**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

----

FORM 10-K

**(Mark One)**

**x**                              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHESECURITIES EXCHANGE ACT OF 1934

**For the fiscal year ended December 31, 2004**

**OR**

**o**                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom               to**

**Commission file number 0-21421**

**VCAMPUS CORPORATION**

(Exactname of registrant as specified in its charter)

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

 

Registrant’stelephone number, including area code: **703-893-7800**

Securitiesregistered pursuant to Section 12(b) of the Act:**None**

Securitiesregistered pursuant to Section 12(g) of the Act:**Common Stock ($0.01 par value per share)**

----

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes  x    No  o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. o

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act) Yes  o    No  x

The aggregate market valueof the common stock held by non-affiliates of the registrant based upon theclosing price of the common stock of $3.07 per share on June 30, 2004 onthe Nasdaq SmallCap Market System was approximately $16,939,778 as of suchdate. Shares of common stock held by each executive officer and director and byeach person known by the registrant who owns 10% or more of the outstandingcommon stock have been excluded in that such persons may be deemed to beaffiliates. This determination of affiliate status may not be conclusive forother purposes.

Asof March 30, 2005, the registrant had outstanding 9,341,089 shares ofcommon stock.

**DOCUMENTS INCORPORATED BY REFERENCE**

Portions of the Company’sProxy Statement for the 2005 Annual Meeting of Stockholders are incorporatedherein by reference into Part III of this report.

 

----

**NOTE REGARDING FORWARD-LOOKING STATEMENTS**

*Statements in this Annual Reporton Form 10-K that are not descriptions of historical facts areforward-looking statements that are subject to risks and uncertainties.Actual events or results could differ materially from those currentlyanticipated due to a number of factors, including those set forth herein and inVCampus’ other SEC filings, and including, in particular: continuing losses andnegative operating cash flows; future capital needs and uncertainty of additionalfunding; intense and increasing competition; dependence on significantcustomers, developing market, rapid technological changes and new products;dependence on online distribution; substantial dependence on courseware andthird party courseware providers; substantial dependence on third partytechnology; risks associated with potential failure to maintain our NasdaqSmallCap listing and our dependence on key personnel.*

**PART I**

**Item 1.**                        Business

**Executive Summary**

VCampus Corporation is a provider of outsourcede-Learning services. We develop courseware and manage and host Internet-basedlearning environments for professional credentialing and certificationorganizations, corporations, government agencies, and associations. Ourservices cover a broad range of e-Learning programs, from registration,enrollment and payment processing to course development and delivery, as wellas 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 customerswith comprehensive services on an outsourced, or hosted, basis. Our goal is tobe the 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.

During the past year, we shifted our emphasis to focuson our Select PartnerTM 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 at our expense. In return, each Select Partnergenerally enters into an exclusive, long-term contract for VCampus to host anddeliver the courses to the Select Partner’s members or target audience. As partof this program, we share the gross revenue generated from these courses withthe Select Partner.

We also maintain customers under our Legacy businessmodel. Under this model, we charge customers a relatively low upfront fee toestablish a customized virtual campus, or “VCampus,” and then charge customerson either a subscription (set fee per period) or usage (charge for actualcourses delivered) basis. We expect to transition the majority of our businessto the Select Partner model over the next 12-18 months and exit ourLegacy business within five years. Approximately 4% of our revenue in 2004 wasderived from the Select Partner model and 96% from our Legacy business. Weanticipate that the percentage of revenue from Select Partner courses willincrease over time as the program matures and the Legacy business stabilizes.

Under the Select Partner model, we target the marketfor professional and technical credentials, certifications and continuingeducation supporting those certifications and credentials. Our primarymarketing goals are to identify and partner with certification andcredentialing organizations with: 

1

----

(1) 10,000 or morememberships; (2) successful instructor-led education programs; and (3) minimalonline education presence. We offer these organizations the opportunity to growtheir revenues by leveraging and scaling their existing instructor-led programsthrough our outsourced e-Learning offering. Under a typical Select Partneragreement, we enter into an exclusive e-Learning relationship with the partnerfor five years, and we typically share the revenue from online sales equallywith the partner in return for our development of the courses from the partner’scontent. Typically, there is 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. VCampus and the partnertypically co-own the completed online course. The Select Partners can thereforerepurpose their highly-demanded training courses for online delivery to enhanceand support their professional development programs. The Select Partnersbenefit from our expert course development, publishing, hosting, e-commerce,reporting and account support and marketing services at little to no upfrontcost to them. We enable these organizations to add online learning quickly,efficiently and inexpensively. The Select Partner program enables us to reachthese targeted markets through courses exclusively available on our platform. Webelieve our application service provider, or ASP, model is particularly wellsuited to our target audience, because most learners are “outside the firewall.”In contrast, most other popular learning management systems, or LMS, are builtfor “behind the firewall” use, and thus require capital and operating expensesnot required for our usage-priced ASP system.

As of March 2005, we had 11 Select Partners,through which we have released a total of nine courses. We are currentlydeveloping four additional Select Partner courses for release. Under thisprogram, we have delivered more than 1,600 courses since completion of thepilot program in the fall of 2003.

Under our Legacy business model, our primary targetmarkets are the corporate, government and association member training markets.Since we are phasing out of and plan to ultimately exit the Legacy model, we nolonger devote significant resources to marketing to this market broadly.Instead, we focus our sales efforts on expanding revenue from our currentLegacy customers as well as pursuing promising leads and referrals that come toour attention.

As of March 2005, under the Legacy model we offermore than 5,000 online course titles and have delivered more than2.9 million courses to more than 920,000 desktops/users since inception ofthe program in 1997.

We believe ourmarket strengths to be:

·                    minimalupfront investment required for customers;

·                    ready-to-golibrary of more than 5,000 online courses;

·                    consistentdelivery of high-quality courseware;

·                    provensystem performance and scalability;

·                    exceptionalcustomer service and relationships; and

·                    systemcompliance with industry standards including: SCORM (Shareable Content ObjectReference Model), Section 508 (of the Federal Rehabilitation Act), AICC(Aviation Industry Computer-based Training Committee—establishedstandards of interoperability) and SOAP (Simple Object Access Protocol).

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

***Diversifiedbusiness base.  ***We serve customers from awide variety of market sectors—including corporations, government agencies,associations and professional credentialing and certification organizations. Assuch, we are able to provide our customers with a unique ability to participatein communities of learning. The VCampus platform enables our customers to sharecontent, thereby creating 

2

----

cross-sale opportunitiesfrom customer to customer. Several of our customers successfully sell theircontent to other VCampus customers simply by offering their content on theadvanced VCampus platform.

***Opentechnology.  ***Our technology affords customersa number of advantages in terms of its ability to rapidly and cost-effectivelyimplement a comprehensive and secure e-Learning and training environment. Ourcontent-neutral, open architecture platform allows for access to a widerange of aggregated content and the ability to quickly add new functionality,leverage new technology and to support a vast number of users. Our web servicescapabilities enable customers to easily integrate our technology with otherexisting systems (including enterprise resource planning systems and humanresource information systems).

***Extensiveexperience.  ***We have delivered over2.9 million courses over the past nine years to more than 920,000desktops/users. We have operated in the e-Learning space for more than eightyears. We maintain solid, long-term relationships with established customersand benefit from a highly experienced and knowledgeable management team.

***Expansivelibrary of content aggregated from leading sources.  ***Ourexisting content library includes publicly-available online courses frommore than 40 publishers, including SkillSoft, ElementK, American Media, VitalLearning and Crisp Learning (Course Technology). We also have agreements todistribute some courseware that has been developed by our customers, such asthe New York Institute of Finance, to other VCampus customers. Our wholly-ownedlibrary of telecommunications and desktop publishing courses are marketed underthe Teletutor and VCampus brand names. Finally, our Select Partner programgives our customers the ability to sell or use credentialing and certificationcourseware appropriate to their market and/or employee-based demographics.

***CoursewareDevelopment Experience.  ***We have significantcourseware development experience, built over the past nine years. We haveexperienced instructional designers and project managers on staff supplementedby offshore 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 growing demands of our Select Partners.

***Flexibility.  ***Ourtechnology and implementation process is flexible to respond to diversecustomer 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.

***Comprehensive Services.  ***Weoffer a completely hosted system, accessible by virtually any web browser. Ourofferings include a leading edge Learning Management System, Course ManagementSystem, and Courseware Delivery Engine. Our technology and service have beenproven and tested through successful implementations for scores of customers,through which thousands of students have experienced VCampus-basede-Learning for up to seven years. Additionally, we continue to introduce newtechnology to provide additional features for our customers.

**Company Strategy**

Our goal is to be the leadingservice provider of integrated e-Learning services by helping customers improvetheir performance and achieve their goals. Our strategies to achieve thisobjective include continuing to: create partnerships with leading credentialingand certification organizations; develop high quality courseware quickly forour Select Partners; provide superior customer service; and develop new andupgrade existing technologies. Our strategy also includes increasing revenuefrom each customer by converting more of each customer’s proprietaryinstructor-led content to online distribution through the 

3

----

VCampusplatform. We also intend to grow the cross-selling of content betweenvarious customers. The intended result is increased penetration and enhancedcustomer loyalty.

*Create Partnershipswith Leading Credentialing Organizations*

The Select Partner program is our core focus to expandthe 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 seek the credentialing orcertification through an online course. By developing online courses under ourSelect Parmer program, we are able to address this market opportunity jointlywith these partners.

During 2004, we formed newrelationships with the following seven Select Partners, the majority of whichoffer credentials or training for learners interested in obtaining credentials:the Association for Financial Professionals, PCI Global, Inc., theNational Council of State Boards of Nursing, the National Contract ManagementAssociation, the American College of Forensic Examiners International, the NewYork Institute of Finance and Kiplinger Washington Editors, Inc.

*Develop HighQuality Courseware Quickly for Select Partners*

Addressing the marketopportunity swiftly is essential to a successful Select Partner strategy. Withnearly a decade experience in the budding e-Learning industry, we havedeveloped the capabilities and expertise to fulfill the course developmentneeds of our current and new partners quickly while delivering superior quality.As such, we are able to work with our Select Partners to transform theirtraditional, instructor-led content into high-quality online courses while themarket opportunity is still ripe.

*Provide SuperiorCustomer Service*

Our core customer serviceprinciple is to deliver uniquely superior service through creative, committedand well-trained employees who work as a team. Each VCampus employee hasdefined roles and responsibilities for monitoring and supporting the health andgrowth of our customer relationships. Furthermore, each team is responsible forcontinuous review of its customers’ content needs, introduction of existing andnew VCampus services, recommendation of suitable additional content,identification of the potential need for custom courseware development andrecommendation of platform configurations for customer-specific businessprocesses.

*Develop and UpgradeProprietary 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).

During 2003 and early 2004, weannounced the introduction of VCampus’ enhanced web-based CourseManagement System to support both self-paced and instructor-managed onlinelearning. The VCampus Course Management System (CMS) 5.0 delivers importantfeatures including a newly designed Gradebook that tracks multiple studentactivities, integrated course discussion boards, a built-in testing andassessment engine as well as powerful communications tools. This CMS releasemarks the implementation of a new Java-based enterprise architecture designedfor highly reliable, hosted e-Learning. CMS 5.0 also includes a newly-designedcourse authoring tool.

4

----

Early in 2004, we introduced a new Learning ManagementSystem (LMS). This LMS, which we license from a third-party provider, providesour customers with the ability to support and manage online, live and blendedlearning. Capabilities include advanced LMS features, live chat, skillsassessment and multilingual capabilities. The LMS provides learners withconvenient access to course-specific data, supporting information andcommunications functions, all in one convenient location on the desktop. Thesystem also includes a personal calendar, reminder notes and other tools thatmake learning more efficient. The system is fully customizable and allows ourclients to obtain their own look, feel and features on a hosted basis. The newLMS integrates with human resource, enterprise resource planning and customerrelationship management and other enterprise systems.

VCampus also developedVNexusTM, a next generation integration platform which made us the first e-Learningcompany to launch a fully SOAP-compliant Learning Management platform withsuperior web services capabilities. By standardizing on the SOAP protocol,VNexus employs XML, a recognized universal standard, to communicate with anorganization’s information technology infrastructure. XML provides inherentflexibility because it can operate across any operating system or platform,thereby reducing possible barriers to integration. Recognizing that someorganizations have not standardized on XML, we also offer other communicationformats with VNexus.

*Existing CoursewareLibrary*

We currently offer morethan 5,000 courses real-time on our e-learning system. The majority arepublicly-available courses. Our courseware strategy involves theprovision of the following three components: (1) strategically-developedcourses from VCampus; (2) COTS, or commercial off-the-shelf, courses froma variety of leading third-party course vendors; and (3) customcourseware development for the proprietary training needs of our customers.

*Strategically DevelopedCourses*

We invest in thedevelopment of courses which we deem strategic in nature to attract customerswith strong revenue prospects. Typically, this type of course is developed inpartnership with a leading expert in the field, typically under the SelectPartner program. Content considered for co-development must target a large,reachable audience and offer the audience some compelling reason to attend thecourse (e.g., compliance with laws, certification, CPEs or CEUs). Examplesof strategically-developed courses include Information Security andseveral HIPAA courses. Courses so developed may be owned, at least partially,by us.

*COTS Library*

The majority of the onlinecourses delivered from our library through our e-leaning system are commercialoff-the-shelf, or COTS courses. The current library was built from acombination of acquisitions, our own development efforts and relationships withleading content providers such as SkillSoft, Infosource, Vital Learning, CrispPublications Inc. (Course Technology), Aztec Software and American Media, Inc.Although we do not provide accreditation or certification itself, a number ofour current courses provide either accreditation or certification through ourcontent providers.

*Custom Library*

Our existing customcourseware library consists of online courses built by our corporate,government agency, and association customers for their own proprietary use.Approximately 50% of these legacy customers have such custom courses rangingfrom a few courses to 50 or more per customer. We believe these courses providemore long-term revenue potential than commercial off-the-shelf courses, whichhave 

5

----

becomecommoditized. We believe the growth of this custom library is evidence ofcustomer satisfaction with our authoring and delivery products.

**Customers**

Our primary target marketsfor our Select Partner program are professional credentialing and certificationorganizations, corporations, government agencies, and associations. In 2003 and2004, our online tuition revenues were balanced fairly equally among thegovernment, corporate training and higher education distance learning segments.In 2004, the amount of revenues we derived from professional credentialing andcertification organizations was relatively small, approximately 4% of our totalrevenues, but we expect it to represent a significantly larger percentage ofour total revenues in the coming years. In 2004, three customers, the U.S.Department of Veterans Affairs, Park University and a large insurance companyaccounted for approximately 27%, 25% and 21% of our revenues, respectively. Weanticipate that future revenues may be derived from sales to a limited numberof customers. Accordingly, the cancellation, non-renewal or deferral of a smallnumber of contracts could have a material adverse effect on us. For example, in May 2004, Park Universityelected not to renew its relationship with us. Park University represented 25%,36% and 28% of our revenues in the years ended December 31, 2004, 2003 and2002, respectively. See the “Risks and Uncertainties” section of this reportfor a discussion of the risks of such customer concentration.

**Sales and Marketing**

Our primary marketing goals are to identify andattract organizations 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 thesemembers. 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 marketingefforts are limited and focused. Our primary target markets are the corporate,government and association member training markets. Since we are phasing out ofand ultimately exiting the Legacy model, we no longer devote significantresources to marketing to this market broadly. Instead, we focus our salesefforts on expanding revenue from our current Legacy customers as well aspursuing promising leads and referrals that come to our attention.

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

**Competition**

The market for online educational and trainingproducts and services is highly competitive and will likely intensify. Althoughwe know of no other company offering a program substantially similar to ourSelect Partner program, there are no significant barriers to entry in theonline education and training market. Competition in the market is based uponvarious factors, including technology, course offerings, pricing, quality,flexibility, reliability of delivery system, marketing and third partyrelationships.

A number of companies, including SkillSoft, SumTotalSystems, DigitalThink and Saba compete in this market, as well as many others.In addition to traditional classroom and distance learning providers, otherinstitutions such as Apollo Group (through University of Phoenix Online) offertheir own accredited courses online. Many education providers use some of ourmethods, including e-mail, bulletin boards, 

6

----

threaded discussion andelectronic conferencing, as well as other delivery methods such as satellitecommunications and audio and videotapes.

We believe that it is becoming increasingly apparentthat e-Learning providers must not only remain technologically advanced, butalso, more importantly, offer “complete” service offerings. This “completeservice offering” approach includes offering customers access to a largelibrary of high quality, off-the-shelf courses; the ability to producecustomized courses quickly and effectively; and value-added features thatallow flexibility and scalability. Additionally, successful e-Learning servicesmust be affordable, convenient and easy to use and administer.

Most of our competitorshave significantly greater financial, technical and marketing resources than wedo. We will require additional financing to compete effectively in thisevolving market. In addition, any of these competitors may be able to respondmore quickly than us to new or emerging technologies and to devote greaterresources to the development, promotion and sale of their services. A number ofour current customers and partners have also established relationships withsome of our competitors, and future customers and partners may establishsimilar relationships. In addition, our partners could use information obtainedfrom us to gain an additional competitive advantage over us. Our competitorsmay have or may develop products and services that are superior to those ofVCampus or that achieve greater market acceptance than our products andservices.

