | —                                      |       | — |   | 328,317 |   |
| Non-cash stock option and stock warrant expense                                                    |       | 153,973                                     |       | 109,493 |   | 858,507 |   |
| Debt discount and deferred financing costs  amortization                                           |       | 2,430,849                                   |       | 1,060,057 |   | 835,630 |   |
| Interest expense paid with stock                                                                   |       | 117,992                                     |       | 42,400 |   | — |   |
| Settlement of accounts payable and accrued expenses                                                |       | (183,210                                    | )          | — |   | — |   |
| Increase (Decrease) in allowance for doubtful  accounts                                            |       | —                                      |       | (584 | ) | 43,839 |   |
| Changes in  operating assets and liabilities net of effect of acquisitions:                        |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                                |       | 7,429                                       |       | 74,346 |   | 53,894 |   |
| Prepaid expenses and other current assets                                                          |       | 116,053                                     |       | 315,812 |   | (336,013 | ) |
| Other assets                                                                                       |       | 1,118                                       |       | 44,541 |   | 346,072 |   |
| Accounts payable and accrued expenses                                                              |       | (541,359                                    | )          | 838,972 |   | (608,482 | ) |
| Deferred revenues                                                                                  |       | (159,445                                    | )          | (381,838 | ) | 74,372 |   |
| Net cash used in  operating activities                                                             |       | (3,408,927                                  | )          | (2,188,886 | ) | (4,338,481 | ) |
| **Investing  Activities**                                                                          | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchases of  property and equipment                                                               |       | (305,374                                    | )          | (90,284 | ) | (145,302 | ) |
| Proceeds from the  sale of property and equipment                                                  |       | 1,324                                       |       | — |   | — |   |
| Acquisition of  Prosoft, net of cash required                                                      |       | —                                      |       | — |   | (1,508,280 | ) |
| Capitalized  software and courseware development costs                                             |       | (931,497                                    | )          | (622,510 | ) | (27,515 | ) |
| Proceeds from  loans receivable from related party                                                 |       | 36,000                                      |       | 36,000 |   | 15,453 |   |
| Interest on loans  receivable from related party                                                   |       | (2,038                                      | )          | (1,670 | ) | — |   |
| Proceeds from  loans receivable                                                                    |       | 74,252                                      |       | — |   | — |   |
| Net cash used in  investing activities                                                             |       | (1,127,333                                  | )          | (678,464 | ) | (1,665,644 | ) |
| **Financing  Activities**                                                                          | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  issuance of Common Stock                                                            |       | 3,474,614                                   |       | 900,450 |   | — |   |
| Proceeds from the  issuance of Series A-1 convertible Preferred Stock, net of  offering costs |       | —                                      |       | 2,032,856 |   | — |   |
| Proceeds from the  issuance of Series B-1 convertible Preferred Stock, net of  offering costs |       | 3,384,166                                   |       | — |   | 2,230,000 |   |
| Proceeds from  notes payable                                                                       |       | —                                      |       | — |   | 2,687,327 |   |
| Payments on  capital lease obligations                                                             |       | —                                      |       | — |   | (14,745 | ) |
| Payment of  dividends                                                                              |       | —                                      |       | — |   | (171,053 | ) |
| Repayments of  notes payable                                                                       |       | (225,000                                    | )          | (210,301 | ) | (665,088 | ) |
| Net cash provided  by financing activities                                                         |       | 6,633,780                                   |       | 2,723,005 |   | 4,066,441 |   |
| Net effect of  exchange rate changes on cash and cash equivalents                                  |       | —                                      |       | — |   | (11,370 | ) |
| Net increase  (decrease) in cash and cash equivalents                                              |       | 2,097,520                                   |       | (144,345 | ) | (1,949,054 | ) |
| Cash and cash  equivalents at the beginning of the year                                            |       | 534,984                                     |       | 2,632,504 |   | 2,488,159 |   |
| Cash and cash  equivalents at the end of the year                                                  |       | $                                           | 2,632,504  |   | $ | 2,488,159 |   | $ | 539,105 |   |
| **Supplemental  cash flow information:**                                                           | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest paid                                                                                      |       | $                                           | 43,530     |   | $ | 66,703 |   | $ | 98,956 |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

F-7

----

**VCAMPUSCORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1. Organization and Nature of Operations**

VCampus Corporation (the “Company”)was incorporated in Virginia in 1984 and reincorporated in Delaware in 1985.VCampus Corporation develops courseware and manages and hosts Internet-basedlearning environments for professional credentialing and certificationorganizations, corporations, government agencies, and associations. The Company’sservices cover a broad range of e-Learning programs, from registration,enrollment and course delivery  to customcourse development, e-commerce and publishing, as well as tracking of students’progress, reporting of results and production of certificates of completion.

***CurrentOperating Conditions and Basis of Presentation***

The accompanying consolidated financial statementshave been prepared on a going concern basis, which contemplates the realizationof assets and the satisfaction of liabilities in the normal course of business.As described more fully below, certain significant factors raise substantialdoubt about the Company's ability to continue to operate as a going concern.The financial statements do not include any adjustments relating to therecoverability and classification of recorded asset amounts or the amounts orclassification of liabilities that might be necessary should the Company beunable to continue as a going concern. A significant portion of the Company'sassets consist of intangibles related to courseware, customer relationships andgoodwill, all of which are primarily related to the ProSoft acquisition. Shouldthe Company be unable to continue as a going concern, the amount at which theseassets might be recovered in a forced sale could be significantly less than theamounts at which they are recorded in the accompanying balance sheet. As ofDecember 31, 2006, the Company had a $1.47 million working capitaldeficiency and has sustained recurring losses from operations. From inception,the Company has met its liquidity and capital expenditure needs primarilythrough the proceeds from sales of common stock, preferred stock andconvertible debt in both public and private offerings, and to a lesser extentfrom borrowings.

While the Companycurrently operates as a going concern, certain significant factors raisesubstantial doubt about the Company’s ability to continue to operate as a goingconcern. The Company has incurred significant losses since inception. TheCompany continues to rely on additional financing to fund its continuingoperations. Management has found additional financings more challenging toarrange and with less desirable terms than in past financings. Managementexpects these challenges to remain and possibly increase until operatingconditions improve. As such, management can provide no assurance that it willbe successful in raising additional capital necessary to sustain operations.The Company expects negative cash flow from operations to continue until itsrevenue streams mature. The Company has a significant unresolved tax liabilitydescribed below. Past financings require significant ongoing cash payments fordividends, interest and principal. Existing lenders have alleged certaindefaults under the Company’s debt instruments, which, if successfully pursued,could lead  to the acceleration of theindebtedness due under those instruments. These factors, among others, raisesubstantial doubt about the Company’s ability to continue to operate as a goingconcern.

***Management’sPlans to Address Operating Conditions***

Management’s plansto address these conditions consist of the following:

·       Raise up to $6 million or more in additional capital beforethe end of the third quarter of 2007. With the current demands on theCompany’s cash based on the operating conditions discussed above, the Companymust raise capital in the short term to continue operations and meet itsobligations. The Company is currently engaged in ongoing discussions withexisting and new 

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investors  who have expressed an interest in, amongother things, funding the international expansion opportunities for theCompany’s certification products.

·       Maintain tight cost controls and continue to operate under aclosely monitored budget approved by the Board of Directors. Managementbelieves it has exhausted most meaningful opportunities for cutting operatingcosts and must now manage the Company at the current operating cost level tosustain operations. Management’s plan is to pursue opportunities to grow thebusiness without a proportional increase in operating expenses and overhead.

·       Increaseinternational sales of current Prosoft certification products. The Company haswitnessed increasing demand for US-based credentials in international markets.Specifically, the Company has experienced success in the adoption of the CIWcertification through its partner in Japan. The Company intends to ramp-up itscurrent sales and marketing efforts in China through a network of affiliatesand in Europe and other Asian markets through further development of its saleslocation in Limerick, Ireland, as well as through an Asian market partner.

·       Opportunistically grow sales tothe Federal Government. The Company now has one of the largest LMSinstallations in the Federal Government e-Learning market and the Companybelieves that the successful operation of this system represents an outstandingreference within the Federal Government for attracting more business in thismarket. The Company plans on leveraging this success and attempting toreplicate it in other departments and agencies of the Federal Government usingthe existing account management team.

***Dependencyon Additional Financing and Operating Improvement to Continue Operation***

If additional capital is not obtained and revenues donot increase significantly in the near future, the Company would likely beunable to continue as a going concern. Management is committed to continuing toreduce expenses to the extent possible while still allowing for sufficientresources to meet projected sales levels.

The Company’s futurecapital requirements will depend on many factors, including, but not limitedto, the risk that the Company’s operating cash flow, combined with proceedsfrom any future financings, will be sufficient to meet substantial principal,interest and dividend payment obligations and the timing and the accelerationof any debt repayments that might arise as a result of certain allegeddefaults. Among the operating factors influencing these capital requirementsare the costs associated with the continuing integration of the Prosoftacquisition, the cost associated with the conversion of Prosoft’s coursematerial to an online format, acceptance of and demand for products andservices, market demand for technology upgrades and the types of arrangementsthat the Company may enter into with customers and agents.

***Salesand Use Tax Issue with the Commonwealth of Virginia***

In April 2006, the Company received notice that theVirginia Department of Taxation denied VCampus’ request for correction of theretail sales and use tax assessment issued to VCampus as a result of an auditfor the period August 1998 through October 2001. Based on this ruling, togetherwith VCampus’ estimate of its liability for additional sales and use tax fromthe end of the audit period in October 2001 to March 31, 2006, the Company hasrecorded a charge of $400,000 In August 2006, the Virginia Department ofTaxation accepted an offer in compromise from the Company, thus reducing theamount of the liability to $252,477, payable in 36 monthly installments of$7,013. However, the settlement is subject to the Department’s post-auditverification of the Company’s calculation of additional sales and use tax fromOctober 2001 to March 2006. The department’s verification proceedings arecurrently under way and pending the final resolution of the amount due, theCompany has not made any adjustments to the previously recorded liability of$400,000.

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**2. Summary of Significant Accounting Policies**

*Principles of Consolidation*

The consolidated financialstatements include the accounts of the Company and its wholly ownedsubsidiaries. All material intercompany transactions and accounts have beeneliminated in consolidation. The Company consolidates investments where it hasa controlling financial interest as defined by Accounting Research Bulletin(ARB) No. 51, *“Consolidated FinancialStatements*,*”* as amended byStatement of Financial Accounting Standards (SFAS) No. 94, *“Consolidation of all Majority-Owned Subsidiaries*.*”* The usual condition for controlling financial interest isownership of a majority of the voting interest and, therefore, as a general rule ownership,directly or indirectly, of more than fifty percent of the outstanding votingshares is a condition pointing towards consolidation.

*Use of Estimates*

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

*Reclassifications*

Certain amounts in theprior years’ financial statements have been reclassified to conform to thecurrent year presentation. These reclassifications had no effect on the resultsof operations or shareholders’ equity as previously reported.

*Risks and Uncertainties*

The Company is subject toall of the risks inherent in a company that operates in the intensely competitiveInternet industry, providing a service that is relatively new and constantlyevolving. These risks include, but are not limited to, market acceptance of theCompany’s products and services, risks associated with acquisitions andexpansion, and reliance on third-party software incorporated in the Company’sproducts. The Company’s operating results may be materially affected by theseforegoing factors.

*Financial Instruments*

SFAS No. 107, *“Disclosures about Fair Value of Financial Instruments*,*”* requires disclosures of fair value information aboutfinancial instruments, whether or not recognized in the balance sheet, forwhich it is practicable to estimate that value. Due to their short-term nature,the carrying amounts reported in the consolidated financial statementsapproximate the fair value for cash and cash equivalents, accounts receivable,accounts payable and accrued expenses. The fair value of the Company’slong-term debt is based upon quoted market prices for the same and similarissuances giving consideration to quality, interest rates, maturity and othercharacteristics. As of December 31, 2006, the Company believes thecarrying amount of its long-term debt approximates its fair value since theinterest rate of the debt approximates a market rate.

*Cash and Cash Equivalents*

Cash equivalents, consistof highly liquid investments, which are readily convertible into cash and haveoriginal maturities of three months or less.