**Trademarks and Proprietary Rights**

We regard our copyrights,trademarks, trade dress, trade secrets and similar intellectual property ascritical to our success, and we rely upon federal statutory as well as commonlaw copyright and trademark law, trade secret protection and confidentialityand/or license agreements with our employees, customers, partners and others toprotect our proprietary rights. We****own registeredtrademarks in the United States for: Courseware Construction Set, Pointpage, Content Matters, V (&design), and VCampus. We have filed intent-to-use applications for thefollowing: VCampus Youre-Learning Partner, VCampus (& design), Pointpage and Govlearn. Wehave licensed the right to use the web address *www.vcmp.com.*

**Employees**

As of March 1, 2005,we had 37 employees, consisting of 10 full-time employees in general businessoperations, nine full-time employees in sales and marketing, 12 full-timeemployees in product development, and six full-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.

**Whereyou can find additional information**

Our website address is *www.vcampus.com.* We make available free of charge throughour website our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and all amendments to those reports assoon as reasonably practicable after such material is electronically filed withor furnished to the SEC.

**Risks and Uncertainties**

This report contains forward-looking statements thatinvolve risks and uncertainties. Our actual results could differ materially fromthose discussed in this report. Factors that could cause or contribute to thesedifferences include, but are not limited to, those discussed below andelsewhere in this report and in any documents incorporated in this report byreference.

7

----

If any of the following risks, or other risks notpresently known to us or that we currently believe to not be significant,develop into actual events, then our business, financial condition, results ofoperations or prospects could be materially adversely affected. If thathappens, the market price of our common stock could decline, and stockholdersmay lose all or part of their investment.

***Wehave incurred losses and anticipate future losses, which could have an adverseimpact on the trading price of our common stock.  ***Wehave incurred significant losses since our inception in 1984, including netlosses attributable to common stockholders of $7.1 million,$6.2 million and $6.6 million for the years ended December 31, 2002,2003 and 2004. As of December 31, 2004, we had an accumulated deficit of$97.0 million, stockholders’ equity of $4.8 million and a workingcapital of $1.8 million. We expect losses from operations to continueuntil our online revenue stream matures. For these and other reasons, we cannotassure you that we will ever operate profitably, which could have an adverseimpact on the trading price of the shares held by our stockholders.

***Ifwe do not have the resources to meet our business objective, we might notsurvive or be successful.  ***Our key objectiveis to be one of the leading providers of outsourced e-Learning services. Pursuingthis objective may significantly strain our administrative, operational andfinancial resources. We cannot assure you that we will have the operational, financialand other resources to the extent required to meet our business objective,which means we might not survive or be successful.

***Failure to raiseadditional capital, as and when needed, could prevent us from executing ourbusiness strategy and could prevent us from maintaining compliance with Nasdaqlisting standards.  ***If we are not able to generate sufficient cash for ongoing operations,we will need to raise additional funds through public or private sale of ourequity or debt securities or from other sources for the following purposes:

·  to build our core online business and executeon our Select Partner business model;

·  to fund our operating expenses; and

·  to maintain compliance with Nasdaq listingrequirements.

We cannot assure you that additional funds will beavailable if and when we need them, or that if funds are available, they willbe on terms favorable to us and our stockholders. If we are unable to obtainsufficient funds or if adequate funds are not available on terms acceptable tous, we may be unable to meet our business objectives. A lack of sufficient fundscould also prevent us from taking advantage of important opportunities or beingable to respond to competitive conditions. Any of these results could have amaterial adverse effect on our business, financial condition and results ofoperations.

Our need to raise additional funds could also directlyand adversely affect stockholder investment in our common stock in another way.When a company raises funds by issuing shares of stock, particularly at adiscount to the market price, the percentage ownership of the existingstockholders of that company is reduced, or diluted. If we raise funds in thefuture by issuing additional shares of stock (as we have in the past),stockholders may experience significant dilution in the value of their shares.Additionally, certain types of equity securities that we have issued in thepast and may issue in the future  couldhave rights, preferences or privileges senior to the rights of the holders ofour common stock.

We have in the past and may in the future fund the Companywith debt obligations which typically require payment of principal and interestin cash, therefore, reducing the cash we would have available to meet operatingrequirements. We must begin making quarterly interest payments of $42,750 incash on our outstanding convertible debt beginning in July 2005. Additionally,debt obligations may make additional financing offerings more difficult toenter into which may result in less favorable terms for us.

***Ifwe fail to maintain compliance with our Nasdaq SmallCap Market listing, thevalue and liquidity of our shares could be impaired.  ***Our common stock is currently listed on the NasdaqSmallCap Market. Nasdaq has certain requirements that a company must meet inorder to remain listed on the Nasdaq 

8

----

SmallCapMarket. If we continue to experience losses from our operations or if we areunable to raise additional funds as needed, we may not be able to maintaincompliance with the minimum $2.5 million stockholders’ equity requirementfor continued listing on the Nasdaq SmallCap Market. At December 31, 2004,our stockholders’ equity was $4.8 million.

The Nasdaq SmallCap Market and the NasdaqOver-the-Counter Bulletin Board are significantly less active markets than theNasdaq National Market. Stockholders could find it more difficult to dispose oftheir shares of our common stock than if our common stock were listed on theNasdaq National Market.

If our common stock were delisted from the NasdaqSmallCap Market, it could be more difficult for us to obtain other sources offinancing in the future. Moreover, if our common stock were delisted from theNasdaq SmallCap Market, our stock could be subject to what are known as the “pennystock” rules. The “penny stock” rules place additional requirements onbroker-dealers who sell or make a market in such securities.Consequently, if we were removed from the Nasdaq SmallCap Market, the abilityor willingness of broker-dealers to sell or make a market in our commonstock could decline. As a result, the ability of our stockholders to reselltheir shares, and the price at which they could sell their shares, of ourcommon stock could be adversely affected. If our common stock were delistedfrom the Nasdaq SmallCap Market, it could be more difficult for us to retainexisting and obtain new customers. The ability to continue to form newstrategic relationships may be negatively impacted. As a result, delistingcould result in a negative impact on our customer base and revenue, and,consequently, a negative impact on stockholder value.

***Thelarge number of our shares eligible for future sale could have an adverseimpact 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 March 1, 2005, we had 8,507,804 shares of commonstock outstanding, another 1,311,354 shares were issuable upon conversion ofconvertible notes and another 4,375,457 shares were issuable upon exercise ofoutstanding warrants and options. Substantially all of the shares subject tooutstanding warrants and options will, when issued upon exercise, be availablefor immediate resale in the public market pursuant to currently effectiveregistration statements under the Securities Act of 1933, as amended, or pursuantto Rule 701 or Rule 144 promulgated thereunder. Some of the sharesthat are or will be eligible for future sale have been or will be issued atdiscounts to the market price of our common stock on the date of issuance.

In March 2005, we issued 641,562 shares of commonstock and warrants to purchase a total of 763,765 shares of common stock in aprivate placement financing and agreed to register the resale of all of theseshares by as early as the end of May 2005. Resales or the prospect ofresales of these shares may have an adverse effect on the market price of ourcommon stock.

***Oursubstantial dependence on third-party relationships could impair ourability to achieve our business objectives and serve our customers.  ***We rely on maintaining and developingrelationships with customers, professional credentialing andcertification organizations and otherbusinesses that provide content for our products and services,corporations, government agencies, and associations and with companies that provide the Internet and relatedtelecommunications services used to distribute our products and services tocustomers.

We have relationships with a number of customers,professional credentialing and certification 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 do not cover use of any future course content and most may beterminated by either party upon breach of the agreement by the other party orbankruptcy 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 

9

----

future licensing ofexisting and new course content to us or fail to make this content available tous at commercially reasonable rates or terms necessary for success under ourbusiness model. Given our plans to introduce additional online courses in thefuture, we will need to license new course content from existing andprospective content providers. However we might not be able to maintain andmodify, if necessary, our existing agreements with content providers, orsuccessfully negotiate agreements with prospective content providers. If thefees we pay and/or the expenses we incur to acquire or distribute contentincrease, our operating costs and results of operations could be adverselyaffected. We might not be able to license or otherwise acquire course contentat commercially reasonable rates or at all.

We have licensed a Learning Management System from athird party provider under an agreement that expires on December 31, 2006.If the provider does not perform on the contract, does not continue to upgradeand maintain the LMS, does not renew the agreement with VCampus or in someother way impairs our ability to provide the LMS to our customers, our abilityto compete would be adversely affected.

We depend heavily on third-party providers ofInternet and related telecommunications services. In order to reach customers,our products and services have to be compatible with the web browsers theytypically use. Our customers have access to us through their arrangements withInternet service providers.

For our customers,the professional credentialing and certification organizations and other businesses that provide content for ourproducts and services, the companies that provide the Internet andrelated telecommunications services used to distribute our products andservices to customers, and the web-site operators that provide links to ourcompany web-sites, we cannot assure you that:

·  they regard their relationships with us assufficiently important to their own businesses and operations;

·  they will not reassess their commitment to ourproducts or services at any time in the future;

·  they will not develop their own competitiveproducts or services;

·  the products or services by which they provideaccess or links to our products or services will achieve market acceptance orcommercial success; or

·  our relationships with them will result insuccessful product or service offerings or generate significant revenues.

If one or more of these entities fail to achieve ormaintain market acceptance or commercial success, or if one or more of theentities that do succeed decide to end their relationship with us, we might notbe able to generate sufficient revenues to be successful and stockholderinvestment would be impaired.

***Weoperate in a highly competitive industry and may not be able to competeeffectively.  ***The market for educational andtraining products and services is highly competitive and we expect thatcompetition will continue to intensify. There are no substantial barriers toentry into our business, and we expect that established and new entities willenter the market for online educational and training products and services inthe near future.

A number of our existing competitors, as well as anumber of potential new competitors (including some of our strategic partners),have longer operating histories, greater name recognition, larger customerbases, more diversified lines of products and services and significantlygreater resources than we do. Such competitors may be able to undertake moreextensive marketing campaigns, adopt more aggressive pricing policies and makemore attractive offers to potential customers. In the past few years, a numberof our customers have demanded upgrades to our technology platform. Ourrelatively limited capital resources might not afford us a full opportunity tomeet these demands. Recently, we have noticed that some of the more widelyavailable online course offerings, particularly those targeted to the corporatetraining market, 

10

----

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

As the revenue potential for online delivery ofeducational and training courses continues to grow, the market is likely toattract a number of large, well capitalized competitors seeking to diversifytheir revenue streams into this market. Not only will some of these potentialcompetitors be well capitalized and be willing to operate in the market at aloss to build market share, they may also acquire and/or substantially fund ourother competitors which could weaken demand for our products and make it moredifficult for us to reach or even prevent us from reaching profitability.

***Theloss of services of any member of our key personnel could prevent us fromadequately executing on our business strategy.  ***Ourfuture success depends on the continued contributions of our key senior managementpersonnel, consisting of Narasimhan Kannan, Chief Executive Officer,Christopher Nelson, Chief Financial Officer, Ronald Freedman, Senior VicePresident of Worldwide Sales and Marketing, Laura Friedman, Vice President—Co-Publishingand Tamer Ali, Vice President of Technology, some of whom have worked together for only a short period oftime. We do not maintain “key man” life insurance on any of our executiveofficers. The loss of services of any of our key management personnel, whetherthrough resignation or other causes, or the inability to attract qualifiedpersonnel as needed, could prevent us from adequately executing our businessstrategy.

***Ourresults of operations have fluctuated significantly from period to period, anda failure to meet the expectations of investors or the financial community atlarge could result in a decline in our stock price.  ***Our expense levels are based in part on ourexpectations as to future revenues. Quarterly sales and operating resultsgenerally depend on the online revenues and development and other revenues,which are difficult to forecast. In addition, past results have shown ourbusiness to be subject to a material adverse seasonality associated with thelarge number of holidays in the calendar fourth quarter. 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 operatingresults may fluctuate significantly in the future as a result of a variety offactors, some of which are outside of our control. These factors include:

·  demand for online education and especially thedemand for professional certification and continuing education;

·  the budgeting cycles of customers,particularly in the government sector;

·  seasonality of revenues corresponding toholidays in the United States;

·  capital expenditures and other costs relatingto the expansion of operations;

·  the introduction of new products or servicesby us or our competitors;

·  the mix of the products and services sold andthe channels through which those products and services are sold;

·  pricing or accounting changes; and

·  general economic conditions.

As a strategic response to a changing competitiveenvironment, we may elect from time to time to make certain pricing, service ormarketing decisions that could have a material adverse effect on us. We 

11

----

believe thatperiod-to-period comparisons of our operating results should not be relied uponas an indication of future performance. Due to all of the foregoing factors, itis possible that in some future quarter, our operating results will be belowthe expectations of public market analysts and investors. In such event, theprice of our common stock would likely decline. We also believe that the priceof our shares has been adversely affected, and may continue to be adverselyaffected, by short sales by unknown groups and by the involuntary listing ofour shares in the unregulated Berlin Stock Exchange. The Berlin StockExchange is known to permit “naked shorts” and create an environment forthe speculation in shares that is not permitted under US Law.

***Werely on significant customers, and if we fail to maintain and developrelationships with such customers, we might not generate revenues necessary toachieve our business objectives.  ***A significant portion of our revenues is generatedby a limited number of customers. We expect that we will continue to depend onlarge contracts with a limited number of significant customers through the nearfuture. This situation can cause our revenue and earnings to fluctuate betweenquarters based on the timing of contracts. Most of our customers have noobligation to purchase additional products or services from us.

Park University elected not to renew its relationshipwith VCampus as of May 2004. Park University represented 25% of VCampusrevenues in 2004 and 36% in 2003. In addition to the loss of the revenue fromPark University, our ability to compete effectively in the higher educationmarket space could be adversely impacted by the loss of this customer.

If we fail to maintain and develop relationships withsignificant customers, we might not be able to generate revenues necessary toachieve our business objectives.

***Systemfailures and capacity constraints could interfere with our efforts to attractcustomers and attain market acceptance of our products and services.  ***A key element of our strategy is to generate ahigh volume of online traffic to our products and services. Accordingly, theperformance of our products and services is critical to our reputation, ourability to attract customers and attain market acceptance of our products andservices. Any system failure that causes interruptions in the availability orincreases response time of our products and services would result in less usageof our products and services and, especially if sustained or repeated, wouldreduce the attractiveness of our products and services. 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******.******  ***Weinclude in our products certain security protocols that operate in conjunctionwith encryption and authentication technology. Despite these technologies, ourproducts may be vulnerable to break-ins and similar disruptive problems causedby online users. Such computer break-ins and other disruptions would jeopardize the security ofinformation stored in and transmitted through our computer systems and thecomputer systems of end-users, which may result in significant liability for usand may also deter potential customers. For example, computer “hackers” couldremove or alter portions of our online courseware. Persistent security problemscontinue to plague the Internet, the Web and other public and private datanetworks. Alleviating problems caused by third parties may require us to makesignificant expenditures of capital and other resources and may causeinterruptions, delays or cessation of service to our customers and to us.Moreover, our security and privacy concerns and those of existing and potentialcustomers, as well as concerns related to computer viruses, may inhibit thegrowth of the online marketplace generally, and our customer base and revenuesin particular. We attempt to limit our liability to customers, includingliability arising from a failure of the security features contained in ourproducts, through contractual provisions 

12

----

limitingwarranties and disallowing damages in excess of the price paid for the productsand services purchased. However, these limitations might not be enforceable. Wemaintain liability insurance to protect against these risks however thisinsurance may be inadequate or may not apply in some situations.

***Wemight not be successful in responding to the changing market for our productsand services.  ***The market for our productsand services is evolving in response to recent developments relating to onlinetechnology. The market is characterized by evolving industry standards andcustomer demands and an increasing number of market entrants who haveintroduced or developed online products and services. It is difficult topredict the size and growth rate, if any, of this market. As is typical in thecase of a rapidly evolving industry, demand and market acceptance for recentlyintroduced products and services are subject to a high level of uncertainty.Our future success will depend in significant part on our ability to continueto improve the performance, features and reliability of our products andservices in response to both evolving demands of the marketplace andcompetitive product offerings, and we cannot assure that we will be successfulin developing, integrating or marketing such products or services. In addition,our new product and courseware releases may contain undetected errors thatrequire significant design modifications, resulting in a loss of customerconfidence.

***Wemight not be able to adequately protect our intellectual property rights.  ***Weregard our copyrights, trademarks, trade dress, trade secrets and similarintellectual property as critical to our success, and we rely upon trademarkand copyright law, trade secret protection and confidentiality and/or licenseagreements with our employees, customers, partners and others to protect ourproprietary rights.

We have had certain trademark applications denied andmay have more denied in the future. We will continue to evaluate the need forregistration of additional marks as appropriate. Despite our efforts to protectour proprietary rights, unauthorized parties may attempt to copy aspects of ourproducts or services or to obtain and use information that we regard asproprietary. In addition, the laws of some foreign countries do not protectproprietary rights to as great an extent as do the laws of the United States.Litigation may be necessary to protect our proprietary technology. Any suchlitigation may be time-consuming and costly, cause product releasedelays, require us to redesign our products or services or require us to enterinto royalty or licensing agreements, any of which could have a materialadverse effect upon us. For example, we were forced to pursue legal actionduring 2004 to prevent unauthorized use of the web address www. vcampus.us. Theseroyalty or licensing agreements, if required, may not be available on termsacceptable to us or at all. Our means of protecting our proprietary rightsmight not be adequate and our competitors might independently develop similartechnology, duplicate our products or services or design around patents orother intellectual property rights we have. In addition, distributing our productsthrough online networks makes our software more susceptible than other softwareto unauthorized copying and use. For example, online delivery of our coursewaremakes it difficult to ensure that others comply with contractual restrictions,if any, as to the parties who may access such courseware. If, as a result ofchanging legal interpretations of liability for unauthorized use of oursoftware or otherwise, users were to become less sensitive to avoidingcopyright infringement, we might not be able to realize the full value of ourintellectual property rights.

***Governmentregulation of business conducted on the Internet could decrease the demand forour products and services or increase our cost of doing business.  ***There are currently few laws or regulations thatdirectly apply to activities on the Internet. We believe that we are notcurrently subject to direct regulation by any government agency in the UnitedStates, other than regulations that are generally applicable to all businesses.A number of legislative and regulatory proposals are under consideration byfederal and state lawmakers and regulatory bodies and may be adopted withrespect to the Internet and/or online delivery of course content. Some of theissues that these laws and regulations may cover include user privacy, pricingand characteristics and quality of products and services. The adoption of anysuch laws or regulations may decrease the growth of the Internet, which couldin turn decrease the projected demand for our products and services or increaseour cost of doing business. The applicability to the Internet of existing 

13

----

U.S.and international laws governing issues such as property ownership, copyright,trade secret, libel, taxation and personal privacy is uncertain and developing.Any new legislation or regulation, or application or interpretation of existinglaws, could decrease online demand for our products and services or increaseour costs.

***Wecould issue preferred stock and take other actions that might discourage thirdparties from acquiring us.  ***Our board ofdirectors has the authority, without further action by the stockholders, toissue shares of preferred stock and to fix the rights, preferences, privilegesand restrictions, including voting rights, of such shares. In 2003, we successfullyconverted all outstanding shares of our preferred stock into common stock. Therights of the holders of the common stock will be subject to, and may beadversely affected by, the rights of the holders of any preferred stock that wemay issue in the future. Issuing preferred stock could have the effect ofmaking it more difficult for a third party to acquire a majority of ouroutstanding voting stock, thereby delaying, deferring or preventing a change incontrol of our company. Furthermore, the preferred stock may have other rights,including economic rights, senior to our common stock, and as a result, issuingpreferred stock could decrease the market value of our common stock.

Certain provisions of our certificate of incorporationand our bylaws could make it more difficult for a third party to acquire, andcould discourage a third party from attempting to acquire, control of VCampus.Some of them eliminate the right of stockholders to act by written consent andimpose various procedural and other requirements which could make it moredifficult for stockholders to undertake certain corporate actions. Theseprovisions could limit the price that certain investors might be willing to payin the future for shares of our common stock and may have the effect ofdelaying or preventing a change in control of VCampus. We may in the futureadopt other measures that may have the effect of delaying, deferring orpreventing a change in control of VCampus. Certain of these measures may beadopted without any further vote or action by the stockholders, although wehave no present plans to adopt any such measures. We are also afforded theprotections of Section 203 of the Delaware General Corporation Law, whichcould delay or prevent a change in control of VCampus, impede a merger,consolidation or other business combination involving our company or discouragea potential acquirer from making a tender offer or otherwise attempting toobtain control of VCampus.

***Wemight not be able to use net operating loss carryforwards.  ***Asof December 31, 2004, we had net operating loss carryforwards for federalincome tax purposes of approximately $65.0 million, which will expire atvarious dates through 2024. Our ability to use these net operating loss andcredit carryforwards to offset future tax obligations, if any, may be limitedby changes in ownership. Any limitation on the use of net operating losscarryforwards, to the extent it increases the amount of federal income tax thatwe must actually pay, may have an adverse impact on our financial condition.

***Wedo not presently anticipate paying cash dividends on our common stock.  ***Weintend to retain all earnings, if any, for the foreseeable future for fundingour business operations. Consequently, we do not anticipate paying any cashdividends on our common stock for the foreseeable future, which could detersome investors from seeking to acquire our common stock.

14

----

**SPECIAL NOTE REGARDING FORWARD-LOOKINGSTATEMENTS**

Some of thestatements contained in this report discuss our plans and strategies for ourbusiness and are “forward-looking statements” as that term is defined inthe Private Securities Litigation Reform Act. The words “anticipates,” “believes,”“estimates,” “expects,” “plans,” “intends” and similar expressions are meant toidentify these statements as forward-looking statements, but they are notthe exclusive means of identifying them. The forward- looking statementsin this report reflect the current views of our management; however, variousrisks, uncertainties and contingencies could cause our actual results,performance or achievements to differ materially from those expressed orimplied by these statements, including:

·       ourhistory of losses and negative operating cash flows;

·       theuncertainties and risks we face relating to our Nasdaq SmallCap Market listing;

·       thelarge number of our shares eligible for future sale could have an adverseimpact on the market price of our common stock;

·       ourfuture capital needs and the uncertainty of additional funding;

·       ourpotential inability to compete effectively;

·       adeveloping market, rapid technological changes and new products;

·       ourdependence on significant clients;

·       oursubstantial dependence on courseware and third-party coursewareproviders;

·       oursubstantial dependence on third-party relationships; and

·       changesin accounting methods or estimates underlying these methods.

We assume no obligation toupdate publicly any forward-looking statements, whether as a result ofnew information, future events or otherwise. In light of the risks anduncertainties discussed in this section and elsewhere in this report, eventsreferred to in forward-looking statements in this report might not occur.

**Item 2.**                        Properties.

Our executive offices andprincipal administration, technical, marketing and sales operations are locatedin approximately 16,700 square feet of leased space in Reston, Virginiapursuant to a lease that expires in February 2010. The aggregate annualmonthly rent for this facility is $42,685, subject to 3% annual increases. Webelieve that our existing office space is sufficient to accommodate our currentneeds and that suitable additional space will be available on commerciallyreasonable terms to accommodate any expansion needs through 2005 should theneed arise.

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

In 2002, the Virginia Department of Taxation completedan audit of our sales and use tax payments from August 1998 through October 2001.In July 2002, we received a draft assessment which contemplated a paymentof taxes, penalties and interest by us of $212,719, primarily associated withour alleged failure to assess use tax on third-party royalties paid by usto content providers for courses we delivered online. We paid the sales and usetax and interest on non-contested items, which amounted to $18,928 out of the$212,719. We have formally contested the remaining items covered by the draftassessment, including the assessment of use tax on the royalties paid by us tocontent providers for courses we delivered online as well as the methodologyused by the Virginia Department of Taxation to estimate the royalties. In July 2003,the assessment was reduced by the Virginia Department of Taxation to $86,678including 

15

----

interest of $17,278. In October 2003,we appealed the assessment. In March 2004, we were notified that thisappeal remains under review. We do not have a firm estimate of the probabilityof liability for this issue or the amount of anticipated legal costs, but havereason to believe that the potential liability will be reduced to the pointwhere it will not be considered material. Accordingly, we cannot estimate atthis time the amount of liability to be incurred, if any. No amounts have beenaccrued in the financial statements for this potential liability.

Although we are notcurrently involved in any other material pending legal proceedings, we could besubject to legalproceedings and claims in the ordinary course of our business or otherwise,including claims relating to license agreements, royalties or claims of allegedinfringement of the trademarks and other intellectual property rights of thirdparties by us and our licensees.

**Item 4.**                        Submission of Matters to a Vote of Security Holders.

Nomatters were submitted to a vote of security holders during the fourth quarterended December 31, 2004.

**Executive Officers**

As of March 30,2005, our executive officers were as follows:
| **Name**               | ** ** | ** ** | ** ** | **Age**                                                           | ** ** | **Positions** |
|------------------------|------------|------------|------------|-------------------------------------------------------------------|------------|---------------|
| Nat  Kannan            |       | 55         |       | Chairman  and Chief Executive Officer                             |
| Christopher  L. Nelson |       | 42         |       | Chief Financial  Officer, Chief Information Officer and Secretary |
| Ronald  E. Freedman    |       | 55         |       | Senior Vice President, Worldwide Sales and Marketing              |
| Laura  B. Friedman     |       | 43         |       | Vice President, Co-Publishing                                     |
| Tamer A. Ali           |       | 32         |       | Vice  President, Technology                                       |

 

*Narasimhan “Nat” Kannan*hasserved as VCampus’ Chairman of the Board of Directors since he founded VCampusin 1984 and he resumed the Chief Executive Officer position in December 2002,a position he formerly held from 1984 to 2000. Prior to founding VCampus, he co-foundedGanesa Group, Inc., a developer of interactive graphics and modelingsoftware, in 1981. He also served as a consultant to Booz Allen and Hamilton, Inc.,the MITRE Corporation, The Ministry of Industry of the French Government, theBrookhaven and Lawrence Livermore National Laboratories, the White HouseDomestic Policy Committee on Energy and Control Data Corporation. He holds aB.S. in Engineering from the Indian Institute of Technology in Madras, India,and he performed advanced graduate work in business and engineering atDartmouth College.

*Christopher** L. Nelson* joined VCampus as ChiefFinancial Officer and Chief Information Officer in June of 2002. Mr. Nelsonoversees the entire technology, operations and customer service areas of thebusiness in addition to his finance and accounting department responsibilities.Prior to his appointment as our CFO, Mr. Nelson was a Principal ofMonticello 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 

16

----

George Mason Fellow,acting as an advisor to start-up and early stage technology companies on avolunteer basis through the TechVenture Partnership at George Mason University.

*Ronald E. Freedman*isresponsible for sales and marketing programs at VCampus with a particularemphasis on the Select Partner program and the government market. Mr. Freedmanhas more than 20 years of hands-on experience in sales management, strategicplanning, business development, and execution of profit and lossresponsibility. Mr. Freedman joined VCampus in 2001 from USinternetworking, Inc.(USi) where he was Vice President of Information Assurance and Chief SecurityOfficer from 1999 through 2001. While at USi, he was responsible for thedesign, implementation, and management of the USi Total Security Architecture,a best-of-breed security portfolio. Prior to joining USi, Freedman was VicePresident of one of the business divisions at The Netplex Group, Inc. forfour years. There, he was responsible for sales, marketing and fulfillment of awide range of technology-based products and services. Previously, Mr. Freedmanwas Vice President, Systems and Services for COMSIS Corporation, where hemanaged the division of the professional services company providing contingencyplanning and information security services to commercial and governmentcustomers. He also served as Executive Vice President of Advanced InformationManagement, Inc., where he was responsible for marketing and deliveringinformation security and contingency planning services to Fortune 500customers. Mr. Freedman worked for General Electric Company for fifteenyears, most recently as General Manager, Disaster Recovery Services and Manager,Strategic Planning and Business Development. He also served as a Presidentialappointee, on loan to The White House from General Electric, responsible fordeveloping contingency plans as part of the Continuity of Government Program. Mr. Freedmanholds a 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***is responsible for developing and managing partnershipsunder the Select Partner program and for our courseware production group, orCustom Design Studio. Ms. Friedman is an experienced professionalpublishing executive, having served for more than 17 years in a variety ofmarketing, editorial and content development positions in both traditional andelectronic publishing. Prior to joining VCampus, she served as Vice Presidentof Learning Services at Zoologic, Inc. from November 2002 to August 2004.A long time supporter of e-Learning, she founded the e-Learning program at TheNew York Institute of Finance (NYIF), Pearson’s financial training division,where she was Vice President of e-Learning from May 1996 to November 2002.In addition to creating NYIF’s portfolio of online courses in financialtraining, Laura oversaw custom development projects for clients such asAccenture, Arthur Andersen, and the Financial Times. She served as Director,International Marketing for Business, Professional and Reference products atSimon & Schuster. At McGraw-Hill and Time Warner’s Book-of-the-MonthClub, Ms. Friedman held a variety of editorial and marketing positions inprofessional publishing. She holds a B.A. from the State University at Albanyand a MBA from Fordham University.

*Tamer A. Ali***is responsible for the development and management ofall VCampus educational technologies. Prior to joining VCampus, Mr. Aliheld Internet technology positions at Capital One from February 1997 to July 1999and Martin Interactive from January 1996 to January 1997, where a Website he helped design for Coca Cola won a national award for creativity. Mr. Aliholds a Master’s in Educational Technology from the George WashingtonUniversity’s Graduate School of Education and Human Development. He holds adegree in Biology from the University of Virginia.

17

----

**PART II**

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

(a)    *Price Range of Common Stock*

Our common stock is currently listed and trades on theNasdaq SmallCap Market under the symbol “VCMP.” For each full fiscal quartersince the beginning of 2003, the high and low bid quotations for our commonstock, as reported by Nasdaq, were as follows:
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2003**       |       |     |       |    |       |
| First quarter  |       | $        | 4.04       |    | $          | 2.29 |   |
| Second quarter |       | $        | 3.81       |    | $          | 2.24 |   |
| Third quarter  |       | $        | 3.19       |    | $          | 1.25 |   |
| Fourth quarter |       | $        | 2.68       |    | $          | 1.20 |   |
| **2004**       |       |     |       |    |       |
| First quarter  |       | $        | 3.74       |    | $          | 1.42 |   |
| Second quarter |       | $        | 10.00      |    | $          | 1.95 |   |
| Third quarter  |       | $        | 3.20       |    | $          | 1.03 |   |
| Fourth quarter |       | $        | 2.95       |    | $          | 1.04 |   |

 

The foregoing bid quotationsreflect inter-dealer prices, without retail mark-ups, mark-downs orcommissions, and may not represent actual transactions.

Since our IPO in late 1996, thepublic market for our common stock has been characterized by low and/or erratictrading volume, often resulting in price volatility. There can be no assurance thatthere will be an active public market for our common stock in the future. Themarket price of the common stock could be subject to significant fluctuationsin response to future announcements concerning us or our partners orcompetitors, the introduction of new products or changes in product pricingpolicies by us or our competitors, proprietary rights or other litigation,general conditions in the e-Learning market, developments in the financialmarkets and other factors. In addition, the stock market has, from time totime, experienced extreme price and volume fluctuations that have particularlyaffected the market prices for technology companies and which have often beenunrelated to the operating performance of the affected companies. Broad marketfluctuations of this type may adversely affect the future market price of thecommon stock. See “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Liquidity and Capital Resources.”

From October 1, 2004 to December 31,2004, VCampus issued the following unregistered securities:

20,079 shares ofcommon stock at $1.27 per share to a consultant as payment for services on October 1,2004.

Thesales of the above securities were deemed to be exempt from registration under Section 4(2) ofthe Securities Act of 1933, as amended (the “Act”), in reliance upon the Act,or Regulation D promulgated thereunder, as transactions by an issuer notinvolving a public offering. Recipients of the securities in each suchtransaction represented their intentions to acquire such securities forinvestment only and not with a view to or for sale in connection with anydistribution thereof and appropriate legends were affixed to the instrumentsissued in such transactions. All recipients had adequate access to informationabout VCampus.

18

----

(b)   *Approximate Number ofEquity Security Holders*

Asof March 18, 2005, the number of record holders of our Common Stock was 81and we believe that the number of beneficial owners was approximately 2,600.

(c)    *Dividends*

We have never paid a cashdividend on our common stock and we do not anticipate paying cash dividends inthe foreseeable future. Moreover, any preferred stock that we could issue inthe future and any future credit facilities might contain restrictions on ourability to declare and pay dividends on our common stock. We plan to retain allearnings, if any, for the foreseeable future for use in the operation of ourbusiness and to fund the pursuit of future growth. Future dividends, if any,will depend on, among other things, our results of operations, capitalrequirements and on such other factors as our Board of Directors, in itsdiscretion, may consider relevant.

19

----

**Item 6.**                        Selected Financial Data.

Thefollowing table sets forth selected financial data of VCampus. The selectedfinancial data presented below has been derived from VCampus’ consolidatedfinancial statements which have been audited by Reznick Group, P.C. for theyears ended December 31, 2003 and 2004 and Ernst & Young LLP forthe years ended December 31, 2000 through 2002, and should be read inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations, and the Consolidated Financial Statements andaccompanying footnotes included in this Annual Report on Form 10-K.