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*Foreign Currency Translation*

The functional currency ofthe Company’s foreign subsidiaries is the U.S. dollar. The Companyremeasures the monetary assets and liabilities of its foreign subsidiaries,which are maintained in the local currency ledgers, at the rates of exchange ineffect at month end. Revenues and expenses recorded in the local currencyduring the period are translated using average exchange rates for each month.Non-monetary assets and liabilities are translated using historical rates.Resulting adjustments from the remeasurement process are included in OtherComprehensive income (loss).

*Concentration of Credit Risk*

Financial instruments thatpotentially subject the Company to significant concentrations of credit riskconsist principally of cash and cash equivalents and accounts receivable. TheCompany deposits its cash with financial institutions that the Companyconsiders to be of high credit quality

With respect to accountsreceivable, the Company performs ongoing credit evaluations of its customers,generally grants uncollateralized credit terms to its customers, and maintainsan allowance for doubtful accounts based on historical experience andmanagement’s expectations of future losses.

In 2004, three customersindividually accounted for approximately 27%, 25% and 21% of net revenues, In2005, two customers individually accounted for 36% and 20% of net revenues andin 2006 the same two customers individually accounted for 25% and 8% of netrevenues.

Two customers individuallyrepresented 37% and 12% of accounts receivable at December 31, 2005. Twocustomers individually represented 15% and 11% of accounts receivable at December 31,2006.

*Accounts Receivable*

Accounts receivable arerecorded at the invoiced amount and do not bear interest. The allowance fordoubtful accounts is the Company’s best estimate of the amount of probablecredit losses in the Company’s existing accounts receivable. The Companydetermines the allowance based on historical write-off experience. The Companyreviews its allowance for doubtful accounts monthly. Past due balances over 90days are reviewed individually for collectibility. Account balances are chargedoff against the allowance after all means of collection have been exhausted andthe potential for recovery is considered remote. The Company does not have anyoff-balance sheet credit exposure related to its customers.

*Loans Receivable*

The Company periodicallyassesses the collectibility of its loans receivable and records balances due atthe amount it believes it will be able to collect during the term of the loan.

*Property and Equipment*

Property and equipment arestated at cost less accumulated depreciation. Depreciation is computed usingthe straight-line method over the estimated useful lives of two to seven years.Leasehold improvements are amortized over the lesser of the lease term or estimateduseful life. Depreciation expense on equipment obtained under capital leaseobligations is included with depreciation expense for similar types ofequipment. Repairs and maintenance that do not improve or extend the lives ofthe respective assets are expensed in the period incurred. Depreciation expensewas $290,050, $300,067 and $231,270 for 2004, 2005 and 2006, respectively.

*Capitalized Software and Courseware Development Costs*

During2004, 2005 and 2006, the Company capitalized certain software and coursewaredevelopment costs. The Company capitalizes the cost of software used forinternal operations once technological 

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feasibilityof the software has been demonstrated. TheCompany capitalizes costs incurred during the development process, includingpayroll costs for employees who are directly associated with the developmentprocess and services performed by consultants. Amortization of such costs isbased on the greater of (1) the ratio of current gross revenues to the sumof current and anticipated gross revenues, or (2) the straight-line methodover the remaining economic life of the vcampus or courseware, typically two tothree years. It is possible that those anticipated gross revenues, theremaining economic life of the products, or both, may be reduced as a result offuture events.

During 2004, 2005 and2006, the Company recognized amortization of capitalized software and coursewaredevelopment costs of $758,047, $891,702 and $724,773,  respectively. During 2006, the Company wroteoff $70,573 in unamortized capitalized software development costs for a portionof its VCampus platform, as a result of impairment analyses conducted by theCompany. During the 2005 and 2006, the Company wrote off $248,976 and $316,776,respectively, in unamortized capitalized courseware development costs, as aresult of impairment analyses conducted by the Company. The Company determinedthat the impairment charges were necessary because the carrying amount of theassets exceeded the Company’s determination of the fair value of the assets. Thewrite-offs have been included in depreciation and amortization expense in the 2005and 2006 statements of operations.

*Web Site Development Costs*

The Company accounts forweb site development costs in accordance with Emerging Issues Task Force (EITF)Issue No. 00-2*, “Accounting forWeb Site Development Costs”*. In 2004, 2005 and 2006 all web sitedevelopment costs were incurred in the operating stage, including maintenanceand minor enhancements and upgrades, and were expensed as incurred.

*Goodwill and Other Intangible Assets*

Goodwill and otherintangibles represent the unamortized excess of the cost of acquiringsubsidiary companies over the fair values of such companies’ net tangibleassets at the dates of acquisition.

The Company performs itsannual goodwill impairment test in accordance with SFAS No. 142, “*Goodwill and Other Intangible Assets”*, during its fourthquarter, or whenever events or changes in circumstances indicate that thecarrying amount of goodwill may not be recoverable. The first step of the testidentifies if potential impairment may have occurred, while the second step ofthe test measures the amount of the impairment, if any. Impairment isrecognized when the carrying amount of goodwill exceeds its fair value. Theprocess of evaluating the potential impairment of goodwill is highly subjectiveand requires significant judgment. For purposes of the Company’s 2005 annualgoodwill impairment test, the Company considered its market capitalization onthe date of the impairment test (since the Company has only one reporting unit)and determined that no goodwill impairment existed. During 2006, the Companydetermined that there were indicators of impairment to the carrying value ofgoodwill, principally from continued losses from operations and the significantdecline in the Company’s stock price and market capitalization. The Companyperformed the two-step process described in SFAS No. 142 to assess itsgoodwill for impairment and recorded a charge of $328,317 relating to goodwillimpairment, which is recorded as a component of operating loss in theaccompanying consolidated statement of operations. The amount of goodwillimpairment was based on the fair value of the Company representing its onlyreporting unit utilizing a valuation based on both the discounted cash flow andmarket approach.

During 2006, the Companyalso determined there were indicators of impairment to the unamortizedintangible assets. The Company wrote off $26,077 in unamortized other intangibleassets as a result of an impairment analysis conducted by the Company. Thewrite-off has been included in depreciation and amortization expense in the2006 statements of operations.

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*Impairment of Long-Lived Assets*

The Company evaluates therecoverability of its long-lived assets for impairment whenever events orchanges in circumstances indicate that the carrying amount of such assets maynot be recoverable. Recoverability of assets to be held and used is measured bya comparison of the carrying amount of any asset to future net undiscountedcash flows expected to be generated by the asset. If such assets are consideredto be impaired, the impairment to be recognized is measured by the futurediscounted cash flows compared to the carrying amount of the asset.

*Derivative Financial Instruments*

The Company does not usederivative instruments to hedge exposures to cash flow, market, or foreigncurrency risks.

The Company reviews theterms of convertible debt and equity instruments issued to determine whetherthere are embedded derivative instruments, including the embedded conversionoption, that are required to be bifurcated and accounted for separately as aderivative financial instrument. When the risks and rewards of any embeddedderivative instrument are not “clearly and closely” related to the risks andrewards of the host instrument, the embedded derivative instrument is generallyrequired to be bifurcated and accounted for separately. If the convertibleinstrument is debt, or has debt-like characteristics, the risks and rewardsassociated with the embedded conversion option are not “clearly and closely”related to that debt host instrument. The conversion option has the risks andrewards associated with an equity instrument, not a debt instrument, becauseits value is related to the value of our common stock. Nonetheless, if the hostinstrument is considered to be “conventional convertible debt” (or “conventionalconvertible preferred stock”), bifurcation of the embedded conversion option isgenerally not required. However, if the instrument is not considered to beconventional convertible debt (or conventional convertible preferred stock),bifurcation of the embedded conversion option may be required in certaincircumstances. Generally, where the ability to physical or net-share settle theconversion option is deemed to be not within the control of the Company, theembedded conversion option is required to be bifurcated and accounted for as aderivative financial instrument liability.

In connection with thesale of convertible debt and equity instruments, the Company may also issuefreestanding options or warrants. Additionally, the Company may issue optionsor warrants to non-employees in connection with consulting or other servicesthey provide. Although the terms of the options and warrants may not providefor net-cash settlement, in certain circumstances, physical or net-sharesettlement may be deemed to not be within the control of the Company and,accordingly, the Company may be required to account for these freestandingoptions and warrants as derivative financial instrument liabilities, ratherthan as equity.

Derivative financialinstruments are required to be initially measured at their fair value. Forderivative financial instruments that shall be accounted for as liabilities,the derivative instrument is initially recorded at its fair value and is thenre-valued at each reporting date, with changes in the fair value reported ascharges or credits to income.

In circumstances where theembedded conversion option in a convertible instrument may be required to bebifurcated and there are also other embedded derivative instruments in theconvertible instrument that are required to be bifurcated, the bifurcatedderivative instruments are accounted for as a single, compound derivativeinstrument.

If the embedded derivativeinstrument is to be bifurcated and accounted for as a liability, the totalproceeds received will be first allocated to the fair value of the bifurcatedderivative instrument. If freestanding options or warrants were also issued andare to be accounted for as derivative instrument liabilities (rather than asequity), the proceeds are next allocated to the fair value of thoseinstruments. The remaining proceeds, if any, are then allocated to theconvertible instrument itself, usually resulting in that 

F-13

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instrumentbeing recorded at a discount from its face amount. In circumstances where afreestanding derivative instrument is to be accounted for as an equityinstrument, the proceeds are allocated between the convertible instrument andthe derivative equity instrument, based on their relative fair values.

To the extent that thefair values of the bifurcated and/or freestanding derivative instrumentliabilities exceed the total proceeds received, an immediate charge to incomeis required to be recognized, in order to initially record the derivativeinstrument liabilities at their fair value. The discount from the face value ofthe convertible debt instrument is required to be amortized over the life ofthe instrument through periodic charges to income, using the effective interestmethod. When the instrument is convertible preferred stock, the periodicamortization of the discount is charged directly to retained earnings.

The Company reviews theclassification of derivative instruments, including whether such instrumentsshould be recorded as liabilities or as equity, at the end of each reportingperiod. Derivative instrument liabilities are required to be classified in thebalance sheet as current or non-current based on whether or not net-cashsettlement of the derivative instrument could be required within 12 months ofthe balance sheet date. The Company currently does not have any derivativeinstruments that are required to be bifurcated and recorded as liabilities.

*Indebtedness with Detachable Warrants and BeneficialConversion Feature*

The Company has accountedfor the issuance of detachable stock purchase warrants in accordance withAccounting Principles Board Opinion (APB) No. 14, whereby the Companyseparately measured the fair value of the indebtedness and the detachablewarrants and allocated the total proceeds on a pro-rata basis to each. Theproceeds allocated to the detachable warrants are credited to paid-in capitaland the discount from the face value of the indebtedness is amortized over theestimated life of the indebtedness.

In accordance with theprovisions of EITF No. 98-5 and EITF No. 00-27, theCompany allocated a portion of the proceeds received to the embedded beneficialconversion feature, based on the difference between the effective conversionprice of the proceeds allocated to the convertible indebtedness and the fairvalue of the underlying common stock on the date the convertible indebtednesswas issued. Since the convertible indebtedness also had detachable stockpurchase warrants, the Company first allocated the proceeds to the stockpurchase warrants and the convertible indebtedness and then allocates theresulting convertible indebtedness proceeds between the beneficial conversionfeature, which was accounted for as paid-in capital, and the initial carryingamount of the convertible indebtedness. The discount resulting from thebeneficial conversion feature is amortized over the estimated life of theconvertible indebtedness.

*Registration Rights Agreements*

In connection with thesale of certain debt and equity instruments, the Company has entered into anumber of registration rights agreements. Generally, these agreements requirethe Company to file registration statements with the Securities and ExchangeCommission (SEC) to register the resale of common shares that may be issued toselling stockholders on conversion of debt or preferred stock, to permit resaleof common shares previously sold under an exemption from registration or toregister the resale of common shares that may be issued on exercise ofoutstanding options or warrants.

These  registration rights agreements sometimesrequire the Company to pay liquidated damages for any time delay in filing therequired registration statements or a delay in the registration statementsbecoming declared effective or subsequently being suspended in excess of someagreed-upon period of time. These liquidated damages are generally expressed asa fixed percentage, per month, of the original investment amount the Companyreceived on issuance of the debt or preferred stock, common shares, options orwarrants. The Company accounts for these liquidated damages as a contingentliability and not as a derivative instrument. Accordingly, the Companyrecognizes the liquidated damages when it becomes probable that they will beincurred. Any penalties are expensed over the period to which they relate.