**Statement of Operations Data:**

**In thousands except per share data**
| ** **                                                                     | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Net revenues:                                                                  |       |     |       |     |       |     |       |     |       |     |       |
| Online tuition revenues                                                        |       | $        | 4,928      |     | $          | 5,782    |       | $        | 5,330      |     | $          | 5,508 |   | $ | 4,498 |   |
| Virtual campus software  revenues                                              |       | 115      |       | 72       |       | —   |       | —   |       | —   |       |
| Online development and  other revenues                                         |       | 1,022    |       | 687      |       | 496      |       | 448      |       | 318      |       |
| Product sales revenues                                                         |       | 414      |       | 45       |       | —   |       | —   |       | —   |       |
| Other service revenues                                                         |       | 175      |       | 122      |       | 100      |       | 110      |       | 48       |       |
| Instructor-led  training revenues                                              |       | 2,665    |       | 102      |       | —   |       | —   |       | —   |       |
| Total net revenues                                                             |       | 9,319    |       | 6,810    |       | 5,926    |       | 6,066    |       | 4,864    |       |
| Costs and expenses:                                                            |       |     |       |     |       |     |       |     |       |     |       |
| Cost of revenues                                                               |       | 3,296    |       | 1,093    |       | 1,462    |       | 1,718    |       | 1,357    |       |
| Sales and marketing                                                            |       | 6,105    |       | 4,554    |       | 2,689    |       | 2,138    |       | 1,895    |       |
| Product development and  operations                                            |       | 3,555    |       | 2,273    |       | 2,536    |       | 2,475    |       | 2,725    |       |
| General and  administrative                                                    |       | 2,761    |       | 2,045    |       | 1,693    |       | 1,910    |       | 1,687    |       |
| Depreciation and  amortization                                                 |       | 2,916    |       | 2,154    |       | 1,356    |       | 880      |       | 1,227    |       |
| Compensation expense in  connection with the acquisition of HTR, Inc           |       | 654      |       | —   |       | —   |       | —   |       | —   |       |
| Reorganization and other  non-recurring  charges                               |       | 2,261    |       | 188      |       | 192      |       | 173      |       | —   |       |
| Stock-based  compensation                                                      |       | 361      |       | 441      |       | 76       |       | 126      |       | 154      |       |
| Total costs and expenses                                                       |       | 21,909   |       | 12,748   |       | 10,004   |       | 9,420    |       | 9,045    |       |
| Loss from operations                                                           |       | (12,590  | )          | (5,938   | )          | (4,078   | )          | (3,354   | )          | (4,181   | )          |
| Other income (expense):                                                        |       |     |       |     |       |     |       |     |       |     |       |
| Other income                                                                   |       | —   |       | —   |       | 422      |       | 207      |       | 183      |       |
| Interest income  (expense)                                                     |       | 166      |       | 5        |       | (220     | )          | (112     | )          | (2,581   | )          |
| Loss on debt  extinguishments                                                  |       | —   |       | —   |       | (503     | )          | —   |       | —   |       |
| Cumulative effect of  accounting change                                        |       | (461     | )          | —   |       | —   |       | —   |       | —   |       |
| Net loss                                                                       |       | $        | (12,885    | )        | $          | (5,933   | )          | $        | (4,379     | )        | $          | (3,259 | ) | $ | (6,579 | ) |
| Dividends to preferred  stockholders                                           |       | (1,153   | )          | (649     | )          | (2,768   | )          | (2,927   | )          | —   |       |
| Net loss attributable to  common stockholders                                  |       | $        | (14,038    | )        | $          | (6,582   | )          | $        | (7,147     | )        | $          | (6,186 | ) | $ | (6,579 | ) |
| Net loss per share  before cumulative effect of change in accounting principle |       | $        | (17.07     | )        | $          | (5.23    | )          | $        | (4.79      | )        | $          | (1.81 | ) | $ | (0.97 | ) |
| Cumulative effect of  change in accounting principle                      |       | (0.58    | )          | —   |       | —   |       | —   |       | —   |       |
| Net loss per share                                                             |       | $        | (17.65     | )        | $          | (5.23    | )          | $        | (4.79      | )        | $          | (1.81 | ) | $ | (0.97 | ) |
| Net loss per share—assuming dilution                                      |       | $        | (17.65     | )        | $          | (5.23    | )          | $        | (4.79      | )        | $          | (1.81 | ) | $ | (0.97 | ) |

 

20

----

 
| ** **                       | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| **Balance Sheet Data:**          |       |     |       |     |       |     |       |     |       |     |       |
| Working capital  (deficit)       |       | $        | (2,036     | )        | $          | (885     | )          | $        | (828       | )        | $          | (1,187 | ) | $ | 1,820 |   |
| Total assets                     |       | 6,652    |       | 7,012    |       | 4,373    |       | 4,864    |       | 7,119    |       |
| Total liabilities                |       | 3,620    |       | 4,198    |       | 2,725    |       | 2,828    |       | 2,274    |       |
| Accumulated  deficit             |       | (70,585  | )          | (77,060  | )          | (84,207  | )          | (90,393  | )          | (101,732 | )          |
| Total stockholders’  equity |       | 3,031    |       | 2,814    |       | 1,648    |       | 2,035    |       | 4,845    |       |
|                                  |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

Per share amounts for allperiods presented have been adjusted to reflect the one-for-ten reverse stocksplit which occurred in July 2002.

21

----

**Item 7.**                        Management’s Discussion and Analysis of Financial Condition and Resultsof Operation.

The following discussionof financial condition and results of operations should be read in conjunctionwith VCampus’ consolidated financial statements and related notes theretoincluded elsewhere in this report.

**Overview**

Our revenues arederived from three primary sources:

·       onlinetuition revenues;

·       developmentrevenues; and

·       otherservice revenues.

Online tuition revenues are generated primarily fromonline tuition derived from corporate, government, and higher educationcustomers and sales of our Select Partner courseware. Development revenuesconsist primarily of fees paid to us for creating and developing new onlinecourseware and web-enabling existing courseware. Other service revenuesconsisted primarily of monthly fees generated by the maintenance of the CYBIScourseware under contract with the U.S. Army.

On June 18, 2002, ourBoard of Directors approved a one-for-ten reverse stock split of our commonstock. The reverse stock split became effective as of the opening of trading onJuly 8, 2002. Stockholders’ equity has been restated to give retroactiverecognition to the reverse stock split for all periods presented byreclassifying the excess par value resulting from the reduced number of sharesfrom common stock to paid-in-capital. All references to common share andper-share amounts for all periods presented have been retroactively restated toreflect the stock split.

**Critical Accounting Policies**

Our critical accountingpolicies are more fully described in note 2 to our consolidated financialstatements included in this Annual Report on Form 10-K. Certain of ouraccounting policies require the application of significant judgment bymanagement in selecting the appropriate assumptions for calculating financialestimates. By their nature, these judgments are subject to an inherent degreeof uncertainty. These judgments are based on practices, information provided byour customers and other assumptions that we believe are reasonable under thecircumstances. Our estimates and assumptions are reviewed periodically and theeffects of revisions are reflected in the consolidated financial statements inthe period in which they are determined to be necessary. Actual results maydiffer from these estimates under different assumptions or conditions. Ourcritical accounting policies and estimates include:

*Revenue Recognition*

We derive our revenues from the followingsources—online tuition revenues, other service revenues and development andother revenues.

Revenue is recognized in accordance with either SECStaff Accounting Bulletin No. 104, *RevenueRecognition* (SAB 104), or Statement of Position 97-2, *Software Revenue Recognition* (“SOP 97-2”),as amended. Both SAB 104 and SOP 97-2 generally require that four basiccriteria must be met before revenue can be recognized: (1) persuasiveevidence of an arrangement exists; (2) delivery has occurred or servicesrendered; (3) the fee is fixed and determinable: and (4) collectibilityis reasonably assured. Determination of criteria (3) and (4) arebased on management’s judgments regarding the fixed nature of the fee chargedfor services rendered and the collectibility of those fees. Should changes inconditions cause management to determine these criteria are not met for certainsales, revenue recognized for any reporting period could be adversely affected.Online tuition revenues are generated primarily through 

22

----

three types of contracts: (i) contractswith higher education partners, (ii) corporate subscriptions, and (iii) corporateusage. For higher education partner contracts and corporate subscriptions,revenue is recognized ratably (on a straight-line basis) over the semester termand subscription period, respectively. For usage contracts, revenue isrecognized upon enrollment in a course. Once a student has enrolled in acourse, he cannot cancel delivery of a course or receive a refund. Revenue fromthe sale of Select Partner courseware is generally recognized ratably (on astraight-line basis) over the length of the subscription period. Initial set-upfees related to all online tuition services are recognized ratably (on astraight-line basis) over the respective contract term.

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 the totalestimated costs of the contract. Provisions for losses on contracts are made inthe period in which they are determined.

Prior to the third quarterof 2004, we had also been recognizing revenues for other services. Revenues forother services were being recognized as the services were delivered. We haveceased providing these other services.

*Allowance for DoubtfulAccounts*

We maintain allowances fordoubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. If the financial condition of thosecustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required in future periods.

*CapitalizedSoftware and Courseware Development Costs*

During 2002, 2003 and2004, we capitalized certain software and courseware development costs. Wecapitalize the cost of software used for internal operations once technologicalfeasibility of the software has been demonstrated. We capitalize costs incurredduring the development process, including payroll costs for employees who aredirectly associated with the development process and services performed byconsultants. 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.

*Goodwill and OtherIdentifiable 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 withStatement of Financial Accounting Standards No. 142, “Goodwill and OtherIntangibles,” we ceased amortizing goodwill and other indefinite-livedintangibles on January 1, 2002. In lieu of amortization, these assets aresubject to an annual impairment review. We may determine through the impairmentreview process that goodwill or other indefinite-lived intangibles havebeen impaired, resulting in an impairment charge in the period the review iscompleted.

23

----

**Results of Operations**

Thefollowing table sets forth certain statement of operations data as a percentageof total net revenues for the periods indicated:
| ** **                                                                   | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statement of  Operations Data:                                               |       |     |       |     |       |     |       |
| Revenues:                                                                    |       |     |       |     |       |     |       |
| Online tuition revenues                                                      |       | 90.0     | %          | 90.8     | %          | 92.5     | %          |
| Development and other revenues                                               |       | 8.3      |       | 7.4      |       | 6.5      |       |
| Other service revenues                                                       |       | 1.7      |       | 1.8      |       | 1.0      |       |
| Total net revenues                                                           |       | 100.0    |       | 100.0    |       | 100.0    |       |
| Costs and  expenses:                                                         |       |     |       |     |       |     |       |
| Cost of revenues                                                             |       | 24.7     |       | 28.3     |       | 27.9     |       |
| Sales and marketing                                                          |       | 45.4     |       | 35.2     |       | 39.0     |       |
| Product development and operations                                           |       | 42.8     |       | 40.8     |       | 56.0     |       |
| General and administrative                                                   |       | 28.5     |       | 31.5     |       | 34.7     |       |
| Depreciation and amortization                                                |       | 22.9     |       | 14.5     |       | 25.2     |       |
| Reorganization and other non-recurring charges  and stock based compensation |       | 4.5      |       | 5.0      |       | 3.2      |       |
| Total costs and expenses                                                     |       | 168.8    |       | 155.3    |       | 186.0    |       |
| Loss from operations                                                         |       | (68.8    | )          | (55.3    | )          | (86.0    | )          |
| Other income  (expense):                                                     |       |     |       |     |       |     |       |
| Other income                                                                 |       | 7.1      |       | 3.4      |       | 3.8      |       |
| Interest expense                                                             |       | (3.7     | )          | (1.8     | )          | (53.1    | )          |
| Loss on debt extinguishment                                                  |       | (8.5     | )          | —   |       | —   |       |
| Net loss                                                                     |       | (73.9    | )%         | (53.7    | )%         | (135.3   | )%         |

 

*2004 Compared to2003*

*Summary*

We incurred a net loss attributable to commonstockholders of $6,579,416 (or $0.97 per share) in 2004 as compared to a netloss attributable to common stockholders of $6,185,877 (or $1.81 per share) in2003. The increase in the net loss in 2004 as compared to 2003 was dueprimarily to a decrease in online tuition revenues and an increase in interestexpense, partially offset by the absence of dividends to preferred stockholdersin 2004 ($2,926,854 of such dividends were included in the net lossattributable to common stockholders for 2003). The decrease in net loss pershare for 2004 compared to 2003 was due to the issuance of additional shares in2004.

24

----

Thefollowing table sets forth selected financial data:
| ** **                                          | ** ** | **For the Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2003**                                                     | ** ** | **2004** | ** ** |
| Revenues                                            |       | $                                                            | 6,066,035  |   | 100.0 | % | $ | 4,863,859 |   | 100.0 | % |
| Cost of revenues                                    |       | 1,718,340                                                    |       | 28.3 |   | 1,356,699 |   | 27.9 |   |
| Sales and  marketing                                |       | 2,137,791                                                    |       | 35.2 |   | 1,895,340 |   | 39.0 |   |
| Product  development and operations                 |       | 2,474,856                                                    |       | 40.8 |   | 2,725,155 |   | 56.0 |   |
| General and  administrative                         |       | 1,909,814                                                    |       | 31.5 |   | 1,686,940 |   | 34.7 |   |
| Depreciation and  amortization                      |       | 879,966                                                      |       | 14.5 |   | 1,227,089 |   | 25.2 |   |
| Reorganization  and other non-recurring charges     |       | 172,729                                                      |       | 2.9 |   | — |   | 0.0 |   |
| Stock-based  compensation                           |       | 126,056                                                      |       | 2.1 |   | 153,973 |   | 3.2 |   |
| Loss from  operations                               |       | (3,353,517                                                   | )          | (55.3 | ) | (4,181,337 | ) | (86.0 | ) |
| Other income                                        |       | 207,138                                                      |       | 3.4 |   | 183,210 |   | 3.8 |   |
| Interest expense                                    |       | (112,644                                                     | )          | (1.8 | ) | (2,581,289 | ) | (53.1 | ) |
| Net loss                                            |       | (3,529,023                                                   | )          | (53.7 | ) | (6,579,416 | ) | (135.3 | ) |
| Dividends to  preferred stockholders                |       | (2,926,854                                                   | )          | (48.3 | ) | — |   | 0.0 |   |
| Net loss attributable to  common stockholders  |       | $                                                            | (6,185,877 | ) | (102.0 | )% | $ | (6,579,416 | ) | (135.3 | )% |

 
| ** **                             | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **2003**                                                     | ** ** | **2004** | ** ** |
| Online tuition  revenues               |       | $                                                            | 5,508,154  |   | 90.8 | % | $ | 4,497,51354 |   | 92.5 | % |
| Online  development and other revenues |       | 448,082                                                      |       | 7.4 |   | 318,456 |   | 6.5 |   |
| Other service  revenues                |       | 109,799                                                      |       | 1.8 |   | 47,890 |   | 1.0 |   |
| Total net  revenues                    |       | $                                                            | 6,066,035  |   | 100.0 | % | $ | 4,863,859 |   | 100.0 | % |

 

Online tuition revenues decreased 18.3% to $4,497,513in 2004, compared to $5,508,154 in 2003. The decrease is primarily due to adecrease in revenue from higher education customers, and more specifically fromPark University (decrease of $1,101,000) and corporate customers (decrease of$197,000), which was partially offset by an increase in revenue from governmentcustomers and Select Partners (increases of $101,000 and $187,000,respectively).

Online development and other revenues decreased 28.9%to $318,456 in 2004, compared to $448,082 in 2003. The decrease is primarilydue to a decline in course development and professional services orders. As wemove away from developing and hosting courses that are proprietary to ourcustomers to the co-development of courses under our Select Partnerstrategy, for which we typically do not charge our Select Partners developmentfees, we expect development revenues to continue to remain a relatively smallcomponent of our total revenues. However, we generally receive a relativelyhigher percentage of the revenue from the sale of Select Partner courses, inlieu of such foregone development fees.

Other service revenuesdecreased 56.4% to $47,890 in 2004, compared to $109,799 in 2003. Our contractwith the U.S. Army, under which all licensing and support revenues weregenerated, was terminated in May 2004. Accordingly, we stopped recognizinglicensing and support revenues under this contract following that date.

*Cost of Revenues*

Cost of revenues decreased21.0% to $1,356,699 in 2004 as compared to $1,718,340 in 2003. The decrease was primarily due to the sale of ahigher percentage of courses with relatively lower associated royalty costs.

25

----

*Operating Expenses*

*Salesand Marketing.  *Sales and marketing expensesdecreased 11.3% to $1,895,340 in 2004 compared to $2,137,791 in 2003. Excludingthe Park Development Fund contribution in 2003, which did not recur in 2004 asa result of the non-renewal of our contract with Park University in May 2004,sales and marketing expenses were $1,895,340 and $1,762,035 for 2004 and 2003,respectively, an increase of 7.6%. The increase was primarily attributable toout-of-pocket costs in sales and marketing associated with the implementationand support for our Select Partner program in 2004.

*ProductDevelopment and Operations.  *Product developmentand operations expenses increased 10.1% to $2,725,155 in 2004 compared to$2,474,856 in 2003. The increase was due tothe fact 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 last three quarters of 2004, whereas in 2003,software development costs had been capitalized.

*Generaland Administrative.  *General and administrativeexpenses decreased 11.7% to $1,686,940 in 2004 as compared to $1,909,814 in2003. The decrease was primarily due to the expiration of the employmentagreement and related termination of employment of our Vice Chairman in December 2003and the absence (in 2004) of legal and accounting costs incurred in 2003associated with the SEC review, in the ordinary course, of the company’s publicfilings.

*Depreciationand Amortization.  *Depreciation and amortizationexpense increased 39.4% to $1,227,089 in 2004 as compared to $879,966 in2003. The increase was primarily due to the release of our new CourseManagement System in the first quarter of 2004 as well as the release of anumber of Select Partner courses, as a result of which we began amortizingcosts we had capitalized for their development.

*Reorganizationand Other Charges.  *Reorganization and othercharges of $172,729 in 2003 consist of amounts paid in excess of prior accrualsto satisfy in full all liabilities in connection with the termination of theRockville, Maryland facility lease and our other recent legal settlements.

*Stock-basedCompensation**.  *Stock-based compensation expense for 2004 and2003 consists of the fair value of stock issued as customary payment to ournon-employee directors for their participation in Board of Directors and BoardCommittee meetings and the fair market value of stock issued to consultants.

*InterestExpense**.  *Interest expense for 2003 primarily consists ofamortization of debt discount and deferred debt offering costs related to theremaining balance of the $925,000 of convertible promissory notes issued in December 2001.Interest expense for 2004 primarily consists of amortization of debt discount anddeferred debt offering costs and accrual of interest payable related to the$3,649,625 ($2,137,500 following mandatory and voluntary partial conversions inthe second, third and fourth quarters of 2004) of convertible promissory notesissued in March 2004.

*Other Income**.  *Other income for 2003 consists of the write-offof royalty obligations to one of our former content providers following theexpiration of the relevant statute of limitations for bringing any action toenforce the obligations. Other income for 2004 consists of amounts recorded inconnection with the settlements with Park University and two of our contentproviders which resulted in the write-off of royalty obligations.

*2003 Compared to2002*

*Summary*

We incurred a net loss attributable to commonstockholders of $6,185,877 (or $1.81 per share) in 2003 as compared to a netloss attributable to common stockholders of $7,147,305 (or $4.79 per share) in2002. The decrease in the net loss in 2003 as compared to 2002 was dueprimarily to a decrease in sales and 

26

----

marketing and depreciationand amortization expenses and the absence of loss on debt extinguishment in2003 ($503,246 of such loss was included in the net loss attributable to commonstockholders for 2002).

Thefollowing table sets forth selected financial data:
| ** **                                          | ** ** | **For the Year Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2002**                                                     | ** ** | **2003** | ** ** |
| Revenues                                            |       | $                                                            | 5,926,146  |   | 100.0 | % | $ | 6,066,035 |   | 100.0 | % |
| Cost of revenues                                    |       | 1,461,663                                                    |       | 24.7 |   | 1,718,340 |   | 28.3 |   |
| Sales and  marketing                                |       | 2,689,136                                                    |       | 45.4 |   | 2,137,791 |   | 35.2 |   |
| Product  development and operations                 |       | 2,535,849                                                    |       | 42.8 |   | 2,474,856 |   | 40.8 |   |
| General and  administrative                         |       | 1,692,851                                                    |       | 28.5 |   | 1,909,814 |   | 31.5 |   |
| Depreciation and  amortization                      |       | 1,355,837                                                    |       | 22.9 |   | 879,966 |   | 14.5 |   |
| Reorganization  and other non-recurring charges     |       | 192,000                                                      |       | 3.2 |   | 172,729 |   | 2.9 |   |
| Stock-based  compensation                           |       | 76,172                                                       |       | 1.3 |   | 126,056 |   | 2.1 |   |
| Loss from  operations                               |       | (4,077,362                                                   | )          | (68.8 | ) | (3,353,517 | ) | (55.3 | ) |
| Other income                                        |       | 421,842                                                      |       | 7.1 |   | 207,138 |   | 3.4 |   |
| Interest income                                     |       | (220,145                                                     | )          | (3.7 | ) | (112,644 | ) | (1.8 | ) |
| Loss on debt  extinguishment                        |       | (503,246                                                     | )          | (8.5 | ) | — |   | 0.0 |   |
| Net loss                                            |       | (4,378,911                                                   | )          | (73.9 | ) | (3,529,023 | ) | (53.7 | ) |
| Dividends to  preferred stockholders                |       | (2,768,394                                                   | )          | (46.7 | ) | (2,926,854 | ) | (48.3 | ) |
| Net loss  attributable to common stockholders  |       | $                                                            | (7,147,305 | ) | (120.6 | )% | $ | (6,185,877 | ) | (102.0 | )% |

 
| ** **                             | ** ** | **For the Year Ended December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                             | ** ** | **2002**                                                     | ** ** | **2003** | ** ** |
| Online tuition  revenues               |       | $                                                            | 5,330,686  |   | 89.9 | % | $ | 5,508,154 |   | 90.8 | % |
| Online  development and other revenues |       | 495,425                                                      |       | 8.4 |   | 448,082 |   | 7.4 |   |
| Other service  revenues                |       | 100,035                                                      |       | 1.7 |   | 109,799 |   | 1.8 |   |
| Total net revenues                     |       | $                                                            | 5,926,146  |   | 100.0 | % | $ | 6,066,035 |   | 100.0 | % |

 

Online tuition revenues increased 3.3% to $5,508,154in 2003, compared to $5,330,686 in 2002. The increase is primarily due to anincrease in revenue from higher education customers (increase of $414,000),which was partially offset by a decrease in revenue from government andcorporate customers (decreases of $122,000 and $114,000, respectively).

Online development andother revenues decreased 9.6% to $448,082 in 2003, compared to $495,425in 2002. The decrease is primarily due to a decline in course developmentand professional services orders.

*Cost of Revenues*

Cost of revenues increased17.6% to $1,718,340 in 2003 as compared to $1,461,663 in 2002. The increase wasprimarily due to an increase in the sale of courses with relatively highassociated content costs under one of our large customer contracts.

*Operating Expenses*

*Salesand Marketing.  *Sales and marketing expensesdecreased 20.5% to $2,137,791 in 2003 compared to $2,689,136 in 2002. Thedecrease was primarily due to a reduction in headcount in the sales andmarketing department and related costs. During 2003 and 2002, we contributed $740,288and $551,056, respectively, to a marketing and development fund (the “DevelopmentFund”) jointly administered by 

27

----

VCampus and one of ourlarger customers as required pursuant to the terms of our contract with thatcustomer. The Development Fund’s primary goal was to fund marketing anddevelopment to grow online revenues for both that customer and derivatively forus in the form of course registration fees. Amounts required to be contributedby VCampus to the Development Fund were determined under the contract based onmeeting or exceeding certain thresholds in course registrations on thatcustomer’s virtual campus, which is hosted by VCampus. We recorded 50% of thesecontributions as a marketing expense in the same period as we recognize revenuefrom such registrations and we record the remaining 50% of the contributions asa reduction to revenue. Contributions to the Development Fund that we accountedfor as a marketing expense represented 17.2% and 16.7% of the recognizedrevenues attributable to that customer in 2003 and 2002, respectively.

*ProductDevelopment and Operations.  *Product developmentand operations expenses decreased 2.4% to $2,474,856 in 2003 compared to$2,535,849 in 2002.

*Generaland Administrative.  *General and administrativeexpenses increased 12.8% to $1,909,814 in 2003 as compared to $1,692,851 in2002. The increase was primarily due to ongoing costs associated with thehiring of our Chief Executive Officer beginning in December 2002.Additionally, VCampus incurred increased general and administrative expensesdue to legal and accounting costs associated with the SEC review of the company’spublic filings.

*Depreciationand Amortization.  *Depreciation and amortizationexpense decreased 35.1% to $879,966 in 2003 as compared to $1,355,837 in2002. The decrease was due primarily to the fact that a significant portion ofour fixed and intangible assets have been fully depreciated and amortized,respectively.

*Reorganizationand Other Charges.  *Reorganization and othercharges of $172,729 in 2003 consist of amounts paid in excess of prior accrualsto satisfy in full all liabilities in connection with the termination of theRockville, Maryland facility lease and our other recent legal settlements.Reorganization and other non-recurring charges of $192,000 in 2002 representthe costs accrued in connection with the termination of the Rockville, Marylandfacility.

*Stock-basedCompensation.  *Stock-based compensationexpense in 2003 and 2002 consists of the fair value of stock options (using theBlack-Scholes valuation method) issued to consultants and the fair valueof stock issued as customary payment to our non-employee directors for theirparticipation in Board of Directors and Board Committee meetings.

*InterestExpense.  *Interest expense in 2003 and 2002primarily consists of debt discount and amortization of deferred debt offeringcosts related to the remaining balance of the $925,000 of convertiblepromissory notes we issued in December 2001.

*Other Income.  *Otherincome in 2003 consists of the write-off of royalty obligations to one of ourformer content providers following the expiration of the relevant statute oflimitations for bringing any action to enforce the obligations. Other income in2002 consists of the extinguishment of liabilities comprised of customerdeposits and prepayments. These prepayments and deposits were received prior toDecember 31, 2000 and were for classroom training to be delivered by HTRand per the terms of the arrangement with customers, they were non refundable.Our HTR subsidiary ceased operations in December 2000.

**Liquidity and Capital Resources**

At December 31, 2004, we had $2,632,504 in cashand cash equivalents, compared to $534,984 at December 31, 2003. Theincrease in cash and cash equivalents during 2004 is principally due to thereceipt of cash proceeds from the equity and convertible debt financing wecompleted in March 2004, as reduced by the net loss recorded. Since ourinception, we have financed our operating cash flow needs primarily throughofferings of equity and debt securities and, to a lesser extent, borrowings.Cash utilized in 

28

----

operating activities was$3,408,927 in 2004 and $2,032,108 in 2003 Use of cash was primarilyattributable to the net loss recorded.

Cash utilized in investing activities was $1,127,333in 2004 and $1,657,352 in 2003. The use of cash for investing activities wasprimarily attributable to investments in software and courseware developmentand, to a lesser extent, purchases of equipment,

Cash provided by financing activities was $6,633,780in 2004 and $3,496,978 in 2003.

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 at $1.63 per share, a Series A senior secured convertiblenote in the original principal amount of $118,500 and a five-year warrantto purchase 61,350 shares of common stock. We issued an additional $250,000 of Series Bsenior secured notes in exchange for cancellation of existing short-termindebtedness in that amount. We issued to the Series B noteholders five-yearwarrants to purchase an aggregate of 383,439 shares of common stock. Theexercise price for the warrants, as adjusted upon shareholder approval in May 2004,is $1.63 per share

Upon approval of the private placement by VCampus’stockholders at our annual meeting on May 18, 2004, $18,500 of principalof each of the Series A notes was converted into common stock at $1.63 pershare and $100,000, or 50%, in principal of each of the Series B notes wasconverted into common stock at $1.63 per share. The total principal amountfor both Series converted upon approval of the stockholders was $999,625.Therefore, following stockholder approval, a total of $2,650,000 of theplacement was recorded as equity and $2,650,000 as senior debt. The notesmature on April 1, 2009 and bear interest at the rate of 8% per annumpayable quarterly in cash or stock (valued at the conversion price) at VCampus’option for the first year. Principal and interest on the notes are payable incash over the following four years in quarterly installments. Interest due forthe quarters ended June 30, September 30 and December 31, 2004in the aggregate of $163,259 was paid through the issuance an aggregate of100,137 shares of common stock valued at $1.63 per share. Absent any voluntaryconversions of the convertible notes into common stock, interest expensepayable by us under the notes in cash for the balance of 2005 will beapproximately $85,500.

During 2004, an additional $512,500 of Series Aand Series B senior secured convertible note principal was converted into314,420 shares of common stock, resulting in $1,512,125 of aggregate principalfrom this financing converted as of the end of 2004. During 2004, we issued1,132,617 shares of common stock upon the exercise of warrants and options. Netcash proceeds to us from these exercises amounted to $1,944,283.

In March 2005, we raised $995,950 in gross proceedsthrough the issuance of 611,012 shares of common stock at a purchase price of$1.63 per share to 12 accredited investors. Under the terms of this financing,we also issued five-year warrants to purchase 763,765 shares of common stockwith an exercise price of $1.63 per share to the same accredited investors. Inconnection with this financing, we paid a placement agent a fee equivalent to5% of the amount raised, paid in common stock. As this was a placement ofcommon stock, the fair value of the warrants issued was accounted for as costof capital.

We have incurred significant losses since inceptionand had an accumulated deficit of $97.0 million as of December 31,2004. We expect negative cash flow from operations to continue until the onlinerevenue stream matures. In addition, we have experienced declining revenues inthe current and prior periods, including the loss of a major customer in 2004which represented 25% of revenues in 2004.

Management’s plans to address these conditions includesales to new customers through the Select Partner program which have partiallyreplaced the sales related to the customer lost in 2004. Management anticipatesthe increase in sales seen in the current and prior periods under theSelect 

29

----

Partner program tocontinue in 2005. Management has also instituted cost cutting measures andoperates under an approved budget, which is closely monitored. Management iscommitted to maintaining operations at current levels to meet projected saleslevels. However, in the event revenues do not meet anticipated levels or we areunable to raise additional funding to meet working capital requirements, we mayneed to further significantly reduce operating expenses.

If we are not able to address our funding needs, wewill be materially adversely affected. Our future capital requirements willdepend on many factors, including, but not limited to, acceptance of and demandfor our products and services including the Select Partner business model,customer demands for technology upgrades, the types of arrangements that we mayenter into with customers and agents, and the extent to which the we invest innew technology and research and development projects. While we believe we havethe ability to raise additional capital, our ability to raise capital in thenear term is uncertain. If we are unable to raise additional funding to meetworking capital requirements, we may unable to maintain compliance with NasdaqSmallCap Market listing requirements and we might not be able to achieve ourbusiness objectives. VCampus believes it has available capital on hand andsources for additional debt and equity capital in amounts necessary to meet itscash needs into 2006. However, such capital, if needed and available, may nothave terms favorable to us or our current stockholders.

As of December 31,2004, we had net operating loss carryforwards of approximately$65.0 million for federal income tax purposes, which will expire atvarious dates through 2024. Our ability to utilize all of our net operatingloss and credit carryforwards may be limited by changes in ownership. We haverecognized a full valuation allowance against these deferred tax assets becauseit is more likely than not that sufficient taxable income will not be generatedduring the carryforward period available under the tax law to utilize thedeferred tax assets.

*ContractualObligations*

Ourfuture liquidity and capital resources will be affected by our contractualobligations. Our significant contractual obligations as of December 31,2004 are for debt and operating leases and purchase obligations. Theseobligations are summarized as follows:
| ** **                       | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                                | ** ** | **Total** | ** ** | **2005** | ** ** | **2006 - 2008** | ** ** | **2009 - 2011** | ** ** | **2012 and  Thereafter** | ** ** |
| Notes payable(1)                 |       | $                                         | 2,137,500  |   | $ | 267,188 |   | $ | 1,603,125 |   |   | $ | 267,187 |   |   |   | $ | — |   |   |
| Operating leases                 |       | 2,886,407                                 |       | 525,027 |   | 1,671,490 |   |   | 689,890 |   |   |   | — |   |   |
| Purchase  obligation(2)          |       | 32,125                                    |       | 32,125 |   | — |   |   | — |   |   |   | — |   |   |
| Total contractual obligations    |       | $                                         | 5,056,032  |   | $ | 824,340 |   | $ | 3,274,615 |   |   | $ | 957,077 |   |   |   | $ | — |   |   |
|                                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          In March 2004, weraised $5,000,000 in gross cash proceeds through the private placement of 20units, 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. We issued an additional $250,000 of Series Bsenior secured notes in exchange for cancellation of existing short-termindebtedness in that amount. Upon approval of the private placement by VCampus’stockholders at our annual meeting on May 18, 2004, $18,500 of principalof each of the Series A notes was converted into common stock at $1.63 pershare and $100,000, or 50%, in principal of each of the Series B notes wasconverted into common stock at $1.63 per share. The total principal amount forboth Series converted upon approval of the stockholders was $999,625.Therefore, following stockholder approval, a total of $2,650,000 of theplacement was recorded as equity and $2,650,000 as senior debt. The notesmature on April 1, 2009 and bear interest at the rate of 8% per annumpayable 

30

----

quarterly in cash or stock(valued at the conversion price) at VCampus’ option for the first year.Principal and interest on the notes are payable in cash over the following fouryears in quarterly installments. During 2004, an additional $512,500 of Series Aand Series B senior secured convertible note principal was converted into314,420 shares of common stock, resulting in $1,512,125 of aggregate principalfrom this financing converted as of the end of 2004.

(2)          In December 2000, weentered into a three-year (subsequently amended to a four-year) reselleragreement with a vendor to resell certain courseware. The agreement, asamended, requires us to generate sales of the vendor’s courseware sufficient togenerate royalties of $650,000 over the four-year period. As of December 31,2004, we were required to generate sales sufficient to generate royalties of$63,975 prior to January 30, 2005. In January 2005, we extended thereseller agreement for another year. Pursuant to this extension, we wereallowed carry up to $50,000 of the unsatisfied portion of our commitment tothis vendor into the twelve months ending January 30, 2006, which is theperiod of the renewal.

We have not engaged inoff-balance sheet financing or commodity contract trading.

*Recent Accounting Pronouncements*

In December 2004, FASB issued SFAS No. 123(R),“Share-Based Payment,” which requires that the cost resulting from allshare-based payments be recognized in the financial statements. In addition,SFAS No. 123(R) establishes fair value as the measurement objectivein accounting for share-based payment arrangements and requires all entities toapply a fair-value based measurement method in accounting for share-basedpayment transactions with employees. The Company believes the pro formadisclosures note 2, “Summary of Significant Accounting Policies,” of theconsolidated financial statements under the sub-heading “Stock-BasedCompensation” provide an appropriate short-term indicator of the level ofexpense that will be recognized in accordance with SFAS 123(R). However, thetotal expense recorded in future periods will depend on several variables,including the number of shared-based awards that vest and the fair value ofthose vested awards.