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The Company was requiredto pay liquidated damages at the rate of 1% per month (based on the grossproceeds received through the issuance of 2,300 shares of Series A-1convertible Preferred Stock) until such time as a Form S-1registration statement was declared effective. The Company has accrued $82,658in liquidated damages, which is included in accrued expenses in theaccompanying consolidated balance sheet at December 31, 2006.

*Revenue Recognition and Deferred Revenue*

The Company derivesrevenues from the following sources—certification related revenues, learningportal revenues and development and other revenues. Certification relatedrevenues are derived from sales of online courses (online tuition) and sales ofcourse materials such as books, CD-ROMs, Web-based course books, assessmentproducts and content licenses, all of which prepare learners for certificationsin a variety of areas. Certification related revenues also include fees paid bycertification candidates to take the Company’s certification tests and annualfees received from education partners, including CIW and CTP ATPs. Learningportal revenues are derived from sales of online courses to the Company’sgovernment, corporate and higher education customers. Development and otherrevenues consist primarily of fees paid to the Company for developing andconverting courseware.

Online tuition revenue isrecognized in accordance with SEC Staff Accounting Bulletin (SAB) No. 104,“*Revenue Recognition”*. SAB No. 104generally requires that four basic criteria must be met before revenue can berecognized: (1) persuasive evidence of an arrangement exists; (2) deliveryhas occurred or services rendered; (3) the fee is fixed and determinable;and (4) collectibility is reasonably assured. Determination of criteria (3) and(4) are based on management’s judgments regarding the fixed nature of thefee charged for services rendered and the collectibility of those fees. Shouldchanges in conditions cause management to determine these criteria are not metfor certain sales, revenue recognized for any reporting period could beadversely affected. Online tuition revenues are generated primarily through twotypes of contracts: (i) time-based subscriptions and (ii) usage-basedcontracts. Under subscription contracts, revenue is recognized ratably (on astraight-line basis) over the subscription period. For usage contracts, revenueis recognized upon enrollment in a course. Once a student has enrolled in acourse, he generally cannot cancel delivery of a course or receive a refund. Onrare occasions, we may extend the subscription length for a specific student’scourse at no charge. Initial set-up fees related to all online tuition servicesare recognized ratably (on a straight-line basis) over the contract term.

Development and otherrevenues consist primarily of fees paid to the Company for developing and convertingcourseware. For arrangements that include more than one element, the Companyallocates the total arrangement fee among each deliverable based onvendor-specific objective evidence (“VSOE”) of the relative fair value of eachdeliverable. VSOE is determined using the price charged when that element issold separately by us. Development and other revenues earned under coursewareconversion contracts are recognized relative to the Company’s proportionateperformance based on the ratio that total costs incurred to-date bear to totalestimated costs. VCampus uses direct labor hours as the key criteria to measureprogress towards completion. The Company develops its estimates to complete aproject based on budgeted total costs and periodic assessment by our projectmanagers.

The Company sometimesrecognizes development and other revenues as a separate element of anarrangement with a customer that also contains an element to provide coursewaredelivery services. The SEC Staff believes that the best indicator that aseparate element exists is that a vendor sells or could readily sell thatelement unaccompanied by other elements. The Company has a history of sellingcourseware development and conversion services unaccompanied by other elements.Further, EITF No. 00-21 *“Revenue Arrangements withMultiple Deliverables”*, states that a deliverable should besegmented and accounted for separately from the remainder of the arrangementif: (1) there is objective and reliable evidence of the fair value of theelement and (2) the element does not affect the quality of use or thevalue of the other elements and the element can be purchased from an unrelatedvendor without effecting the 

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qualityof use or value of the other elements. The Company believes that the hourly ratescharged for development revenues are consistent and represent the fair value ofthese services.

In most cases, developmentprojects are requested after delivery of online tuition services has begun(i.e. no development work was considered when terms of the online tuitionagreement were negotiated). The Company has demonstrated the ability for itsdeveloped and converted material to be used in the absence of the Company’splatform. In addition, customers can use other vendors to develop electroniccourse material or develop course material internally for use on the Company’splatform. Accordingly, management believes that separate recognition ofdevelopment revenues for customers who have online tuition contracts isappropriate.

Content revenues include feesreceived from the sale of course materials such as books, CD-ROMs, Web-basedcourse books, assessment products and content licenses. The Company recognizescontent revenue from the sale of course books and other products when they areshipped. Shipping and handling charges are invoiced to the customer and areincluded in gross revenues, reduced by the Company’s actual shipping expenses.Content licenses are either purchased on a fee-per-use basis or for a one-timefee. Revenue is recognized over the period in which the Company has acommitment for continuing involvement or obligation to provide services to thecustomer. In most cases, no such commitment exists, and revenue is recognizedwhen content is shipped.

Certification revenuesinclude fees paid by certification candidates to take the Company’scertification tests and annual fees received from education partners, includingCIW and CTP ATPs. The Company recognizes certification revenue whencertification tests are administered, and partner fees over the period duringwhich there is a commitment for continuing involvement or obligation to provideservices to the partner.

The Company accounts forcash received from customers as prepayments for future services as deferredrevenue. The Company recognizes revenue associated with those cash receipts inaccordance with the above policies.

*Royalties*

Royalties are due andpayable by the Company upon the sale of certain courses for which the Companyhas acquired or otherwise licensed the online publishing rights. In addition,the Company may be obligated to pay certain royalties related to courses whicha customer may have converted to an online format and elected to distribute toall the Company’s customers. Royalties accrue at a rate of 10% to 70% of thetuition fees received with respect to certain courses.

Royalties are classifiedas a cost of revenues and amounted to approximately $1,198,000, $1,342,000 and$991,000 during the years ended December 31, 2004, 2005 and 2006,respectively.

*Advertising Costs*

The Company expensesadvertising costs as incurred. Advertising costs amounted to approximately$70,000, $132,000 and $138,000 for the years ended December 31, 2004,2005, and 2006 respectively.

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*Accounting forStock-Based Compensation*

Prior to January 1, 2006, the Company accountedfor its stock-based compensation plans under the recognition and measurementprovisions of APB No. 25, *“Accounting for StockIssued to Employees”*(APB No. 25), and the relatedinterpretations, as permitted by SFAS No. 123, *“Accountingfor Stock-Based Compensation”*(SFAS 123). Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS No. 123(revised 2005), *“Share-Based Payment”*(SFAS 12R),using the modified prospective transition method. Under the  modified prospective transition method,compensation cost recognized in fiscal 2006 includes: (a) compensationcost for all equity-based payments granted prior to but not vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of SFAS 123 and (b) compensation cost for allequity-based payments granted subsequent to January 1, 2006, based on thegrant date fair value estimated in accordance with the provisions of SFAS 123R.Results of prior periods have not been restated.

As a result of adopting SFAS 123R on January 1,2006, the Company’s net loss for the year ended December 31, 2006 wasapproximately $722,507  more than if theCompany had continued to account for stock-based compensation under APB No. 25.Basic and diluted net loss per common share for the year ended December 31,2006 were each approximately $0.09 more than if the Company had not adoptedSFAS 123R.

Thefollowing table illustrates the effect on net loss and net loss per commonshare if the Company had applied the fair value recognition provisions ofSFAS 123R to stock-based compensation for the years ended December 31,2004 and 2005. The reported and pro forma net loss and net loss per commonshare for the year ended December 31, 2006 are the same becausestock-based compensation is calculated under the provisions of SFAS 123R.The amounts for the year ended December 31, 2006 are included in thefollowing table only to provide net loss and net loss per common share for acomparative presentation to the period of the previous year. The pro formadisclosure for the years ended December 31, 2004 and 2005 utilized theBlack-Scholes option-pricing formula to estimate the value of the respectiveoptions with such value recognized as expense over the options’ vestingperiods. 

| ** **                                                                                             | ** ** | **2004**   | ** ** | **2005**   | ** ** | **2006**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Pro forma net loss  attributable to common stockholders:                                               |       |       |       |       |       |       |       |
| As reported                                                                                            |       | $          | (6,579,416 | )          | $          | (5,880,639 | )          | $ | (12,811,455 | ) |
| Add: Stock-based compensation included in reported  net loss attributable to common  stockholders      |       | 153,973    |       | 109,493    |       | —     |       |
| Deduct: Stock—based compensation expense determined  under fair value based method for all awards |       | (3,212,044 | )          | (2,185,731 | )          | —     |       |
| Pro forma net  loss attributable to common stockholders                                                |       | $          | (9,637,487 | )          | $          | (7,956,877 | )          | $ | (12,811,455 | ) |
| Net loss  attributable to common stockholders per common share:                                   |       |       |       |       |       |       |       |
| Basic and diluted—as reported                                                                     |       | $          | (0.97      | )          | $          | (0.63      | )          | $ | (1.30 | ) |
| Basic and  diluted—pro forma                                                                      |       | $          | (1.42      | )          | $          | (0.86      | )          | $ | (1.30 | ) |

 

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Theweighted average fair value of the options at the date of grant during 2004,2005 and 2006 was $1.94, $0.96 and $0.30, respectively. The fair value of eachoption is estimated on the date of grant using the Black-Scholes option-pricingmodel with the following weighted-average assumptions for stock options grantedduring the years ended December 31, 2004, 2005 and 2006: 

| ** **                       | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield                   |       | 0        | %          | 0        | %          | 0        | %          |
| Expected Volatility              |       | 130      | %          | 132      | %          | 132      | %          |
| Average risk-free  interest rate |       | 3.87     | %          | 4.15     | %          | 4.76     | %          |
| Expected term                    |       | 8 years  |       | 8 years  |       | 8 years  |       |
| Forfeiture rate                  |       | 0        | %          | 0        | %          | 0        | %          |

 

*Dividendyield—**The*Company has never declared orpaid dividends on its common stock and does not anticipate paying dividends inthe foreseeable future.

*Expectedvolatility—**Volatility*is a measure of theamount by which a financial variable such as a share price has fluctuated(historical volatility) or is expected to fluctuate (expected volatility)during a period. The Company based its estimate of expected volatility for thetwelve months ended December 31, 2006 on the sequential historical dailytrading data of its common stock for a period equal to the expected life of theoptions granted. The selection of the historical volatility approach was basedon available data indicating the Company’s historical volatility is as equallyrepresentative of irs future stock price trends as is implied volatility.Management has no reason to believe the future volatility of the Company’sstock price is likely to differ from its past volatility.

*Risk-freeinterest rate—**This*is the averageU.S. Treasury rate (having a term that most closely approximates theexpected life of the option) for the period in which the option was granted.

*Expectedlife of the options—**This*is the period of time that theoptions granted are expected to remain outstanding. This estimate is basedprimarily on historical exercise data. Options granted during the year ended December 31,2006 have a maximum term of ten years.

*Forfeiturerate—**This***isthe estimated percentage of options granted that are expected to be forfeitedor cancelled on an annual basis before becoming fully vested. The Companyestimates the forfeiture rate based on past turnover data.

The compensation cost that has been recognized in theconsolidated statements of operations for the Company’s stock option plans forthe year ended December 31, 2006 was $858,507. For stock subject to gradedvesting, the Company has utilized the “straight-line” method for allocatingcompensation cost by period.

As of December 31,2006, there was $1,179,805 of total unrecognized compensation cost relatedto unvested stock options granted under the Company’s stock option plans. Thecost is expected to be recognized through December 2010 with a weightedaverage recognition period of approximately 1.7 years.

*Income Taxes*

The Company provides forincome taxes in accordance with the liability method. Under this method,deferred tax assets and liabilities are determined based on differences betweenfinancial reporting and tax bases of assets and liabilities and are measuredusing the enacted tax rates and laws that are expected to be in effect when thedifferences are expected to reverse. Because the realization of tax benefitsrelated to the Company’s net deferred tax asset is uncertain, a full valuationallowance of $31,085,000 has been provided against the net deferred tax asset.

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*Net Loss Per Share*

The Company follows theprovisions of SFAS No. 128, *Earningsper Share* (“SFAS No. 128”) which requires the Company topresent basic and diluted earnings (or net loss) per share. Basic earnings (ornet loss) per share is based on the actual weighted-average sharesoutstanding and excludes any dilutive effects of shares issuable upon theexercise or conversion of outstanding options, warrants and convertiblesecurities. To calculate diluted earnings (or net loss) per share, the earnings(or net loss) is divided by a denominator which includes not only actual sharesof common stock outstanding, but also the additional shares of common stockissuable upon exercise or conversion of stock options, warrants, andconvertible preferred stock. For all years presented, shares of common stockissuable upon the exercise or conversion of stock options, warrants, andconvertible preferred stock have been excluded from diluted earnings per sharebecause their effect is anti-dilutive.