In December 2004, the FASB issued SFAS No. 153(SFAS 153), Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29,effective for nonmonetary asset exchanges occurring in the fiscal year beginningJanuary 1, 2006. SFAS 153 requires that exchanges of productive assets beaccounted for at fair value unless fair value cannot be reasonably determinedor the transaction lacks commercial substance. SFAS 153 is not expected to havea material effect on our consolidated financial Statements.

In December 2003, theSEC issued Staff Accounting Bulletin No. 104, Revenue Recognition, whichupdates the guidance in SAB No. 101, integrates the related set ofFrequently Asked Questions, and recognizes the role of EITF 00-21. Theadoption of SAB No. 104 did not have a material effect on our consolidatedfinancial statements.

**Item 7A.**                Quantitativeand Qualitative Disclosures About Market Risk.

In the normal course ofbusiness, we are exposed to a variety of risks including market risk associatedwith interest rate movements. Our exposure to market risk for changes ininterest rates relates primarily to any investments we may hold at varioustimes and also related to its long-term debt. When investing, our purchasesconsist of highly liquid investments with maturities at the date of purchasegenerally no greater than twelve months, thus, due to the short-term nature ofsuch investments and our usual intention to hold these investments untilmaturity, the impact of interest rate changes would not have a material impacton our results of operations. In addition, all of our long-term debtobligations are at fixed interest rates. Given the fixed rate nature of thedebt, the impact of interest rate changes also would not have a material impact

31

----

on ourresults of operations. If we receive payments in local currencies whendelivering courses in overseas markets, we could experience losses inconnection with currency translation.

**Item 8.**                        Financial Statements and Supplementary Data.

The information requiredby this item is included in this Report at pages F-1 through F-34.See Index to Consolidated Financial Statements on page F-1.

**Item 9.**                        Changes In and Disagreements With Accountants on Accounting and FinancialDisclosure.

Not applicable.

**Item 9A.**                Controlsand 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 Control Over Financial Reporting*:   Nochange in the Company’s internal control over financial reporting occurredduring the Company’s last fiscal quarter that has material affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**Item 9B.**               Other Information.

None.

**PART III**

Certaininformation required by Part III is omitted from this report because theRegistrant intends to file a definitive proxy statement for its 2005 AnnualMeeting of Stockholders (the “Proxy Statement”) within 120 days after the endof its fiscal year pursuant to Regulation 14A promulgated under the SecuritiesExchange Act of 1934, as amended, and the information included therein isincorporated herein by reference to the extent provided below.

**Item 10.**                 Directorsand Executive Officers of the Registrant.

The information required by Item10 of Form 10-K concerning the Registrant’s executive officers isset forth under the heading “Executive Officers” located at the end of Part Iof this Report.

The Board of Directors hasdetermined that the members of the Audit Committee are independent as definedin Rule 4200(a)(15) of the National Association of Securities Dealers’listing standards. The Board of Directors has determined that Martin Maleska isan “audit committee financial expert” as defined in Item 401(h) ofRegulation S-K.

The Board of Directors hasadopted a code of conduct that applies to all of our directors and employees.Our Board has also adopted a separate code of conduct for our Chief ExecutiveOfficer, Chief Financial Officer and Controller, or persons performing similarfunctions. We will provide copies of our codes of conduct without charge uponrequest. To obtain a copy of our codes of conduct, please send your written requestto VCampus Corporation, 1850 Centennial Park Drive, Suite 200, Reston, VA20191, Attention: Chief Financial Officer.

32

----

Theother information required by Item 10 of Form 10-K concerning theRegistrant’s directors is incorporated by reference to the information underthe headings “Proposal No. 1—Election of Directors” and “OtherInformation—Section 16(a) Beneficial Ownership Reporting Compliance”in the Proxy Statement.

**Item 11.**                 ExecutiveCompensation.

Theinformation required by Item 11 of Form 10-K is incorporated byreference to the information under the heading “Proposal No. 1—Election ofDirectors—Information Concerning the Board of Directors and Its Committees”, “OtherInformation—Executive Compensation”, “—Compensation of Directors”, “—Report ofthe Compensation Committee on Executive Compensation”, “—Compensation CommitteeInterlocks and Insider Participation” and “—Performance Graph” in the ProxyStatement.

**Item 12.**                 SecurityOwnership of Certain Beneficial Owners and Management.

Theinformation required by Item 12 of Form 10-K is incorporated byreference to the information under the heading “Other Information—PrincipalStockholders” and “Other Information—Equity Compensation Plan Information” inthe Proxy Statement.

**Item 13.**                 CertainRelationships and Related Transactions.

Theinformation required by Item 13 of Form 10-K is incorporated byreference to the information under the heading “Other Information—CertainTransactions” in the Proxy Statement.

**Item 14.**                 PrincipalAccountant Fees and Services

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

 

33

----

**PART IV**

**Item 15.**                 Exhibitsand Financial Statement Schedules.

(a)   The following Financial Statements, Financial Statement Schedulesand Exhibits are filed as part of this report or incorporated herein byreference:

(1)   Financial Statements.

See Index to ConsolidatedFinancial Statements on page F-1.

(2)   Financial Statement Schedules.

The following financialstatement schedule is filed with this report: Schedule II—Valuation andQualifying Account and Reserve

All other financial statementschedules for which provision is made in Regulation S-X are omitted becausethey are not required under the related instructions, are inapplicable, or therequired information is given in the financial statements, including the notesthereto and, therefore, have been omitted.

(b)   Exhibits.
| Exhibit No. | ** ** | ** **                                                                                                                  | ** ** | **Description** |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1              | (e)        | Amended and Restated  Certificate of Incorporation, as currently in effect.                                                 |
| 3.2              | (a)        | Amended and Restated Bylaws,  as currently in effect.                                                                       |
| 4.1              | (a)        | Form of Common Stock  certificate.                                                                                     |
| 10.60            | (b)        | Warrant issued to the  purchasers dated as of May 29, 2001.                                                            |
| 10.61            | (b)        | Warrant issued to the  placement agent for the May 29, 2001 private placement.                                         |
| 10.67            | (c)        | Form of warrant issued in connection with the  Series F, F-1 and F-2 preferred stock financings                   |
| 10.68            | (d)        | Employment Agreement, dated  June 3, 2002, with Christopher L. Nelson                                                  |
| 10.79            | (f)        | Form of Warrant issued on September 30,  2002 to the purchasers of Series G Preferred Stock.                 |
| 10.81            | (g)        | Employment Agreement, effective January 1,  2003, with Narasimhan P. Kannan                                            |
| 10.84            | (i)        | Form of warrant issued to the Series H  holders on May 13, 2003.                                             |
| 10.85            | (i)        | Registration Rights Agreement dated May 13,  2003 relating to the Series H financing.                             |
| 10.87            | (j)        | Amended employment agreement between VCampus and Narasimhan P.  Kannan dated June 25, 2003.                       |
| 10.88            | (j)        | Amended employment agreement between VCampus and  Christopher L. Nelson dated June 25, 2003.                      |
| 10.89            | (j)        | Form of Notice of Conversion of VCampus  preferred stock.                                                              |
| 10.90            | (j)        | Form of warrant issued in connection with the  conversion of VCampus preferred stock.                                  |
| 10.91            |       | Purchase Agreement dated March 23, 2004 for the  $5.3 million private placement                                        |
| 10.92            |       | Form of Series A Senior Secured  Convertible Note issued on March 23, 2004                                   |
| 10.93            |       | Form of Series B Senior Secured  Convertible Note issued on March 23, 2004                                   |
| 10.94            |       | Form of Warrant issued on March 23, 2004  in connection with the $5.3 million private placement                   |
| 10.95            |       | Registration Rights Agreement dated March 23,  2004 entered into in connection with the $5.3 million private placement |
|                  |            |                                                                                                                             |            |                 |  |  |

34

----

 
| 10.96 |   | Security Agreement dated  March 23, 2004 entered into in connection with the $5.3 million  private placement                     |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| 10.97 | (k)*   | Content Client License Agreement between VCampus and  Net Dimensions Limited dated February 24, 2004                                  |
| 10.98 | (k)    | Settlement Agreement and Release between VCampus and  Park University dated May 3, 2004                                               |
| 10.99 | (l)    | VCampus’ standard form of Online Content Conversion  and Distribution Agreement (also known as the form of Select Partner  Agreement) |
| 21.1  |   | List of Subsidiaries                                                                                                                       |
| 23.1  |   | Consent of Reznick Group, P.C., Independent  Registered Public Accounting Firm                                                             |
| 23.2  |   | Consent of Ernst & Young LLP, 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.                                     |
| 99.4  | (h)    | Form of Warrant issued to  the Series F holders on December 28, 2001                                                        |
| 99.5  | (h)    | Form of Warrant issued to  the convertible noteholders on December 28, 2001                                                      |
| 99.7  | (b)    | Audit Committee Charter                                                                                                                    |

----

*                    The registrant has received confidentialtreatment with respect to certain portions of this exhibit. Such portions havebeen omitted from this exhibit and have been filed separately with the SEC.

(a)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sRegistration Statement on Form S-1 (File No. 333-12135).

(b)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentReport on Form 8-K filed June 1, 2001.

(c)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sQuarterly Report on Form 10-Q filed May 15, 2002.

(d)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentreport on Form 8-K filed June 28, 2002.

(e)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’sPost-Effective Amendment No. 1 to Registration Statement No. 333-108380as filed on July 19, 2004.

(f)             Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentreport on Form 8-K filed October 3, 2002.

(g)           Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentreport on Form 8-K filed January 24, 2003.

(h)          Incorporatedby reference to the similarly numbered Exhibit to the Registrant’s currentreport on Form 8-K filed January 8, 2002

(i)             Incorporated byreference to the similarly numbered Exhibit to the Registrant’s QuarterlyReport on Form 10-Q filed May 15, 2003.

(j)              Incorporated byreference to the similarly numbered Exhibit to the Registrant’s QuarterlyReport on Form 10-Q for the quarter ended June 30, 2003.

35

----

(k)          Incorporated byreference to the similarly numbered Exhibit to the Registrant’s QuarterlyReport on Form 10-Q for the quarter ended March 31, 2004.

(l)             Incorporated byreference to the similarly numbered Exhibit to the Registrant’s QuarterlyReport on Form 10-Q for the quarter ended June 30, 2004.

36

----

 

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities and Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.
|                            | VCAMPUS  CORPORATION |
|----------------------------|----------------------|
|                       | By:                  | /s/  NARASIMHAN P. KANNAN |
|                       |                 | Narasimhan P. Kannan,*Chief Executive Officer* |
| Date:  March 29, 2005 |                 |   |

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, this report has been signed below by the following person onbehalf of the Registrant and in the capacities and on the dates indicated.
|                            | **Signature** | ** **                                    | ** ** | ** **          | **Capacity** | ** ** | ** ** | ** ** | **Date** | ** ** |
|----------------------------|---------------|-----------------------------------------------|------------|---------------------|--------------|------------|------------|------------|----------|------------|
| /s/ NARASIMHAN  P. KANNAN  |          | Chairman  and Chief  Executive Officer   |       | March 29, 2005 |
| Narasimhan P.  Kannan      |          | (Principal Executive  Officer)           |       |                |
| /s/ CHRISTOPHER  L. NELSON |          | Chief  Financial Officer                      |       | March 29, 2005 |
| Christopher L. Nelson      |          | (Principal Financial and  Accounting Officer) |       |                |
| /s/ EDSON D. DECASTRO      |          | Director                                      |       | March 28, 2005 |
| Edson D. deCastro          |          |                                          |       |                |
| /s/ MARTIN E. MALESKA      |          | Director                                      |       | March 28, 2005 |
| Martin E. Maleska          |          |                                          |       |                |
| /s/ JOHN D.  SEARS         |          | Director                                      |       | March 28, 2005 |
| John D. Sears              |          |                                          |       |                |

 

37

----

 

**VCAMPUS CORPORATION**

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**
| Report of Reznick Group,  P.C., Independent Registered Public Accounting Firm                                    | ** ** | F-2  | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------|------------|
| Report  of Ernst & Young LLP, Independent Registered Public Accounting Firm                             |       | F-3  |       |
| Consolidated Balance Sheets  as of December 31, 2003 and 2004                                               |       | F-4  |       |
| Consolidated Statements of  Operations for the years ended December 31, 2002, 2003 and 2004                 |       | F-5  |       |
| Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2002, 2003 and  2004 |       | F-6  |       |
| Consolidated Statements of Cash  Flows for the years ended December 31, 2002, 2003 and 2004                 |       | F-10 |       |
| Notes to Consolidated Financial  Statements                                                                      |       | F-11 |       |
| Schedule II—Valuation and  Qualifying Account and Reserve                                                   |       | F-34 |       |

 

 

----

 

**REPORT OF REZNICK GROUP, P.C., INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

Board of DirectorsVCampus Corporation

We have audited the accompanying consolidated balancesheets of VCampus Corporation and subsidiaries as of December 31, 2003 and2004, and the related consolidated statements of operations, stockholders’equity and cash flows for the years then ended. Our audit also included thefinancial statement schedule for the years ended December 31, 2003 and2004 as listed in Item 15(a)2. These financial statements and schedule arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements and schedule based on ouraudits. The financial statements and financial statement schedule of VCampus Corporationand subsidiaries as of December 31, 2002 and for the year then ended wereaudited by other auditors whose report dated March 14, 2003, except fornote 17, as to which date was March 28, 2003, expressed an unqualifiedopinion on those statements.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements and schedule. TheCompany has determined that it is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes assessing the accounting principles usedand significant estimates made by management, and evaluating the overallpresentation of the financial statements and schedule. We believe that ouraudits provide a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of VCampus Corporationand subsidiaries as of December 31, 2003 and 2004, and the results oftheir operations and their cash flows for the years then ended in conformitywith accounting principles generally accepted in the United States of America.In addition, in our opinion, the financial statement schedule for the yearsended December 31, 2003 and 2004, when considered in relation to the basicfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.
| /s/  REZNICK GROUP, P.C.                                                              |   |
|---------------------------------------------------------------------------------------|--------|
| Bethesda, Maryland                                                                    |
| March 11, 2005, except for note 15, as to which  the date is March 30, 2005 |

 

F-2

----

 

**REPORT OF ERNST & YOUNG LLP, INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM**

Board of DirectorsVCampus Corporation

We have audited the accompanying consolidatedstatements of operations, stockholders’ equity, and cash flows of VCampusCorporation for the year ended December 31, 2002. Our audits also includedthe financial statement schedule listed in the Index at Item 15(a). Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audit.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

In our opinion, the 2002 financial statements referredto above present fairly, in all material respects, the consolidated results ofoperations and cash flows of VCampus Corporation for the year ended December 31,2002, in conformity with U,S, generally accepted accounting principles. Also,in our opinion, the related financial statement schedule, when considered inrelation to the basic financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

Asdiscussed in note 2 to the consolidated financial statements, effective January 1,2002, VCampus Corporation adopted Statement of Financial Accounting Standards No. 142,“Accounting for Goodwill and Other Intangible Assets.”
| /s/ ERNST &  YOUNG LLP |
|---------------------------------|
| McLean, Virginia                |
| March 14, 2003             |

 

F-3

----

 

**VCAMPUS CORPORATIONCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                           | ** ** | **December 31,  2003** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                               |       |                        |       |                        |       |
| Current assets:                                                                                                                                                                      |       |                        |       |                        |       |
| Cash and cash equivalents                                                                                                                                                            |       | $                           | 534,984    |                        | $          | 2,632,504 |   |
| Accounts receivable, less allowance of $5,000 at  December 31, 2003 and 2004                                                                                                    |       | 290,530                     |       | 283,101                     |       |
| Loans receivable from related party                                                                                                                                                  |       | 83,745                      |       | 49,783                      |       |
| Loans receivable—current                                                                                                                                                        |       | 40,526                      |       | —                      |       |
| Prepaid expenses and other current assets                                                                                                                                            |       | 691,781                     |       | 665,663                     |       |
| Total current  assets                                                                                                                                                                |       | 1,641,566                   |       | 3,631,051                   |       |
| Property and  equipment, net                                                                                                                                                         |       | 509,662                     |       | 523,662                     |       |
| Capitalized  software costs and courseware development costs, net                                                                                                                    |       | 1,653,295                   |       | 1,826,745                   |       |
| Loans  receivable—less current portion                                                                                                                                          |       | 33,726                      |       | —                      |       |
| Other assets                                                                                                                                                                         |       | 127,598                     |       | 418,684                     |       |
| Other intangible  assets, net                                                                                                                                                        |       | 569,494                     |       | 390,502                     |       |
| Goodwill                                                                                                                                                                             |       | 328,317                     |       | 328,317                     |       |
| Total assets                                                                                                                                                                         |       | $                           | 4,863,658  |                        | $          | 7,118,961 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                           |       |                        |       |                        |       |
| Current liabilities:                                                                                                                                                                 |       |                        |       |                        |       |
| Accounts payable                                                                                                                                                                     |       | $                           | 1,222,987  |                        | $          | 575,183 |   |
| Accrued expenses                                                                                                                                                                     |       | 369,763                     |       | 318,478                     |       |
| Notes payable                                                                                                                                                                        |       | 225,000                     |       | 66,207                      |       |
| Deferred revenues                                                                                                                                                                    |       | 1,010,563                   |       | 851,118                     |       |
| Total current liabilities                                                                                                                                                            |       | 2,828,313                   |       | 1,810,986                   |       |
| Long-term  liabilities:                                                                                                                                                              |       |                        |       |                        |       |
| Notes payable—less discount and current portion                                                                                                                                 |       | —                      |       | 463,446                     |       |
| Total liabilities                                                                                                                                                                    |       | 2,828,313                   |       | 2,274,432                   |       |
| Commitments and  contingencies:                                                                                                                                                      |       | —                      |       | —                      |       |
| Stockholders’  equity:                                                                                                                                                          |       |                        |       |                        |       |
| Common Stock, $0.01 par value per share; 36,000,000  shares authorized; 5,167,000 and 8,461,086 shares issued and outstanding at December 31,  2003 and 2004, respectively |       | 51,670                      |       | 84,611                      |       |
| Additional paid-in capital                                                                                                                                                           |       | 92,376,579                  |       | 101,732,238                 |       |
| Accumulated deficit                                                                                                                                                                  |       | (90,392,904                 | )          | (96,972,320                 | )          |
| Total stockholders’ equity                                                                                                                                                      |       | 2,035,345                   |       | 4,844,529                   |       |
| Total liabilities  and stockholders’ equity                                                                                                                                     |       | $                           | 4,863,658  |                        | $          | 7,118,961 |   |