*Segment Information*

The Company currentlyoperates in one business segment; namely a provider of comprehensive outsourcede-Learning products and related services. The Company evaluates its marketopportunities by referring to the Select Partner program business model and theLegacy business model. The Company is not organized by market and is managedand operated as one business. A single management team that reports to thechief operating decision maker comprehensively manages the entire business. TheCompany does not operate any material separate lines of business or separatebusiness entities with respect to its products or product development.Accordingly, the Company does not accumulate discrete financial informationwith respect to separate product lines and does not have separately reportablesegments as defined by SFAS No. 131, “Disclosure about Segments of anEnterprise and Related Information”.

*Foreign Operations*

Substantially all of theCompany’s material identifiable assets are located in the United States.Revenues derived from international sales were $842,097 for the years ended December 31,2006. Substantially all international sales are denominated inU.S. dollars.

*Recent AccountingPronouncements*

In June 2006, the Financial Accounting StandardsBoard (FASB) issued FASB Interpretation (FIN) No. 48, *“Accountingfor Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109”*(FIN 48). FIN 48 prescribes a recognition threshold and measurement attributefor financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return, and also provides guidance onde-recognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The Company is currently evaluating theeffect, if any, the adoption of FIN 48 will have on its consolidated results ofoperations and financial condition.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (SFAS 157). SFAS 157 provides enhancedguidance for using fair value to measure assets and liabilities. It clarifiesthe principle that fair value should be based on the assumptions marketparticipants would use when pricing the asset or liability and establishes afair value hierarchy that prioritizes the information used to develop thoseassumptions. SFAS 157 is effective for fiscal years beginning after November 15,2007. The Company is currently evaluating the impact of SFAS 157 on itsconsolidated results of operations and financial condition.

In September 2006, the SEC issued SAB No. 108,*“Quantifying Misstatements.”* SAB 108provides interpretative guidance on how public companies quantify financialstatement misstatements. There have been two common approaches used to quantifysuch errors. Under an income statement approach, the 

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“roll-over” method, theerror is quantified as the amount by which the current year income statement ismisstated. Alternatively, under a balance sheet approach, the “iron curtain”method, the error is quantified as the cumulative amount by which the currentyear balance sheet is misstated. In SAB 108, the SEC established an approachthat requires quantification of financial statement misstatements based on theeffects of the misstatements on each of the company’s financial statements andthe related financial statement disclosures. This model is commonly referred toas a “dual approach” because it requires quantification of errors under boththe roll-over and iron curtain methods. SAB 108 is effective for the firstfiscal year ending after November 15, 2006. The adoption of SAB 108 didnot have a material impact on the Company’s financial position and results ofoperations.

In December 2006, theFASB issued FASB Staff Position on No. EITF 00-19-2, *“Accounting for Registration Payment Arrangements”* (FSP EITF00-19-2). FSP EITF 00-19-2 provides that the contingentobligation to make future payments or otherwise transfer consideration under aregistration payment arrangement should be separately recognized and measuredin accordance with SFAS No. 5, *“Accounting forContingencies”*, which defines that loss contingencies should berecognized as liabilities if they are probable and reasonably estimable. Theguidance in FSP EITF 00-19-2 is effective immediately forregistration payment arrangements and the financial instruments subject tothose arrangements that are entered into or modified subsequent to the date ofissuance of FSP EITF 00-19-2. For registration payment arrangementsand financial instruments subject to those arrangements that were entered intoprior to the issuance of FSP EITF 00-19-2, this guidance shall beeffective for financial statements issued for fiscal years beginning after December 15,2006, and interim periods within those fiscal years. The Company is currentlyevaluating the effect, if any, the adoption of FSP EITF 00-19-2will have on its consolidated results of operations and financial condition.

*Comprehensive NetIncome (loss)*

Comprehensivenet income (loss) is the result of foreign currency translation adjustments forforeign operations from the 2006 Prosoft acquisition. The components ofcomprehensive net income (loss) for 2004, 2005 and 2006 are as follows:

| ** **                                | ** ** | **2004** | ** ** | **2005** | ** ** | **2006**   | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|------------|------------|
| Net Loss                                  |       | $        | (6,579,416 | )        | $          | (5,866,327 | )          | $ | (7,624,960 | ) |
| Other  comprehensive income (loss):       |       |     |       |     |       |       |       |
| Foreign currency  translation adjustments |       | —   |       | —   |       | (11,410    | )          |
| Comprehensive loss                        |       | $        | (6,579,416 | )        | $          | (5,866,327 | )          | $ | (7,636,370 | ) |

 

*Non-Cash FinancingActivities*

In 2004, the Company issued 927,696 shares of commonstock upon mandatory and voluntary conversions of $999,625 and $512,500,respectively, of Series A and Series B senior secured convertiblenote principal at $1.63 per share.

In March and May 2004, the Company issued76,688 shares of common stock with a value of $189,419 and five-year fullyvested warrants to purchase 250,000 shares of common stock at $1.63 per sharevalued at $545,000 in satisfaction of accrued financing costs related to the March 2004private placement. The Company allocated $505,730 of the total value of theshares and warrants to deferred debt issuance costs, which will be recognizedas interest expense over the period the notes are expected to be outstanding.  The remaining amount was accounted for as acost of capital. In addition, the Company issued one quarter unit of the March 2004private placement with an aggregate value of $50,000 to the lead investor’scounsel as payment for legal services in connection with the private placement.The Company allocated $34,430 of the total value of the one quarter unit todeferred debt issuance costs, which will be recognized as interest 

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expense over the periodthe notes are expected to be outstanding. The remaining amount was accountedfor as a cost of capital.

In 2005, the Company issued 332,398 shares of commonstock upon voluntary conversions of $541,809 of Series A and Series Bsenior secured convertible note principal at $1.63 per share.

In 2005, the Company issued 30,550 shares of commonstock with a value of $50,000 in satisfaction of a finder’s fee related to the March 2005private placement. In 2005, the Company issued 42 shares of Series A-1Preferred Stock and a five-year warrant to purchase 75,450 shares of commonstock, in satisfaction of a finder’s fee related to the December 2005private placement. The Series A-1 Preferred Stock and warrant havethe same terms as the securities issued in the December 2005 financing.

In 2005, the Company issued 11,860 shares of commonstock with a value of $25,500 in satisfaction of accounts payable to a financialadvisor.

In 2005, the Company issued 27,749 shares of commonstock with a value of $45,232 in satisfaction of accrued and unpaid interest onits Series A and Series B secured convertible notes.

In 2005, the Company declared and accrued $14,312 ofdividends on its Series A-1 convertible Preferred Stock.

In 2006, the Company issued 134,000 shares of commonstock upon voluntary conversions of 67 shares of Series A-1convertible Preferred Stock at $0.50 per share.

In 2006, the Company issued 24.375 shares of A-1convertible Preferred Stock in satisfaction of accrued and unpaid dividends tocertain Series A-1 investors pursuant to their consent to receivecash dividends in additional shares of Series A-1 convertiblePreferred Stock.

In 2006, the Company issued 184 shares of Series B-1convertible Preferred Stock in satisfaction of accrued and unpaid dividends tocertain Series B-1 investors pursuant to their consent to receivecash dividends in additional shares of Series B-1 convertiblePreferred Stock.

In 2006, the Company issued 328,823, 20,527 and150,000 shares of common stock with values of $127,498, $8,500 and $46,500 insatisfaction of accounts payable to financial advisors, directors and bridgeloan lenders, respecitvely.

In 2006, the Companydeclared and accrued $156,844 of dividends on its Series A-1 and B-1convertible Preferred Stock.

**3. Acquisition ofProsoft Learning Corporation**

On June 12, 2006, the Company completed itsacquisition of Prosoft pursuant to the Acquisition and Reorganization Agreementdated as of April 11, 2006. Pursuant to the Acquisition and ReorganizationAgreement, the Company acquired all of the outstanding common stock of Prosoftfor $1,800,000 in cash, together with one-year promissory notes in the principalamount of $300,000, subsequently adjusted to $1,394,722 in cash and $120,225 inoutstanding principal under the notes, respectively, to offset Prosoft’snegative working capital (as subsequently adjusted) of $585,053 as provided bythe terms of the Asset Purchase Agreement. The effective purchase price ofProsoft before transaction costs was $1,425,380, net of Prosoft’s June 12,2006 cash balance of $89,566. The Company has included the financial results ofProsoft in its consolidated financial statements beginning June 12, 2006.

The acquisition wasaccounted for under the purchase method of accounting in accordance with SFAS No. 141,*“Business Combinations.”* Assets acquiredand liabilities assumed were recorded at their fair values as of June 12,2006. The total purchase price was $1,764,947, including theacquisition-related transaction costs of approximately $250,000.Acquisition-related transaction costs include legal and accounting fees, andother external costs directly related to the merger.

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*Purchase PriceAllocation*

Underthe purchase method of accounting, the total estimated purchase price as shownin the table below was allocated to Prosoft’s net tangible and intangibleassets based on their estimated fair values as of June 12, 2006. The excessof the purchase price over the net tangible and identifiable intangible assetswas recorded as goodwill. The allocation of the purchase price was based upon avaluation and the Company’s estimates and assumptions are subject to change.The areas of the purchase price allocation that are not yet finalized relateprimarily to income and non-income based taxes. Based on independent thirdparty valuations, and other factors as described above, the estimated purchaseprice was allocated as follows:

| Cash and cash  equivalents                 |   | $          | 89,566    |   |
|--------------------------------------------|--------|------------|-----------|--------|
| Accounts  receivable                       |   | 573,167    |      |
| Prepaid expenses  and other current assets |   | 98,836     |      |
| Property and  equipment                    |   | 111,558    |      |
| Accounts payable  and accrued expenses     |   | (1,431,198 | )         |
| Capital lease  obligation                  |   | (73,168    | )         |
| Net tangible assets  to be acquired        |   | (631,239   | )         |
| Definite-lived  intangible assets acquired |   | 1,554,000  |      |
| Goodwill                                   |   | 842,186    |      |
| Total estimated purchase  price            |   | $          | 1,764,947 |   |

 

Of the total estimated purchase price, $1,554,000 hasbeen allocated to definite-lived intangible assets acquired. Definite-livedintangible of $1,554,000 consist of developed content of $1,129,000, the value assigned to Prosoft’scustomer relationships of $178,000 and the value assigned to Prosoft’s andtrade names of $247,000.

The value assigned to Prosoft’s developed content andcustomer relationships was determined by estimating the cost to recreate suchcontent and relationships. The value assigned to Prosoft’s trade names wasdetermined by discounting the net cash flows associated with the names. TheCompany determined that a discount rate of 25% was appropriate for valuing theexisting trade names. VCampus expects to amortize the value of Prosoft’sdeveloped content, customer relationships and trade names on a straight-linebasis over an estimated useful life of three years.

Amortization expense related to Prosoft definite-livedintangible assets for the years ended December 31, 2007, 2008 and 2009 isexpected to be approximately $518,000, $518,000 and $233,100, respectively.

Of the total estimatedpurchase price, approximately $842,186 has been allocated to goodwill. Goodwillrepresents the excess of the purchase price of an acquired business over thefair value of the net tangible and intangible assets acquired. Goodwill is notdeductible for tax purposes.

*Pre-AcquisitionContingencies*

The Company has currently not identified any materialpre-acquisition contingencies where a liability is probable and the amount ofthe liability can be reasonably estimated. If information becomes availableprior to the end of the purchase price allocation period, which would indicatethat it is probable that such events had occurred and the amounts can bereasonably estimated, such items will be included in the purchase priceallocation.

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*Pro Forma Financial Information*

Theunaudited financial information in the table below summarizes the combinedresults of operations of the Company and Prosoft on a pro forma basis, asthough the companies had been combined as of the beginning of each of theperiods presented. The pro forma financial information is presented forinformational purposes only and is not indicative of the results of operationsthat would have been achieved if the acquisition had taken place as of thebeginning of each of the periods presented. The pro forma financial informationfor all periods presented also includes amortization expense from acquiredintangible assets.

| ** **                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Total revenues                                |       | $        | 11,128,170 |     | $          | 10,725,547 |   |
| Net loss                                      |       | $        | (8,571,599 | )        | $          | (14,680,481 | ) |
| Net loss  attributable to common shareholders |       | $        | (8,585,911 | )        | $          | (19,866,976 | ) |
| Basic net loss  per common share .            |       | $        | (0.93      | )        | $          | (2.02 | ) |
| Diluted net loss per  common share .          |       | $        | (0.93      | )        | $          | (2.02 | ) |

 

**4. Property and Equipment**

Propertyand equipment consists of the following:

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Computer and  office equipment                  |       | $                     | 2,518,702  |   | $ | 4,039,083 |   |
| Software                                        |       | 1,311,325             |       | 2,743,813 |   |
| Leasehold  improvements                         |       | 105,598               |       | 484,571 |   |
| Furniture and  fixtures                         |       | 656,419               |       | 1,089,369 |   |
|                                            |       | 4,592,044             |       | 8,356,836 |   |
| Less accumulated  depreciation and amortization |       | (4,278,164            | )          | (8,031,095 | ) |
| Total property and  equipment, net              |       | $                     | 313,880    |   | $ | 325,741 |   |

 

Equipment recorded undercapital lease obligations aggregated $81,824 at December 31, 2006. Accumulateddepreciation of assets under capital lease obligations totaled $25,000 at December 31,2006.

**5. Capitalized Software and Courseware DevelopmentCosts**

Capitalizedsoftware and courseware development costs consists of the following:

| ** **                                                         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                         | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Capitalized  software costs                                        |       | $                     | 5,008,247  |   | $ | 5,008,247 |   |
| Capitalized  courseware development costs                          |       | 2,323,305             |       | 2,350,421 |   |
|                                                               |       | 7,331,552             |       | 7,358,668 |   |
| Less accumulated  amortization                                     |       | (6,022,975            | )          | (7,134,703 | ) |
| Total capitalized software  and courseware developments costs, net |       | $                     | 1,308,577  |   | $ | 223,965 |   |

 

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**6. Goodwill andOther Intangible Assets**

Goodwilland other intangible assets consists of the following:

| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Goodwill                       |       | $                     | 328,317    |   | $ | 842,186 |   |
| Developed content              |       | $                     | 523,800    |   | $ | 1,652,800 |   |
| Trademarks and  names          |       | 904,720               |       | 1,151,720 |   |
| Customer base                  |       | 304,820               |       | 482,820 |   |
| Subtotal                       |       | 1,733,340             |       | 3,287,340 |   |
| Less accumulated  amortization |       | (1,476,334            | )          | (1,887,815 | ) |
| Other intangible assets,  net  |       | $                     | 257,006    |   | $ | 1,399,525 |   |

 

Intangible assets fromacquisitions are amortized on a straight-line basis over an estimated usefullife of three years. Amortization expense related to intangible assets totaled$178,998, $133,496 and $411,481 for the years ended December 31, 2004,2005 and 2006, respectively. Amortization expense related to intangible assetsfor the years ended December 31, 2007, 2008 and 2009 is expected to beapproximately $569,000, $562,000 and $269,000, respectively.

**7. Loans Receivable from Related Party**

At December 31, 2005,the Company had an unsecured loan receivable from a Company officer. The amountreceivable at December 31, 2005 was $15,453. The Company accrued intereston the loan receivable at a rate of prime less 1% payable monthly. During 2006the note was repaid in its entirety. Interest income related to loan receivableamounted to $2,038, $1,670 and $135 during the years ended December 31,2004, 2005 and 2006, respectively. The amount repaid on loan receivable was$36,000 in each of 2004 and 2005 and $15,453 in 2006.

**8. Notes Payable**

In December 2001 and January 2002,the Company raised $925,000 through the issuance of 8% debentures together withfive-year, fully vested warrants to purchase 132,143 shares of common stock at$4.00 per share. The Company allocated the proceeds of the offering to thedebentures and the warrants based on their relative fair values using theBlack-Scholes option pricing model. The amount allocated to the warrants($335,841 and $40,708 for the 2001 and 2002 funding, respectively), wasrecorded as a debt discount and was amortized to interest expense using theeffective interest method over the period the debentures were outstanding. In March 2002,the Company issued 1,458,413 shares of Series F-1 Preferred Stockand five-year fully vested warrants to purchase 14,584 shares of common stockat $4.00 per share in exchange for the cancellation of a note in the originalprincipal amount of $500,000 plus $10,445 in accrued interest. In May 2002,the Company issued of 5,878 shares of Series F-2 Preferred Stockplus a warrant to purchase 5,878 shares of common stock at $4.00 per share, inexchange for the cancellation of a convertible promissory note in the principaland accrued interest amount of $205,730. Upon shareholder approval of the debtfinancing, the Company recorded an additional $91,563 of debt discount for theinstruments’ beneficial conversion feature. The debt discount was fullyamortized at December 31, 2004. Principal and accrued interest under thedebentures was due and payable at December 31, 2003. The debentures wereconvertible into shares of the Company’s common stock at the election of theholders at a conversion price of $3.50 per share. In March 2004, theCompany repaid the entire principal of $225,000 and accrued interestof approximately $40,000 under the debentures. As of December 31,2004, these convertible debentures had been satisfied and no further amountswere due.

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In March 2004, theCompany raised $5,000,000 in gross cash proceeds through the private placementof 20 units, at a purchase price of $200,000 per unit, and Series B seniorsecured convertible notes in the aggregate principal amount of $1,000,000. Eachunit consisted of 50,000 shares of common stock (initially priced at $1.63 pershare), a Series A senior secured convertible note in the originalprincipal amount of $118,500 and a five-year warrant to purchase 61,350shares of common stock. The Company issued an additional $250,000 of Series Bsenior secured notes in exchange for cancellation of existing short-termindebtedness in that amount. The Company issued to the Series B noteholdersfive-year warrants to purchase an aggregate of 383,439 shares of commonstock. The exercise price for the warrants is $1.63 per share. Additionally,the Company issued one quarter unit to the lead investor’s counsel as paymentfor legal services. The Company allocated the proceeds from the issuance of thenotes to the notes and to that subset of warrants allocated to the notes basedon their relative fair values using the Black-Scholes option pricingmodel. The amount allocated to the warrants ($1,462,538) was recorded as a debtdiscount to be amortized to interest expense using the effective interestmethod over the period the notes are expected to be outstanding. The notes areconvertible into shares of the Company’s common stock at the election of theholders at a conversion price of $1.63 per share. Total shares of common stockissued in connection with this private placement were 1,012,500. The fair valueof the warrants allocated to the common stock on a pro-rata basis has beenaccounted for as cost of capital.

The terms of the financingincluded antidilution provisions to the effect that if and whenever in theperiod commencing after the issuance date (March 23, 2004) and ending 24months thereafter (March 22, 2006) (the “Antidilution Period”), theCompany issues or sells, or is deemed to have issued or sold, any shares ofcommon stock, with the exception of specific customary issuances which areexcluded, for a consideration per share less than the conversion price orexercise price in effect immediately prior to such time for the relevantshares, then concurrent with such dilutive issuance, the conversion price orexercise price for the notes and warrants, as the case may be, then in effectshall be reduced to an equal amount to the new securities issuance price.

Upon stockholder approvalof the private placement in May 2004, the Company recorded an additional$2,187,087 of debt discount for the instrument’s beneficial conversion feature.In addition, $18,500 of principal of each of the Series A notes wasconverted into common stock at $1.63 per share and $100,000, or 50%, inprincipal of each of the Series B notes was converted into common stock at$1.63 per share. The total principal amount for both Series converted uponapproval of the stockholders was $999,625, resulting in the issuance of 613,276shares of common stock. The Company recorded a total of $2,650,000 of theplacement as equity and $2,650,000 as senior debt. The notes mature on April 1,2009 and bear interest at the rate of 8% per annum payable quarterly in cash orstock (valued at the conversion price) at VCampus’ option for the first year. Principaland interest on the notes are payable in cash over the following four years inquarterly installments. The note holders have alleged an event of default hasoccurred under the notes. The Company is continuing to negotiate with the noteholders in an effort to reach an amicable resolution to the matter (see note 9).The principal and interest under these notes is subject to acceleration in theevent of default under the notes, which events of default include, among otherthings, failure to:  (a) makepayments when due; (b) timely issue shares upon conversion; (b) redeemshares upon a change of control; and (c)  satisfy ongoing registrationobligations. Although the Company continues to believe these notes are not indefault, the Company has been accruing a liability on its financial statements,starting in September 2006, based on the default rate of interest of 13%per year.

During 2005, an additional$541,809 of Series A and Series B senior secured convertible noteprincipal was converted into 332,398 shares of common stock, respectively,resulting in $2,053,934 of aggregate principal from this financing converted asof December 31, 2005. The total outstanding principal remaining underthese convertible notes as of December 31, 2005 and 2006 amounted to$1,385,390 and $989,565 respectively. The total unamortized debt discountassociated with these notes as of December 31, 2005 and 2006 amounted to$714,105 and $359,550, respectively, resulting in a net liabilities balance onthe notes of 

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$671,285and $630,015, respectively, of which $191,796 and $161,120, respectively, isclassified as a current liability on the financial statements.

The Company is required tomaintain the effectiveness of a registration statement permitting the resale ofthe shares issuable upon conversion of the convertible notes and upon exerciseof the related warrants. The Company filed such a resale registration statementon Form S-1 (File No. 333-133664) with the Securities andExchange Commission, which was declared effective on December 19, 2006.If, following the effective date of the registration statement, theregistration statement ceases to remain effective, or if the Company fails todeliver unlegended shares to the investors as and when required, the debentureswould bear default interest at a rate of 13% per annum.

Interest due for thequarters ended June 30, September 30, December 31, 2004 and March 31,2005 amounted to $205,634 and was paid through the issuance of an aggregate of126,142 shares of common stock valued at $1.63 per share on July 1, 2004, October 1,2004, January 1, 2005 and April 1, 2005, respectively.

During the year ended December 31,2005, Company made cash payments aggregating $277,000 to the holders of theseconvertible debentures, which represented two quarterly installments. As of December 31,2005, $1,385,390 of the principal amount of these convertible debenturesremained outstanding. During the year ended December 31, 2006, the Companymade cash payments aggregating $494,800 to the holders of these convertibledebentures, which represented four quarterly installments. As of December 31,2006, $989,565 of the principal amount of these convertible debentures remainedoutstanding.

In August 2006, theCompany issued a $300,000 promissory bridge note to an accredited investor. Thenote bore interest at an annual rate of 10% and was payable upon the earlier ofOctober 31, 2006 or the closing of a more permanent financing. Theprincipal and interest was repaid from the proceeds of the September 2006convertible debenture financing (see below). In connection with the note, theCompany issued 150,000 shares of common stock to the same accredited investoras an inducement for the investment. The shares were valued at $45,000 usingthe closing price ($0.30) of the Company’s shares on the date of issuance. Accordingly,the Company recorded an additional interest charge related to the inducement. Asof December 31, 2006, the promissory bridge note had been satisfied and nofurther amounts were due.

In September 2006,the Company entered into a Securities Purchase Agreement with one accreditedinvestor pursuant to which VCampus completed a $3.0 million private placementof a convertible note and warrants. The convertible note bears interest at10% per annum and matures 30 months from the date of issuance. The Company mustbegin making monthly installment payments of interest and principal beginningten months from the date of issuance. The indebtedness represented by theconvertible note is secured by a blanket lien on substantially all of theassets of the Company and its subsidiary Prosoft Learning Corporation. The newindebtedness is senior to all of the Company’s existing indebtedness except forthe Company’s remaining senior indebtedness of approximately $1.0 million owedto SIAR Capital and the other holders of notes issued in the Company’s March 2004financing. The indebtedness due under the convertible note can be acceleratedupon a change of control or following an event of default, which includescustomary events such as nonpayment of interest, failure to satisfy SECregistration obligations and breach of restrictive covenants. The Company mayprepay or redeem the Note at any time upon repayment of 120% of the outstandingprincipal and accrued interest. The note is convertible, at the election of theinvestor, into shares of common stock at $0.30 per share. The convertible notewas issued at 94% of par, resulting in gross proceeds to the Company (beforededuction of placement agent fees and other transaction-related expenses) of$2.82 million.  As an additionalinducement to the investor, the Company also issued a five-year warrant to theinvestor to purchase up to 2,500,000 shares of common stock at $0.30 per share.The Company filed a registration statement with the SEC to cover the resale ofthe shares of common stock issuable upon conversion of the note and exercise ofthe warrants issued in the 

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financing.The Company paid the placement agent for the financing a fee of seven percentof the gross cash proceeds received by the Company in the financing, togetherwith a warrant to purchase 940,000 shares of common stock at $0.30 per share.