 

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

F-4

----

 

**VCAMPUS CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                     | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| Revenues:                                      |       |                                        |       |   |   |   |   |
| Online tuition revenues                        |       | $                                           | 5,330,686  |   | $ | 5,508,154 |   | $ | 4,497,513 |   |
| Online development and other revenues          |       | 495,425                                     |       | 448,082 |   | 318,456 |   |
| Other service revenues                         |       | 100,035                                     |       | 109,799 |   | 47,890 |   |
| Net revenues                                   |       | 5,926,146                                   |       | 6,066,035 |   | 4,863,859 |   |
| Costs and expenses:                            |       |                                        |       |   |   |   |   |
| Cost of revenues                               |       | 1,461,663                                   |       | 1,718,340 |   | 1,356,699 |   |
| Sales and marketing                            |       | 2,689,136                                   |       | 2,137,791 |   | 1,895,340 |   |
| Product development and operations             |       | 2,535,849                                   |       | 2,474,856 |   | 2,725,155 |   |
| General and administrative                     |       | 1,692,851                                   |       | 1,909,814 |   | 1,686,940 |   |
| Depreciation and amortization                  |       | 1,355,837                                   |       | 879,966 |   | 1,227,089 |   |
| Reorganization and other non-recurring charges |       | 192,000                                     |       | 172,729 |   | — |   |
| Stock-based compensation                       |       | 76,172                                      |       | 126,056 |   | 153,973 |   |
| Total costs and  expenses                      |       | 10,003,508                                  |       | 9,419,552 |   | 9,045,196 |   |
| Loss from  operations                          |       | (4,077,362                                  | )          | (3,353,517 | ) | (4,181,337 | ) |
| Other income                                   |       | 421,842                                     |       | 207,138 |   | 183,210 |   |
| Interest income  (expense)                     |       | (220,145                                    | )          | (112,644 | ) | (2,581,289 | ) |
| Loss on debt  extinguishment                   |       | (503,246                                    | )          | — |   | — |   |
| Net loss                                       |       | (4,378,911                                  | )          | (3,259,023 | ) | (6,579,416 | ) |
| Dividends to  preferred stockholders           |       | (2,768,394                                  | )          | (2,926,854 | ) | — |   |
| Net loss  attributable to common stockholders  |       | $                                           | (7,147,305 | ) | $ | (6,185,877 | ) | $ | (6,579,416 | ) |
| Basic and diluted net  loss per share          |       | $                                           | (4.79      | ) | $ | (1.81 | ) | $ | (0.97 | ) |

 

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

F-5

----

**VCAMPUS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**
| **   **                                                                                          | ** ** | **Series C  Convertible  Preferred Stock** | ** ** | **Series D  Convertible  Preferred Stock** | ** ** | **Series E  Convertible  Preferred Stock** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                      | ** ** | **Shares**                                           | ** ** | **Amount**                                           | ** ** | **Shares**                                           | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Balance at December 31, 2001                                                                               |       | 623,339                                              |       | $                                                    | 6,233      |                                                 | 1,013,809  |   | $ | 10,138 |   | 545,075 |   | $ | 5,451 |   |
| Issuance of Preferred Stock for payment of  Series E Dividends                                             |       | —                                               |       | —                                               |       | —                                               |       | — |   | 29,820 |   | 298 |   |
| Issuance of Series F convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Series F-1 convertible  Preferred Stock                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Series F-2 convertible  Preferred Stock                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Series F-2 convertible  Preferred Stock—primarily in connection with cancellation of debt |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Series G convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Series F convertible Preferred Stock subscribed                                                            |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Common Stock in connection with reverse  stock split                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of common stock—for payment of Series D  dividends                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Exercise of options & warrants                                                                         |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Compensatory stock, stock options and warrants                                                                  |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Net loss                                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Dividends on convertible preferred stock                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Balance at December 31, 2002                                                                               |       | 623,339                                              |       | $                                                    | 6,233      |                                                 | 1,013,809  |   | $ | 10,138 |   | 574,895 |   | $ | 5,749 |   |
| Issuance of Preferred Stock for payment of  Series E Dividends                                             |       | —                                               |       | —                                               |       | —                                               |       | — |   | 9,940 |   | 100 |   |
| Issuance of Series G convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Series H convertible Preferred Stock                                                           |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Common Stock                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Conversion of Preferred Stock to common stock                                                                   |       | (623,339                                             | )          | (6,233                                               | )          | (1,013,809                                           | )          | (10,138 | ) | (584,835 | ) | (5,849 | ) |
| Compensatory stock, stock options and warrants                                                                  |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Net loss                                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Balance at December 31, 2003                                                                               |       | —                                               |       | $                                                    | —     |                                                 | —     |   | $ | — |   | — |   | $ | — |   |
| Issuance of Common Stock                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Issuance of Common Stock in connection with debt  conversions                                              |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Exercises of options and  warrants                                                                              |       |                                                 |       |                                                 |       |                                                 |       |   |   |   |   |   |   |
| Compensatory stock, stock options and warrants                                                                  |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Net loss                                                                                                        |       | —                                               |       | —                                               |       | —                                               |       | — |   | — |   | — |   |
| Balance at  December 31, 2004                                                                              |       | —                                               |       | $                                                    | —     |                                                 | —     |   | $ | — |   | — |   | $ | — |   |

 

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

F-6

----

**VCAMPUS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)**

 
|                                                                                                                       | ** ** | **Series F  Convertible  Preferred Stock** | ** ** | **Series F-1  Convertible  Preferred Stock** | ** ** | **Series F-2  Convertible  Preferred Stock** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **Shares**                                           | ** ** | **Amount**                                             | ** ** | **Shares**                                             | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Balance at  December 31, 2001                                                                                         |       | 2,642,836                                            |       | $                                                      | 26,428     |                                                   | —     |   | $ | — |   | — |   |   | $ | — |   |   |
| Issuance of  Preferred Stock for payment of Series E Dividends                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of  Series F convertible Preferred Stock                                                                     |       | 357,164                                              |       | 3,572                                                  |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of  Series F-1 convertible Preferred Stock                                                              |       | —                                               |       | —                                                 |       | 1,458,413                                              |       | 14,584 |   | — |   |   | — |   |   |
| Issuance of  Series F-2 convertible Preferred Stock                                                              |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | 17,859 |   |   | 179 |   |   |
| Issuance of  Series F-2 convertible Preferred Stock—primarily in  connection with cancellation of debt |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | 9,719 |   |   | 97 |   |   |
| Issuance of  Series G convertible Preferred Stock                                                                     |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Series F  convertible Preferred Stock subscribed                                                                      |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Common  Stock in connection with reverse stock split                                                      |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of common  stock—for payment of Series D dividends                                                 |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Exercise of  options & warrants                                                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Compensatory  stock, stock options and warrants                                                                            |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Net loss                                                                                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Dividends on  convertible preferred stock                                                                                  |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Balance at  December 31, 2002                                                                                         |       | 3,000,000                                            |       | $                                                      | 30,000     |                                                   | 1,458,413  |   | $ | 14,584 |   | 27,578 |   |   | $ | 276 |   |   |
| Issuance of  Preferred Stock for payment of Series E Dividends                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of  Series G convertible Preferred Stock                                                                     |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of  Series H convertible Preferred Stock                                                                     |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Common  Stock                                                                                                  |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Conversion of  Preferred Stock to common stock                                                                             |       | (3,000,000                                           | )          | (30,000                                                | )          | (1,458,413                                             | )          | (14,584 | ) | (27,578 | ) |   | (276 | ) |   |
| Compensatory  stock, stock options and warrants                                                                            |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Net loss                                                                                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Balance at  December 31, 2003                                                                                         |       | —                                               |       | $                                                      | —     |                                                   | —     |   | $ | — |   | — |   |   | $ | — |   |   |
| Issuance of Common  Stock                                                                                                  |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Issuance of Common  Stock in connection with debt conversions                                                              |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Exercises of  options and warrants                                                                                         |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Compensatory  stock, stock options and warrants                                                                            |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Net loss                                                                                                                   |       | —                                               |       | —                                                 |       | —                                                 |       | — |   | — |   |   | — |   |   |
| Balance at December 31,  2004                                                                                         |       | —                                               |       | $                                                      | —     |                                                   | —     |   | $ | — |   | — |   |   | $ | — |   |   |

 

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

F-7

----

**VCAMPUS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)**

 
|                                                                                                              | ** ** | **Series G  Convertible** | ** ** | **Series H  Convertible** | ** ** | ** **            | ** ** | ** **       | ** ** | **Additional** | ** ** | **Preferred** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|---------------|------------|
| ** **                                                                                                        | ** ** | **Preferred Stock**       | ** ** | **Preferred Stock**       | ** ** | **Common Stock** | ** ** | **Paid in** | ** ** | **Stock**      | ** ** |
| ** **                                                                                                        | ** ** | **Shares**                     | ** ** | **Amount**                     | ** ** | **Shares**            | ** ** | **Amount**       | ** ** | **Shares**     | ** ** | **Amount**    | ** ** | **Capital** | ** ** | **Subscribed** | ** ** |
| Balance at December 31, 2001                                                                  |       | —                         |       |                           | $          | —                |       |             | —     |           |       | $             | —     |   |   | 1,469,868 |   | $ | 14,699 |   | $ | 79,910,507 |   | $ | (100,000) |   |
| Issuance of  Preferred Stock for payment of Series E Dividends                                               |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 10,655 |   | — |   |
| Issuance of  Series F convertible Preferred Stock                                                            |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 121,435 |   | — |   |
| Issuance of  Series F-1 convertible Preferred Stock                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 583,894 |   | — |   |
| Issuance of  Series F-2 convertible Preferred Stock                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 604,886 |   | — |   |
| Issuance of  Series F-2 convertible Preferred Stock—primarily in connection  with cancellation of  debt |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 594,198 |   | — |   |
| Issuance of  Series G convertible Preferred Stock                                                            |       | 49,320                         |       |                           | 492        |                  |       | —           |       |           | —     |          |       | — |   | — |   | 1,256,337 |   | — |   |
| Series F  convertible Preferred Stock subscribed                                                             |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | — |   | 100,000 |   |
| Issuance of Common  Stock in connection with reverse stock split                                                  |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 73 |   | — |   | — |   | — |   |
| Issuance of common  stock—for payment of Series D dividends                                             |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 81,325 |   | 813 |   | 277,952 |   | — |   |
| Exercise of  options & warrants                                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 1,844 |   | 19 |   | 1,078 |   | — |   |
| Compensatory  stock, stock options and warrants                                                              |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 20,794 |   | 208 |   | 2,410,679 |   | — |   |
| Net loss                                                                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | — |   | — |   |
| Dividends on  convertible preferred stock                                                                         |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | — |   | — |   |
| Balance at  December 31, 2002                                                                                |       | 49,320                         |       |                           | $          | 492                   |       |             | —     |           |       | $             | —     |   |   | 1,573,904 |   | $ | 15,739 |   | $ | 85,771,622 |   | $ | — |   |
| Issuance of  Preferred Stock for payment of Series E Dividends                                               |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | 3,248 |   | — |   |
| Issuance of  Series G convertible Preferred Stock                                                            |       | 28,721                         |       |                           | 288        |                  |       | —           |       |           | —     |          |       | — |   | — |   | 874,649 |   | — |   |
| Issuance of  Series H convertible Preferred Stock                                                            |       | —                         |       |                           | —     |                  |       | 7,503            |       |           | 75         |          |       | — |   | — |   | 1,740,165 |   | — |   |
| Issuance of Common  Stock                                                                                         |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 548,551 |   | 5,486 |   | 899,844 |   | — |   |
| Conversion of  Preferred Stock to common stock                                                                    |       | (78,041                        | )          |                           | (780       | )                     |       | (7,503           | )          |           | (75        | )             |       | 3,008,886 |   | 30,088 |   | 37,847 |   | — |   |
| Compensatory  stock, stock options and warrants                                                              |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 35,659 |   | 357 |   | 3,049,204 |   | — |   |
| Net loss                                                                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | — |   | — |   |
| Balance at  December 31, 2003                                                                                |       | —                         |       |                           | $          | —                |       |             | —     |           |       | $             | —     |   |   | 5,167,000 |   | $ | 51,670 |   | $ | 92,376,579 |   | $ | — |   |
| Issuance of Common  Stock                                                                                         |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 1,012,500 |   | 10,125 |   | 1,520,209 |   | — |   |
| Issuance of Common  Stock in connection with debt conversions                                                     |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 1,076,772 |   | 10,766 |   | 1,808,808 |   | — |   |
| Exercises of  options and warrants                                                                                |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 1,132,617 |   | 11,326 |   | 1,932,957 |   | — |   |
| Compensatory  stock, stock options and warrants                                                              |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | 72,197 |   | 724 |   | 4,093,685 |   | — |   |
| Net loss                                                                                                          |       | —                         |       |                           | —     |                  |       | —           |       |           | —     |          |       | — |   | — |   | — |   | — |   |
| Balance at  December 31, 2004                                                                                |       | —                         |       |                           | $          | —                |       |             | —     |           |       | $             | —     |   |   | 8,461,086 |   | $ | 84,611 |   | $ | 101,732,238 |   | $ | — |   |

 

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

F-8

----

**VCAMPUS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Continued)**

 
| ** **                                                                                                      | ** ** | **Accumulated   Deficit** | ** **  | **Total   Stockholders’   Equity** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------|-------------|---------------------------------------------------|------------|
| Balance at December 31, 2001                                                                               |       | $                              | (77,059,723 | )                                                 |       | $ | 2,813,733 |   |   |
| Issuance of Preferred Stock for payment of  Series E Dividends                                             |       | (10,954                        | )           |                                              | (1         | ) |   |
| Issuance of Series F convertible Preferred Stock                                                           |       | —                         |        |                                              | 125,007    |   |   |
| Issuance of Series F-1 convertible  Preferred Stock                                                        |       | (44,282                        | )           |                                              | 554,196    |   |   |
| Issuance of Series F-2 convertible  Preferred Stock                                                        |       | —                         |        |                                              | 605,065    |   |   |
| Issuance of Series F-2 convertible  Preferred Stock—primarily in connection with cancellation of debt |       | (81,894                        | )           |                                              | 512,401    |   |   |
| Issuance of Series G convertible Preferred Stock                                                           |       | (198,166                       | )           |                                              | 1,058,663  |   |   |
| Series F convertible Preferred Stock subscribed                                                            |       | —                         |        |                                              | 100,000    |   |   |
| Issuance of Common Stock in connection with reverse  stock split                                                |       | —                         |        |                                              | —     |   |   |
| Issuance of common stock—for payment of Series D  dividends                                           |       | —                         |        |                                              | 278,765    |   |   |
| Exercise of options & warrants                                                                         |       | —                         |        |                                              | 1,097      |   |   |
| Compensatory stock, stock options and warrants                                                                  |       | (2,154,298                     | )           |                                              | 256,590    |   |   |
| Net loss                                                                                                        |       | (4,378,911                     | )           |                                              | (4,378,911 | ) |   |
| Dividends on convertible preferred stock                                                                        |       | (278,800                       | )           |                                              | (278,800   | ) |   |
| Balance at December 31, 2002                                                                               |       | $                              | (84,207,028 | )                                                 |       | $ | 1,647,805 |   |   |
| Issuance of Preferred Stock for payment of  Series E Dividends                                             |       | (3,348                         | )           |                                              | —     |   |   |
| Issuance of Series G convertible Preferred Stock                                                           |       | —                         |        |                                              | 874,937    |   |   |
| Issuance of Series H convertible Preferred Stock                                                           |       | —                         |        |                                              | 1,740,240  |   |   |
| Issuance of Common Stock                                                                                        |       | —                         |        |                                              | 905,330    |   |   |
| Conversion of Preferred Stock to common stock                                                                   |       | —                         |        |                                              | —     |   |   |
| Compensatory stock, stock options and warrants                                                                  |       | (2,923,505                     | )           |                                              | 126,056    |   |   |
| Net loss                                                                                                        |       | (3,259,023                     | )           |                                              | (3,259,023 | ) |   |
| Balance at December 31, 2003                                                                               |       | $                              | (90,392,904 | )                                                 |       | $ | 2,035,345 |   |   |
| Issuance of Common Stock                                                                                        |       | —                         |        |                                              | 1,530,334  |   |   |
| Issuance of Common Stock in connection with debt  conversions                                                   |       | —                         |        |                                              | 1,819,574  |   |   |
| Exercises of options and warrants                                                                               |       | —                         |        |                                              | 1,944,283  |   |   |
| Compensatory stock, stock options and warrants                                                                  |       | —                         |        |                                              | 4,094,409  |   |   |
| Net loss                                                                                                        |       | (6,579,416                     | )           |                                              | (6,579,416 | ) |   |
| Balance at  December 31, 2004                                                                              |       | $                              | (96,972,320 | )                                                 |       | $ | 4,844,529 |   |   |