Pursuant to antidilutionprotection provisions applicable to the investors in the Company’s Series A-1preferred stock financing closed in December 2005, the conversion pricefor the Series A-1 preferred stock and the exercise price of therelated warrants issued in connection therewith automatically adjusted to $0.30per share upon completion of the September 2006 Financing. In exchange foran agreement by the holders of Series B-1 Preferred Stock to acceptpayment of certain dividends in additional shares of Series B-1Preferred Stock instead of cash,  theCompany agreed to adjust the conversion price for the Series B-1preferred stock and the exercise price of the related warrants issued inconnection therewith to a formula with a floor of $0.37 per share plus 2% ofthe amount by which the trading price of the common stock exceeds $0.37 pershare on the date of conversion.

The securities issued inthe September 2006 financing likewise have antidilution protection thatwould cause the conversion price or exercise price of such securities toautomatically adjust to any lower price applicable to a future financing ofVCampus.  The transaction documents limitthe investor’s beneficial ownership of the Company to no more than 4.99% at anygiven time, subject to the investor’s waiver of such restrictive covenant upongiving at least 61 days notice to the Company.

The Company allocated theproceeds from the September 2006 financing to the convertible note andwarrants on a pro rata basis based on their relative fair values using theBlack-Scholes option pricing model. The amount allocated to the warrants($551,020) was recorded as a debt discount and will be amortized to interestexpense using the effective interest method over the period the convertiblenote is expected to be outstanding. The Company recorded an additional $651,020of debt discount for the instruments’ beneficial conversion feature which willbe amortized to interest expenses using the effective interest method over theperiod the convertible note is expected to be outstanding. The Company alsorecorded a discount (amortizable using the effective interest method over theperiod the convertible note is expected to be outstanding) of $180,000representing the amount by which the face amount of the convertible noteexceeded the proceeds from the convertible note. As of December 31, 2006,the unamortized aggregate discount for the note amounted to $1,170,209. Inconnection with the convertible debenture financing, the Company incurred anestimated $686,473 of financing costs primarily consisting of the seven percentplacement agent fee, the fair market value of the warrant issued to theplacement agent (using the Black Scholes method), legal and other costs. Thesecosts will be amortized to interest expense using the effective interest methodover the period the convertible notes are expected to be outstanding.

The Company is required tomaintain the effectiveness of a registration statement permitting the resale ofthe shares issuable upon conversion of the convertible notes and upon exerciseof the related warrants. The Company filed such a resale registration statementon Form S-1 (File No. 333-13808) with the Securities andExchange Commission, which was declared effective on January 10, 2007. If,following the effective date of the registration statement, the registrationstatement ceases to remain effective for more than 20 consecutive trading days,the Company shall immediately reduce the then exercise price of each of thewarrants by $0.11 and shall be further reduced by an additional $0.05 for eachsubsequent thirty (30) day period thereafter until the registration failure iscured.

As of December 31,2006, future maturities of long-term debt obligations were as follows:

| 2007   |   | $         | 1,270,037 |   |
|--------|--------|-----------|-----------|--------|
| 2008   |   | 2,195,826 |      |
| 2009   |   | 647,913   |      |
|   |   | $         | 4,113,776 |   |

 

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**9. Commitments and Contingencies**

*Leases*

The Company leases officespace and office equipment under non-cancelable operating lease agreements withvarious renewal options. Future minimum lease payments may be periodicallyadjusted based on changes in the lessors’ operating charges. Rent expense forthe years ended December 31, 2004, 2005 and 2006 was $520,710, $521,959and $726,644, respectively.

As of December 31,2006, payments due under non-cancelable operating leases were as follows:

| 2007   |   | $       | 670,860   |   |
|--------|--------|---------|-----------|--------|
| 2008   |   | 575,111 |      |
| 2009   |   | 592,364 |      |
| 2010   |   | 49,484  |      |
|   |   | $       | 1,887,819 |   |

 

TheCompany also leases equipment under lease agreements which are capitalizedusing the interest rates appropriate at the inception of the lease. The relatedequipment is included in property and equipment and depreciated accordingly. Futureminimum lease payments under capital lease obligations at December 31,2006 are as follows:

| 2007                                   |   | $      | 30,456 |   |
|----------------------------------------|--------|--------|--------|--------|
| 2008                                   |   | 30,456 |   |
| 2009                                   |   | 2,538  |   |
| Less amounts  representing interest    |   | (5,027 | )      |
| Present value of net  minimum payments |   | $      | 58,423 |   |

 

*Employment Agreements*

The Company has enteredinto employment agreements with certain members of management. These agreementsspecify minimum annual salaries as well as objective-based and discretionaryperformance bonus amounts to be paid over the next year.

*Purchase Commitment*

In January 2005, theCompany and a vendor extended a reseller agreement they had initially enteredinto in 2000, for another year. Pursuant to this extension, the Company wasrequired to generate sales of the vendor’s courseware sufficient to generateroyalties of $150,000. To satisfy its obligations under the extension, theCompany paid the vendor $100,000 in cash in 2005 and was allowed to carry$50,000 of the paid-for but unsatisfied portion of its prior year commitment tothis vendor into the twelve months ending January 30, 2006, which is theperiod of the renewal. As of December 31, 2005, the Company had fullysatisfied the $150,000 commitment for the twelve months ending January 31,2006 and owed the vendor an additional $41,763, which is included in accruedexpenses on the consolidated balance sheet. In 2006 the Company extended theagreement for two additional years through January 31, 2009 for two $75,000amounts to be paid in 2007 and 2008.

*Alleged Default on Secured Convertible Notes*

In February 2006,holders of a majority of the Company’s Series A and Series B securedconvertible notes issued in March 2004 notified VCampus that they believean event of default exists under the notes based on the Company’s failure toacknowledge their alleged right to have the conversion price on their notesreduced from $1.63 per share to $0.30 per share, which is the lowest potentialreset conversion price 

F-28

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for the Series A-1Preferred Stock the Company issued to other investors in the December 2005financing. The Company disputes the claims made by the note holders for anumber of reasons, including the fact that their antidilution rights expire,pursuant to the express terms of the notes and warrants, prior to the pricereset date on March 31, 2006, and hence they expire prior to the happeningof the alleged event or contingency that might otherwise trigger their rights. Consequently,the Company believes the note holders’ allegations are without merit.

*Litigation*

On April 18, 2006,the Company received notice that the Virginia Department of Taxation has deniedVCampus’ request for correction of the retail sales and use tax assessmentissued to VCampus as a result of an audit for the period August 1998through October 2001. As disclosed in VCampus’ prior SEC filings, in 2002,the Virginia Department of Taxation completed an audit of the VCampus’ salesand use tax payments from August 1998 through October 2001. The totalassessment from the Virginia Department of Taxation is approximately $104,000for the audit period. In addition, based on this ruling and the Department’sinterpretation of local law, VCampus has estimated its liability for additionalsales and use tax from the end of the audit period in October 2001 to March 31,2006 to be approximately $296,000 including penalties and interest   As a result,****the Company has recorded a charge of $400,000 included on thefirst quarter 2006 consolidated statements of operations. In May 2006, theCompany submitted an application for an Offer in Compromise to the VirginiaDepartment of Taxation requesting partial relief from amounts assessed andpost-audit sales and use tax liability as well as a payment plan for theremaining liabilities. In August 2006, the Virginia Department of Taxationaccepted the Company’s offer in compromise, thus reducing the amount of theliability to $252,477, payable in 36 monthly installments of $7,013, subjecthowever, to the Department’s post-audit verification of the Company’scalculation of additional sales and use tax from October 2001 to March 2006.The department’s verification proceedings are currently under way and, pendingthe final resolution of the amount due, the Company has not made any adjustmentsto the previously recorded liability of $400,000.

*Nasdaq Listing*

On April 27, 2006,Nasdaq provided the Company with written notice that the Company’s common stockwould be delisted from the Nasdaq Capital Market because the Company did notregain compliance with Nasdaq’s requirements for continued listing under theMinimum Bid Price Rule during the 180-day compliance periodpreviously granted. The Company requested a hearing before the Nasdaq ListingQualifications Panel, which automatically stayed the delisting pendingresolution of the appeal. The hearing occurred on June 15, 2006 and, whilethe Panel was considering the Company’s appeal, the Company decided to proceedwith voluntary delisting of its shares of common stock from trading on the NasdaqCapital Market as of the opening of trading on July 5, 2006. VCampus’shares of common stock are currently trading on the Nasdaq OTC Bulletin Board.

**10. Composition of Certain Financial StatementCaptions**

Prepaidexpenses and other current assets consists of the following:

| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Deferred debt offering  costs  |       | $                     | 66,554     |   | $ | 488,543 |   |
| Prepaid royalties              |       | 121,144               |       | 198,639 |   |
| Prepaid maintenance  contracts |       | 49,668                |       | 41,965 |   |
| Inventory                      |       | —                |       | 35,087 |   |
| Other                          |       | 88,452                |       | 107,819 |   |
|                           |       | $                     | 325,818    |   | $ | 832,053 |   |

 

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Other assetsconsists of the following:

| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Deferred debt  offering costs |       |                  | $          | 149,924 |   |   | $ | 244,697 |   |
| Other                         |       |                  | 81,935     |   |   | 81,935 |   |
|                          |       |                  | $          | 231,859 |   |   | $ | 326,632 |   |

 

Accrued expensesconsists of the following:

| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Accrued payroll  and payroll taxes |       | $                     | 123,215    |   | $251,642 |   |
| Accrued vacation                   |       | 35,965                |       | 114,484 |   |
| Deferred rent                      |       | 128,440               |       | 109,622 |   |
| Accrued interest                   |       | 27,708                |       | 112,083 |   |
| Liquidated  damages                |       | —                |       | 82,658 |   |
| Other                              |       | 163,988               |       | 237,087 |   |
|                               |       | $                     | 479,316    |   | $ | 907,576 |   |
|                                    |            |                       |            |  |  |  |  |

 

Accrued payroll as of December 31,2005 and 2006 primarily consists of earned but unpaid incentive compensation.

**11. Stockholders’ Equity**

*Series A-1 Preferred Stock*

In December 2005, the Company issued 2,300 sharesof a newly created class of Series A-1 Preferred Stock at a purchaseprice of $1,000 per share to a group of accredited investors. The shares of Series A-1Preferred Stock were initially convertible into common stock at a conversionprice of $1.67 per share. In March 2006, the conversion price of the Series A-1Preferred Stock and the exercise price of the related warrants reset to $0.61per share per their terms. The number of shares issuable upon exercise of thewarrants was also automatically adjusted from 1,032,929 to 2,827,864. In May 2006,following approval of the Series A-1 private placement by theCompany’s stockholders, the conversion price of the Series A-1Preferred Stock and the exercise price of the related warrants was furtherreset to $0.50 per their terms. In connection with this reset, the Companyrecorded a deemed dividend to the Series A-1 Preferred Stockholdersin the amount of $1,031,703 in the second quarter of 2006, representing thebeneficial conversion feature of the Series A-1 Preferred Stock andthe incremental value of the warrants. As a result of the September 2006convertible debenture financing (see note 8), the conversion price for the Series A-1Preferred Stock and the exercise of the warrants issued under that financing’sterms was adjusted to $0.30 per share pursuant to their anti-dilutionprovisions. In connection with this reset, the Company recorded a deemeddividend to the Series A-1 Preferred Stockholders in the amount of$1,491,666 in the third quarter of 2006, representing the beneficial conversionfeature of the Series A-1 Preferred Stock and the incremental valueof the warrants.

The shares of Series A-1 Preferred Stockare entitled to receive quarterly cash dividends at an annual rate of 10% andare redeemable by VCampus, at any time after effectiveness of the registrationstatement, for 120% of the original purchase price. None of the Series A-1investors may hold more than 4.99% of VCampus’ outstanding shares of commonstock at any given time, subject to waiver of that limitation by the Series A-1investor upon 75 days’ notice.

The Company incurred a finder’s fee for the financingequal to 8.0% of the gross proceeds from covered investors payable in cash,plus a fee of 2.0% of proceeds from covered investors paid in shares of Series A-1Preferred Stock, together with a warrant, with the same terms as the investors,to purchase 75,450 shares of common stock.

The Company agreed to register the resale of shares ofits common stock issuable to the investors and finders upon conversion of thepreferred stock and exercise of the warrants issued in the private 

F-30

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placement. Resale of theshares issuable upon conversion of the Series A-1 convertiblePreferred Stock and exercise of the related warrants is registered under theCompany’s Form S-1 registration statements (File Nos. 333-133664and 333-138808) filed with the Securities and Exchange Commission, whichwere declared effective on December 19, 2006 and January  10,2007, respectively. If the Company is unable to maintain the effectiveness ofthe registration statement related to the Series A-1 convertiblePreferred stock for more than 30 days in any given year, the Company isobligated to pay investors liquidated damages in cash equal to 1.0% of thestated value of the Series A-1 convertible Preferred Stock permonth. Liquidated damages will not accrue nor be payable for times during whichthe shares covered by the related prospectus are transferable by the holderpursuant to Rule 144(k) under the Securities Act of 1933, as amended.

In 2006, the Company issued 24.375 shares of A-1convertible Preferred Stock in satisfaction of accrued and unpaid dividends tocertain Series A-1 investors pursuant to their consent to receivecash dividends in additional shares of Series A-1 convertiblePreferred Stock.

*Series B-1Preferred Stock*

In March 2006, the Company completed a privateplacement of Series B-1 convertible Preferred Stock. Under the termsof this financing, the Company raised $2,300,000 in gross proceeds through theissuance of 2,300 shares of Series B-1 convertible Preferred Stockat a purchase price of $1,000 per share to two accredited investors. Underthe terms of this financing, the Company also issued ten-year warrants topurchase 1,000,000 shares of common stock to the same accredited investors atan exercise price per share equal to the then applicable conversion price ofthe Series B-1 Preferred Stock. The warrants were initially firstexercisable commencing four years from their issuance date. Initially,beginning three years from their date of issuance, the shares of Series B-1Preferred Stock were convertible, at the option of their holders, into commonstock based on a formula that yields a discount of between 10% and37.5% to the last closing bid price of the common stock priorto the date of conversion, subject to a price floor of $1.64 per share. Theshares of Series B-1 Preferred Stock are entitled toreceive dividends paid quarterly at the greater of:  (a) anannual rate of 16%, or (b) 6% (subsequently adjusted to 6.48%) of the netsales proceeds from two Prosoft courses. Each share of Series B-1Preferred Stock has a liquidation preference equal to 150% of the purchaseprice paid for the share. The shares of Series B-1Preferred Stock are non-voting. The Company obtained shareholderratification for the financing at its 2006 annual meeting held in May 2006.Following the September 2006 convertible debenture financing (see note 8),the Company agreed to adjust the conversion price for the Series B-1Preferred Stock and the exercise of the warrants issued under that financing’sterms to a formula with a floor of $0.37 per share plus 2% of the amount bywhich the trading price of the common stock exceeds $0.37 per share on the dateof conversion. In connection with this reset, the Company recorded a deemeddividend to the Series B-1 Preferred Stockholders in the amount of$2,141,166 in the fourth quarter of 2006, representing the beneficialconversion feature of the Series B-1 Preferred Stock and the incrementalvalue of the warrants.

The Company agreed to register the resale of shares ofits common stock issuable to the investors and finders upon conversion of thepreferred stock and exercise of the warrants issued in the private placement.Resale of the shares issuable upon conversion of the Series B-1convertible Preferred Stock and exercise of the related warrants is registeredunder the Company’s Form S-1 registration statements (FileNos. 333-133664 and 333-138808) filed with the Securities andExchange Commission, which were declared effective on December 19, 2006and January 10, 2007, respectively. If the Company is unable to maintainthe effectiveness of the registration statement related to the Series B-1convertible Preferred Stock for more than 30 days in any given year, theCompany is obligated to pay investors liquidated damages in cash equal to 1.0%of the stated value of the Series B-1 convertible Preferred Stockper month. Liquidated damages will not accrue nor be payable for times duringwhich the shares covered by the related prospectus are transferable by theholder pursuant to Rule 144(k) under the Securities Act of 1933, asamended.

In 2006, the Company issued 184 shares of Series B-1convertible Preferred Stock in satisfaction of accrued and unpaid dividends tocertain Series B-1 investors pursuant to their consent to receivecash dividends in additional shares of Series B-1 convertiblePreferred Stock.

F-31

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*Common Stock*

In March 2004, the Company raised $5,000,000 ingross cash proceeds through the private placement of 20 units, at a purchaseprice of $200,000 per unit, and Series B senior secured convertible notesin the aggregate principal amount of $1,000,000. Each unit consisted of 50,000shares of common stock (initially priced at $1.63 per share), a Series Asenior secured convertible note in the original principal amount of $118,500and a five-year warrant to purchase 61,350 shares of common stock. The Companyissued an additional $250,000 of Series B senior secured notes in exchangefor cancellation of existing short-term indebtedness in that amount. TheCompany issued to the Series B noteholders five-year warrants topurchase an aggregate of 383,439 shares of common stock. The exercise price forthe warrants is $1.63 per share. Additionally, the Company issued one quarterunit to the lead investor’s counsel as payment for legal services. See thedisclosures in note 8, “Notes Payable” on page F-[20] for further detailsof the March 2004 private placement.

During 2004 and 2005, the Company issued an additional314,420 and 332,398 shares of common stock upon the conversion of $512,500 and$541,809 of Series A and Series B senior secured convertible note principal,respectively, resulting in $2,053,934 of aggregate principal from thisfinancing converted as of December 31, 2005. During 2004 and 2005, theCompany issued an additional 72,388 and 53,754 shares of common stock upon theconversion of $117,992 and $87,642 of interest on the Series A and Series Bsecured convertible promissory notes, respectively.

In May 2004, the Company issued 76,688 shares ofcommon stock valued at $2.47 per share in full satisfaction of accruedfinancing costs of $189,419 incurred in conjunction with the March 2004financing.

During 2004, the Company issued 1,132,617 shares ofcommon stock upon the exercise of warrants and options with an average strikeprice of $1.76 per share. Net proceeds to the Company from these exercises amountedto $1,944,283.

During 2004, the Company issued 17,112 shares of itscommon stock, at an average price of $2.01 (equal to the fair market value ofthe stock on the date of each transaction) per share, to certain of itsdirectors in lieu of cash compensation for their services. The Company recorded$34,474 of compensation expense in connection with these issuances.

During 2004, the Company issued 55,085 shares ofits common stock at an average price of $1.71 (equal to the fair market valueof the stock of the date of each transaction) to two financial advisors asretainer fees. The Company recorded an expense related to these stock issuancesof $94,000.

In March 2005, the Company completed a privateplacement of its common stock. Under the terms of this private placement, theCompany raised $995,950 in gross proceeds through the issuance of 611,012shares of common stock at a purchase price of $1.63 per share to 12 accreditedinvestors. Under the terms of this financing, the Company also issued five-yearwarrants to purchase 763,765 shares of common stock with an exercise price of$1.63 per share to the same accredited investors. In connection with thisfinancing, the Company incurred a finder’s fee of approximately $50,000, paidin 30,550 shares of common stock. As this was a placement of common stock, thefair value of the warrants issued was accounted for as cost of capital.

During 2005, the Company issued 23,263 shares of itscommon stock, at an average price of $1.03 (equal to the fair market value of thestock on the date of each transaction) per share, to certain of its directorsin lieu of cash compensation for their services. The Company recorded $23,993of compensation expense in connection with these issuances.

During 2005, the Company issued 80,011 shares ofits common stock at an average price of $1.39 (equal to the fair market valueof the stock of the date of each transaction) to two financial advisors as 

F-32

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retainer fees. The Companyrecorded an expense related to these stock issuances of $111,000 of which$25,500 was recorded in 2004 and $85,500 was recorded in 2005.

In 2006, the Company issued 134,000 shares of commonstock upon voluntary conversions of 67 shares of Series A-1convertible Preferred Stock at $0.50 per share.

During 2006, in connection with the $300,000promissory bridge note to an accredited investor, the Company issued 150,000shares of common stock as an inducement for the investment. The shares werevalued at $45,000 using the closing price ($0.30) of the Company’s shares on thedate of issuance. Accordingly, the Company recorded an additional interestcharge related to the inducement.

In 2006, the Company issued 328,823 shares of commonstock at an average price of $0.39 (equal to the greater of fair market valueor preferred conversion right price of the stock at the date of eachtransaction) to two financial advisors as retained fees. The Company recordedan expense related to these stock issuances of $127,500.

During 2006, the Companyissued 20,527 shares of common stock at an average price of $0.41 (equal to thegreater of fair market value or preferred conversion right price of the stockat the date of each transaction) to certain of its directors in lieu of cashcompensation for their services. The Company recorded $8,500 of compensationexpense in connection with these stock issuances.

*Stock Option Plans*

The Company adopted a stock option plan (the OriginalStock Option Plan) which permitted the Company to grant options to purchase upto 28,892 shares of Common Stock to employees, directors and others whocontribute materially to the success of the Company. In November 1996, theCompany’s Board of Directors decided not to grant any further options under theOriginal Stock Option Plan.

During 1996, the Company’s Board of Directors approveda stock plan (the 1996 Stock Option Plan), for the grant of stock awards toemployees, directors and consultants. The 1996 Stock Option Plan expired in August 2006.

In May 2006, the Company’s Board of Directors andits stockholders approved a new stock plan (the 2006 Stock Option Plan) for thegrant of stock awards to employees, directors and consultants. The 2006 StockOption Plan expires in May 2016. Shares available for future grant as of December 31,2006 were 280,730 under the 2006 Stock Option Plan.

Stock options are generally granted at prices whichthe Company’s Board of Directors believes approximates the fair market value ofits common stock at the date of grant. Individual grants generally becomeexercisable ratably over a period of four years from the date of grant. Thecontractual terms of the options range from four to ten years from the date ofgrant.

F-33

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Asummary of the status of the Company’s stock option plans is presented belowfor the years ended December 31, 2004, 2005 and 2006: 

| ** **                                          | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **Shares**                                  | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at  the beginning of the Year |       | 529,243                                     |       |   | $ | 7.50 |   |   | 1,414,047 |   |   | $ | 3.95 |   |   | 2,401,542 |   |   | $ | 2.59 |   |   |
| Granted                                             |       | 1,129,544                                   |       |   | 1.94 |   |   | 1,240,020 |   |   | 0.96 |   |   | 1,179,031 |   |   | 0.30 |   |   |
| Exercised                                           |       | (76,837                                     | )          |   | 2.26 |   |   | (75,770 | ) |   | 1.11 |   |   | (140,031 | ) |   | 0.30 |   |   |
| Canceled or  expired                                |       | (167,903                                    | )          |   | 2.38 |   |   | (176,755 | ) |   | 2.65 |   |   | (407,603 | ) |   | 3.57 |   |   |
| Outstanding at  the end of the Year                 |       | 1,414,047                                   |       |   | 3.95 |   |   | 2,401,542 |   |   | 2.59 |   |   | 3,032,939 |   |   | 1.80 |   |   |
| Options exercisable at  year-end                    |       | 259,756                                     |       |   | $ | 11.92 |   |   | 640,426 |   |   | $ | 5.94 |   |   | 1,129,189 |   |   | $ | 3.16 |   |   |

 

Forvarious price ranges, weighted average characteristics of outstanding andexercisable options as of December 31, 2006 were as follows:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding at  December 31,  2006** | ** ** | **Weighted Average  Remaining  Contractual  Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable at  December 31,  2006** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Less than $0.50                             |       |                         | 1,039,000  |                                                     |       |   | 9.9 |   |   |   | $ | 0.30 |   |   |   | 15,000 |   |   |   | $ | 0.44 |   |   |
| $0.50 - $0.99                               |       |                         | 913,750    |                                                     |       |   | 8.5 |   |   |   | 0.98 |   |   |   | 349,920 |   |   |   | .98 |   |   |
| $1.00 - $1.49                               |       |                         | 143,250    |                                                     |       |   | 7.2 |   |   |   | 1.32 |   |   |   | 98,436 |   |   |   | 1.33 |   |   |
| $1.50 - $1.99                               |       |                         | 27,500     |                                                     |       |   | 8.0 |   |   |   | 1.62 |   |   |   | 15,000 |   |   |   | 1.61 |   |   |
| $2.00 - $2.99                               |       |                         | 735,220    |                                                     |       |   | 7.3 |   |   |   | 2.05 |   |   |   | 483,518 |   |   |   | 2.08 |   |   |
| $3.00 -  $3.99                              |       |                         | 138,170    |                                                     |       |   | 5.9 |   |   |   | 3.78 |   |   |   | 132,703 |   |   |   | 3.78 |   |   |
| $4.00 -  $4.99                              |       |                         | 2,750      |                                                     |       |   | 5.0 |   |   |   | 4.43 |   |   |   | 2,000 |   |   |   | 4.44 |   |   |
| $5.00 -  $9.99                              |       |                         | 1,000      |                                                     |       |   | 4.0 |   |   |   | 8.75 |   |   |   | 750 |   |   |   | 8.75 |   |   |
| $10.00 -  $19.99                            |       |                         | 8,577      |                                                     |       |   | 4.1 |   |   |   | 10.88 |   |   |   | 8,577 |   |   |   | 10.88 |   |   |
| $20.00 -  $260.00                           |       |                         | 23,722     |                                                     |       |   | 2.4 |   |   |   | 61.77 |   |   |   | 23,285 |   |   |   | 62.11 |   |   |
|                                        |       |                         | 3,032,939  |                                                     |       |   | 8.4 |   |   |   | $ | 1.67 |   |   |   | 1,129,189 |   |   |   | $ | 3.16 |   |   |
|                                             |            |                              |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

There was no aggregateintrinsic value on stock options outstanding as of December 31, 2006 andno aggregate intrinsic value on stock options exercised during the year ended December 31,2006.

*Warrants*

TheCompany has also granted warrants to purchase common stock to various investors,employees and outside vendors. Warrant activity was as follows for the periodsindicated (in shares of common stock):

| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Outstanding at  the beginning of the year |       | 2,375,116                                   |       | 2,961,410 |   | 4,678,621 |   |
| Granted                                   |       | 3,751,560                                   |       | 1,872,144 |   | 14,993,266 |   |
| Exercised                                 |       | (1,111,942                                  | )          | — |   | — |   |
| Canceled or  expired                      |       | (2,053,324                                  | )          | (154,933 | ) | (8,719,633 | ) |
| Outstanding at the end  of the year       |       | 2,961,410                                   |       | 4,678,621 |   | 10,952,254 |   |

 

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Exercise prices on theoutstanding warrants range from $0.30 to $70.00 per share. The weighted averagegrant date fair value of warrants issued in 2006 was $0.50. The fair value ofeach warrant grant is estimated on the date of grant using the Black-Scholesoption-pricing fair value model with the following ranges of assumptions:dividend yield of 0%; expected volatility of 69% to 133%; risk-free interestrate of 4.39% to 6.50%; and expected life of the warrant term of three to eightyears.

*Reserve for Issuance*

As of December 31,2006, the Company had reserved 13,985,180 shares of common stock for issuanceupon the exercise of outstanding options and warrants.

**12. RetirementPlans**

The VCampus Corporation401(k) plan (adopted in 1997) allows employees to elect an amount between1% and 15% of their total compensation to contribute to the plan. All full-timeemployees are eligible to make participation elections at any time whileemployed by the Company. There is a graduated vesting schedule for employercontributions in which contributions fully vest over a period of four years.The plan allows discretionary Company contributions. In 2004 and 2005, therewere no discretionary Company contributions made to the plan. In 2006 theCompany made $87,599 in discretionary contributions to the plan.

**13. Income Taxes**

Incometax expense for the years ended December 31, 2004, 2005 and 2006 isdifferent from the amount computed by applying the statutory federal income taxrates to losses before income tax expense. The reconciliation of thesedifferences is as follows:

| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2004**              | ** ** | **2005** | ** ** | **2006** | ** ** |
| Tax benefit at  federal statutory rate         |       | $                     | (2,303,000 | ) | $ | (2,010,000 | ) | $ | (2,723,000 | ) |
| State income  taxes, net of federal tax effect |       | (329,000              | )          | (230,000 | ) | (297,000 | ) |
| Increase in  valuation allowance               |       | 1,844,000             |       | 870,000 |   | 2,824,000 |   |
| Other                                          |       | 788,000               |       | 650,000 |   | 386,000 |   |
| Change in  effective tax rate                  |       | —                |       | 720,000 |   | (190,000 | ) |
| Income tax expense                             |       | $                     | —     |   | $ | — |   | $ | — |   |

 

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Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting and incometax purposes. The Company has recognized a full valuation allowance against thedeferred tax assets because the Company has determined that it is more likelythan not that sufficient taxable income will not be generated during thecarryforward period available under the tax law to utilize part or all of thedeferred tax assets. The valuation allowance for deferred taxes increased$1,844,000, $870,000 and $4,240,000 in the years ended December 31, 2004,2005 and 2006. Significant components of the Company’s net deferred tax assetswere as follows:

| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Net operating  loss carryforwards |       | $                     | 27,160,000 |   | $ | 29,639,000 |   |
| Accrued payroll                   |       | 13,000                |       | — |   |
| Other accruals                    |       | 50,000                |       | 295,000 |   |
| Other assets and  liabilities     |       | 1,401,000             |       | 1,151,000 |   |
| Total deferred  tax assets        |       | 28,624,000            |       | 31,085,000 |   |
| Valuation  allowance              |       | (28,624,000           | )          | (31,085,000 | ) |
| Net deferred tax assets           |       | $                     | —     |   | $ | — |   |

 

As of December 31,2005 and 2006, the Company had net operating loss carryforwards for federalincome tax purposes of approximately $69,700,000 and $76,600,000, respectively,which will expire at various dates through 2026. The Company may be deemed tohave experienced changes in ownership which may impose limitations on itsability to utilize net operating loss carryforwards under Section 382 ofthe Internal Revenue Code.

**14. Net Loss PerShare**

Thefollowing table sets forth the computation of basic and diluted net loss pershare:

| ** **                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                    | ** ** | **2005** | ** ** | **2006** | ** ** |
| Numerator:                                                                        |       |                                        |       |   |   |   |   |
| Net loss                                                                          |       | $                                           | (6,579,416 | ) | $ | (5,866,327 | ) | $ | (7,624,960 | ) |
| Less: Dividends  accruing to preferred stockholders                               |       | —                                      |       | (14,312 | ) | (5,186,495 | ) |
| Net loss  available to common stockholders                                        |       | $                                           | (6,579,416 | ) | $ | (5,880,639 | ) | $ | (12,811,455 | ) |
| Denominator:                                                                      |       |                                        |       |   |   |   |   |
| Denominator for  basic earnings per share—weighted-average shares            |       | 6,792,321                                   |       | 9,266,800 |   | 9,858,079 |   |
| Denominator for  diluted earnings per share—adjusted weighted-average shares |       | 6,792,321                                   |       | 9,266,800 |   | 9,858,079 |   |
| Basic and diluted  loss per share:                                                |       |                                        |       |   |   |   |   |
| Net loss per share  available to common stockholders                              |       | $                                           | (0.97      | ) | $ | (0.63 | ) | $ | (1.30 | ) |

 

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Thefollowing equity instruments (with underlying common share numbers shown in thetable) were not included in the diluted net loss per share calculation becausetheir effect would have been anti-dilutive:

| ** **                    | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2006** | ** ** |
| Convertible notes  payable:   |       | 1,311,354                                  |       | 849,946 |   | 10,607,126 |   |
| Convertible  preferred stock: |       |                                       |       |   |   |   |   |
| Series A-1               |       | —                                     |       | 1,402,391 |   | 7,664,583 |   |
| Series B-1               |       | —                                     |       | — |   | 6,713,512 |   |
| Stock options                 |       | 1,414,047                                  |       | 2,401,542 |   | 3,032,939 |   |
| Warrants                      |       | 2,961,410                                  |       | 4,678,621 |   | 10,952,257 |   |

 

**15. SubsequentEvents**

In February 2007, the Company issued $380,000 inshort term working capital notes to accredited investors including $50,000 to arelated party. The notes bear interest at an annual rate of 10% plus a 5%origination fee due and payable, along with principal, upon receipt of a largepayment on a governmental customer contract but, in any event, no later than June 30,2007. The Company received the contract payment in April 2007 andthereafter repaid the short term notes in full.

In March 2007, theholders of the September 2006 convertible notes notified the Company thatthey believe that grounds exist for declaring multiple defaults under theirnotes based on, among other things, non-payment of interest to date and theCompany securing of $380,000 of working capital financing in February 2007.Although the Company believes these claims are without merit, the Company isnegotiating with the note holders in an effort to resolve these issues. If theCompany is unable to resolve these issues and in the event either or bothgroups of note holders were successful in pursuing their claims, they wouldthereafter be entitled to formally declare a default and immediately acceleratethe entire amount of the indebtedness and pursue their rights as the seniorsecured creditors with respect to the Company’s assets.

**16. Quarterly Salesand Earnings Data—Unaudited**

Thefollowing table presents the quarterly results for VCampus Corporation and itssubsidiaries for the years ended December 31, 2005 and 2006. In theopinion of management, this information has been prepared on the same basis asthe audited financial statements appearing elsewhere in this Form 10-K,and all necessary adjustments, consisting only of normal recurring adjustments,have been included in the amounts stated below to present fairly the unauditedquarterly results of operations. 

| ** **                                    | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|-----------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| **2006**                                      | ** ** | ** **           | ** ** | ** **           | ** ** | ** **           | ** ** | ** **           | ** ** |
| Revenue                                       |       | $                    | 1,277,202  |                 | $          | 1,407,668            |       | $                    | 2,524,733  |   | $ | 2,235,930 |   |
| Loss from  operations                         |       | (1,841,688           | )          | (1,442,713           | )          | (2,175,694           | )          | (2,164,865           | )          |
| Net loss  attributable to common stockholders |       | (1,907,393           | )          | (2,624,342           | )          | (3,816,235           | )          | (4,463,485           | )          |
| Net loss per  share, basic and diluted        |       | $                    | (0.20      | )                    | $          | (0.27                | )          | $                    | (0.38      | ) | $ | (0.44 | ) |
| **2005**                                      | ** ** | ** **           | ** ** | ** **           | ** ** | ** **           | ** ** | ** **           | ** ** |
| Revenue                                       |       | $                    | 1,128,582  |                 | $          | 1,093,089            |       | $                    | 1,244,612  |   | $ | 1,098,180 |   |
| Loss from  operations                         |       | (1,422,218           | )          | (1,230,238           | )          | (905,633             | )          | (1,152,843           | )          |
| Net loss  attributable to common stockholders |       | (1,902,673           | )          | (1,456,104           | )          | (1,212,427           | )          | (1,309,435           | )          |
| Net loss per share,  basic and diluted        |       | $                    | (0.22      | )                    | $          | (0.15                | )          | $                    | (0.13      | ) | $ | (0.14 | ) |

 

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**SCHEDULE II—VALUATIONAND QUALIFYING ACCOUNT AND RESERVE(in thousands)**

**VCampus Corporation**

| **Classification**                 | ** ** | ** ** | ** ** | **Balance at  Beginning of  Period** | ** ** | **Additions** | ** ** | **Deductions** | ** ** | **Balance at  End of Period** | ** ** |
|------------------------------------|------------|------------|------------|------------------------------------------------|------------|---------------|------------|----------------|------------|----------------------------------------------|------------|
| Allowance for doubtful  accounts:  |       |       |       |                                           |       |          |       |           |       |                                         |       |   |   |   |   |   |   |
| Year ended December 31,  2004 |       |       | $          | 5                                              |       |          |       | $              | —     |                                         |       |   | $ | — |   |   |   | $ | 5 |   |   |
| Year ended  December 31, 2005 |       |       | 5          |                                           |       |          | —     |           |       |                                         | —     |   |   |   | 5 |   |   |
| Year ended  December 31, 2006 |       |       | 5          |                                           |       |          | 63         |           |       |                                         | (12        | )(1) |   |   | 70 |   |   |
|                                    |            |            |            |                                                |            |               |            |                |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Uncollectible amountswritten off. Net of recoveries.

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