 

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

F-9

----

**VCAMPUS CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                                         | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| **Operating Activities**                                                                           |       |                                        |       |   |   |   |   |
| Net loss                                                                                           |       | $                                           | (4,378,911 | ) | $ | (3,259,023 | ) | $ | (6,579,416 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities:                       |       |                                        |       |   |   |   |   |
| Depreciation                                                                                       |       | 694,998                                     |       | 283,354 |   | 290,050 |   |
| Amortization                                                                                       |       | 660,839                                     |       | 596,611 |   | 937,039 |   |
| Bad debt expense                                                                                   |       | 6,833                                       |       | 8,622 |   | — |   |
| Loss on debt  extinguishment                                                                       |       | 503,246                                     |       | — |   | — |   |
| Impairment of  capitalized software and courseware development costs                               |       | 276,535                                     |       | — |   | — |   |
| Non-cash  stock option and stock warrant expense                                                   |       | 76,172                                      |       | 126,056 |   | 153,973 |   |
| Write-off of  note receivable                                                                      |       | 120,693                                     |       | — |   | — |   |
| Debt discount and  deferred financing costs amortization                                           |       | 214,574                                     |       | 84,841 |   | 2,430,849 |   |
| Interest expense  paid with stock                                                                  |       | —                                      |       | — |   | 117,992 |   |
| Settlement of  accounts payable and accrued expenses                                               |       | —                                      |       | — |   | (183,210 | ) |
| Decrease in  allowance for doubtful accounts                                                       |       | (68,386                                     | )          | (26,019 | ) | — |   |
| Changes in operating  assets and liabilities:                                                      |       |                                        |       |   |   |   |   |
| Accounts  receivable                                                                               |       | 382,225                                     |       | 81,207 |   | 7,429 |   |
| Prepaid expenses  and other current assets                                                         |       | (438,353                                    | )          | (32,194 | ) | 116,053 |   |
| Other assets                                                                                       |       | 52,440                                      |       | 62,848 |   | 1,118 |   |
| Accounts payable  and accrued expenses                                                             |       | (543,645                                    | )          | (185,971 | ) | (541,359 | ) |
| Deferred revenues                                                                                  |       | (220,889                                    | )          | 227,560 |   | (159,445 | ) |
| Net cash used in  operating activities                                                             |       | (2,661,629                                  | )          | (2,032,108 | ) | (3,408,927 | ) |
| **Investing Activities**                                                                           |       |                                        |       |   |   |   |   |
| Purchases of  property and equipment                                                               |       | (85,539                                     | )          | (464,720 | ) | (305,374 | ) |
| Proceeds from the  sale of property and equipment                                                  |       | —                                      |       | — |   | 1,324 |   |
| Capitalized software  and courseware development costs                                             |       | (383,789                                    | )          | (1,255,579 | ) | (931,497 | ) |
| Proceeds from  loans receivable from related party                                                 |       | 23,097                                      |       | 36,000 |   | 36,000 |   |
| Interest on loans  receivable from related party                                                   |       | (6,500                                      | )          | (2,992 | ) | (2,038 | ) |
| Proceeds from  loans receivable                                                                    |       | 37,085                                      |       | 35,000 |   | 74,252 |   |
| Advances under  loans receivable                                                                   |       | (6,792                                      | )          | (5,061 | ) | — |   |
| Net cash used in  investing activities                                                             |       | (422,438                                    | )          | (1,657,352 | ) | (1,127,333 | ) |
| **Financing Activities**                                                                           |       |                                        |       |   |   |   |   |
| Proceeds from  issuance of Common Stock                                                            |       | 1,096                                       |       | 905,330 |   | 3,474,614 |   |
| Proceeds from the  issuance of Series F convertible Preferred Stock, net of offering costs    |       | 225,007                                     |       | — |   | — |   |
| Proceeds from the  issuance of Series F-2 convertible Preferred Stock, net of  offering costs |       | 605,065                                     |       | — |   | — |   |
| Proceeds from the  issuance of Series G convertible Preferred Stock, net of offering costs    |       | 1,058,663                                   |       | 874,937 |   | — |   |
| Proceeds from the  issuance of Series H convertible Preferred Stock, net of offering costs    |       | —                                      |       | 1,740,240 |   | — |   |
| Payments on  capital lease obligations                                                             |       | (206,069                                    | )          | (23,529 | ) | — |   |
| Proceeds from  notes payable                                                                       |       | 100,000                                     |       | — |   | 3,384,166 |   |
| Repayments of  notes payable                                                                       |       | —                                      |       | — |   | (225,000 | ) |
| Net cash provided  by financing activities                                                         |       | 1,783,762                                   |       | 3,496,978 |   | 6,633,780 |   |
| Net increase  (decrease) in cash and cash equivalents                                              |       | (1,300,305                                  | )          | (192,482 | ) | 2,097,520 |   |
| Cash and cash  equivalents at the beginning of the year                                            |       | 2,027,771                                   |       | 727,466 |   | 534,984 |   |
| Cash and cash  equivalents at the end of the year                                                  |       | $                                           | 727,466    |   | $ | 534,984 |   | $ | 2,632,504 |   |
| **Supplemental cash flow information:**                                                            |       |                                        |       |   |   |   |   |
| Interest paid                                                                                      |       | $                                           | —     |   | $ | — |   | $ | 43,530 |   |

 

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

F-10

----

**VCAMPUS CORPORATIONNOTES 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 is a provider of outsourced e-Learning services. TheCompany develops courseware and manages and hosts Internet-based learningenvironments for professional credentialing and certification organizations,corporations, government agencies, and associations. The Company’s servicescover a broad range of e-Learning programs, from registration, enrollment andpayment processing to course development and delivery, as well as tracking ofstudents’ progress and reporting of results.

*Management’s Plansto Address Operating Conditions*

The Company has incurred significant losses sinceinception. The Company expects negative cash flow from operations to continueuntil the online revenue stream matures. In addition, the Company hasexperienced declining revenues in the current and prior periods, including theloss of a major customer in 2004 which represented 25% of revenues in 2004.

Management’s plans to address these conditions includesales to new customers through the Select Partner program which have partiallyreplaced the sales related to the customer lost in 2004. Management anticipatesthe increase in sales seen in the current and prior periods under theSelect Partner program to continue in 2005. Management has also instituted costcutting measures and operates under an approved budget which is closelymonitored. Management is committed to maintaining operations at current levelsto meet projected sales levels.

If the Company is not ableto address its funding needs, it will be materially adversely affected. TheCompany’s future capital requirements will depend on many factors, including,but not limited to, acceptance of and demand for its products and servicesincluding the Select Partner business model, customer demands for technologyupgrades, the types of arrangements that the Company may enter into withcustomers and agents, and the extent to which the Company invests in newtechnology and research and development projects. While the Company believes ithas the ability to raise additional capital, the Company’s ability to raisecapital beyond the $1,000,000 raised in the March 2005 private placement(see note 15) is uncertain. If the Company is unable to raise additionalfunding to meet working capital requirements, it may be unable to maintaincompliance with Nasdaq SmallCap market listing requirements.

**2.**   Summary of Significant AccountingPolicies

*Principles ofConsolidation*

The consolidated financialstatements include the accounts of the Company and its wholly-ownedsubsidiaries. All significant intercompany accounts and transactions have beeneliminated.

*Use of Estimates*

The preparation of theconsolidated financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

F-11

----

*Cash Equivalents*

Cash equivalents, whichare stated at cost, consist of highly liquid investments with originalmaturities of three months or less.

*Non-Cash FinancingActivities*

In November 2002, the Company issued 120 sharesof Series G Preferred Stock with an aggregate value of $2,988 andfive-year fully vested warrants to purchase 300 shares of common stock with anexercise price of $2.74 per share to a placement agent in connection withprivate placement of its Series G Preferred Stock. As this was a placementof preferred stock, the fair value of the common stock and warrants issued tothe placement agent was accounted for as cost of capital.

In February 2003, the Company issued 226 sharesof Series G Preferred Stock with an aggregate value of $8,927 andfive-year fully vested warrants to purchase 564 shares of common stock with anexercise price of $2.99 per share to a placement agent in connection withprivate placement of its Series G Preferred Stock. As this was a placementof preferred stock, the fair value of the common stock and warrants issued tothe placement agent was accounted for as cost of capital.

In September and October 2003,the Company issued an aggregate of 27,711 shares of its common stockwith an aggregate value of $71,771 and three-year fully vested warrants to purchase27,711 shares of common stock with an exercise price of $2.59 per share to aplacement agent in connection with the financings completed in that period. Asthis was a placement of common stock, the fair value of the common stock andwarrants issued to the placement agent was accounted for as cost of capital.

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 convertible noteprincipal at $1.63 per share.

In March and May 2004,the Company issued 76,688 shares of common stock with a value of $189,419 andfive-year fully vested warrants to purchase 250,000 shares of common stock at$1.63 per share valued at $545,000 in satisfaction of accrued financing costsrelated to the March 2004 private placement. The Company allocated$505,730 of the total value of the shares and warrants to deferred debtissuance costs which will be recognized as interest expense over the period thenotes are expected to be outstanding. The remaining amount was accounted for asa cost 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 expense overthe period the notes are expected to be outstanding. The remaining amount wasaccounted for as a cost of capital.

*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.

F-12

----

*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.The Company had a loan receivable resulting from the 1999 sale of HTR’sKnowledgeworks business totaling approximately $123,000. During 2002, theCompany determined that the loan receivable was impaired and wrote off theremaining balance totaling approximately $121,000. No interest income wasrecognized on that note for the years ended December 31, 2002, 2003 and2004.

*Property andEquipment*

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 orestimated useful life. Depreciation expenseon equipment obtained under capital lease obligations is included withdepreciation expense for similar types of equipment. Repairs andmaintenance that do not improve or extend the lives of the respective assetsare expensed in the period incurred. Depreciation expense was $694,998,$283,354 and $290,050 for 2002, 2003 and 2004, respectively.

*CapitalizedSoftware and Courseware Development Costs*

During2002, 2003 and 2004, the Company capitalized certain software and coursewaredevelopment costs. The Company capitalizes the cost of software used forinternal operations once technological feasibility of the software has beendemonstrated. The Company capitalizes costsincurred during the development process, including payroll costs for employeeswho are directly associated with the development process and services performedby consultants. 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. During 2002, 2003 and2004, the Company recognized amortization of capitalized software andcourseware development costs of $438,754, $417,613 and $758,047, respectively.During 2002, the Company wrote off $276,535 in capitalized software andcourseware development costs for courses within the telecommunications industrysegment determined to have no future value. The write-off, which represents thecarrying value of the courses, has been included in product development costsin the 2002 statement of operations.

*Web SiteDevelopment Costs*

The Company accounts forweb site development costs in accordance with Emerging Issues Task Force Issue No. 00-2*, Accounting for Web Site Development Costs*(“EITF 00-2”). In 2002, 2003 and 2004 all web site development costs wereincurred in the operating stage, including maintenance and minor enhancementsand upgrades, and were expensed as incurred.

*Goodwill and OtherIntangible Assets*

Goodwill and other intangibles represent theunamortized excess of the cost of acquiring subsidiary companies over the fairvalues of such companies’ net tangible assets at the dates of acquisition.

On January 1, 2002, the Company adopted Statementof Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and OtherIntangible Assets” (SFAS 142). In accordance with the provisions ofSFAS 142, the Company reclassified the net carrying value of its workforceintangible asset recognized in connection with the acquisition of HTR, Inc.($57,818) into goodwill on January 1, 2002. The workforce asset wascomprised of at-will employees and no longer met the criteria for recognitionapart from 

F-13

----

goodwill. Amortization of goodwill,including goodwill previously identified as a workforce intangible, ceased on January 1,2002. The Company does not have any indefinite-lived intangibles. Inaccordance with SFAS 142, the Company reviewed the useful lives of itsintangible assets and determined that they remained appropriate.

In connection with the adoption of SFAS 142, theCompany performed an assessment of whether there were indicators that goodwillwas impaired at the date of adoption. To accomplish this, the Companyidentified its reporting units and determined the carrying value of eachreporting unit. The Company then determined the fair value of the reportingunit and compared it to the reporting unit’s carrying amount. To the extent thereporting unit’s carrying amount exceeds its fair value, an indication existsthat the reporting unit’s goodwill may be impaired and the Company must performthe second step of the impairment test. In the second step, the Company mustcompare the implied fair value of the reporting unit’s goodwill, determined byallocating the reporting unit’s fair value to all of its assets and liabilitiesin a manner similar to a purchase price allocation in accordance withSFAS 141, to its carrying amount, both of which would be measured as ofthe date of adoption.

The Company performed theinitial goodwill impairment test required by SFAS 142 during the secondquarter of fiscal 2002. The Company considers itself to be a single reportingunit. Accordingly, all of the Company’s goodwill is associated with the entireCompany. The Company performed its initial impairment test and as of June 30,2002, based on the Company’s market capitalization; there was no impairment ofgoodwill recorded upon implementation of SFAS 142. The Company willcontinue to test for impairment on an annual basis, coinciding with its fiscalyear end, or on an interim basis if circumstances change that would more likelythan not reduce the fair value of the Company’s reporting unit below itscarrying amount. The Company performed its annual impairment test as of December 31,2004, and concluded that no impairment charge was required.

*Impairment ofLong-Lived Assets*

The Company accounts for long-lived assets inaccordance with the provisions of SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*(SFAS No. 144). SFAS No. 144 requires that long-lived assets andcertain identifiable intangibles be reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.

Recoverability of assets is measured by comparing thecarrying amount of an asset to future undiscounted net cash flows expected tobe generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets. Assets to bedisposed of by sale are reflected at the lower of their carrying amount or fairvalue less cost to sell.

During 2002, the Companywrote off $276,535 in capitalized software and courseware development costs forcourses within the telecommunications industry segment, as a result of animpairment analysis. The write-off has been included in product developmentcosts in the 2002 statement of operations.

*Revenue Recognition*

The Company currently derives its revenues from thefollowing sources: online tuition revenues, development and other revenues andother service revenues.

Online tuition revenues are generated primarilythrough three types of contracts: (i) contracts with higher educationpartners, (ii) corporate subscriptions, and (iii) corporate usage.For higher education partner contracts and corporate subscriptions, revenue isrecognized ratably (on a straight-line basis) over the semester term andsubscription period, respectively. For usage contracts, revenue is recognizedupon enrollment in a course. Once a student has enrolled in a course, he cannotcancel delivery of a course or 

F-14

----

receive a refund. Revenuesfrom the sales of Select Partner courseware are generally recognized ratably(on a straight-line basis) over the length of the subscription period. Initialset-up fees related to all online tuition services are recognized ratably (on astraight-line basis) over the respective contract term.

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 thetotal estimated costs of the contract. Provisions for losses on contracts aremade in the period in which they are determined.

Revenues for other services are recognized as theservices are delivered.

The Company accounts for cash received from customersas prepayments for future services as deferred revenue. The Company recognizesrevenue associated with those cash receipts in accordance with the abovepolicies.

In 2002 two customersindividually represented 28% and 12% of net revenues. In 2003, three customersindividually accounted for approximately 36%, 18% and 15% of net revenues, andin 2004 the same three customers individually accounted for 27%, 25% and 21% ofnet revenues.

*Stock-BasedCompensation*

The Company applies theintrinsic-value-based method of accounting prescribed by Accounting PrinciplesBoard Opinion No. 25 (“APB 25”), *Accountingfor Stock Issued to Employees,*and related interpretations includingFASB Interpretation No. 44 (“FIN 44”),*Accounting for Certain Transactions Involving Stock Compensation, aninterpretation of APB 25*, issued in March 2000, to account forits fixed-plan stock options. Under this method, compensation expense isrecorded only if the current market price of the underlying stock exceeded theexercise price on the date of the grant. Statement of Financial AccountingStandards No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation*, established accounting and disclosurerequirements using a fair-value-based method of accounting for stock-basedemployee compensation plans. As allowed by SFAS 123, the Company has elected tocontinue to apply the intrinsic-value-based method of accounting describedabove, and has adopted only the disclosure requirements of SFAS 123 as amendedby Statement of Financial Accounting Standards No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure, Amendment of SFAS 123* (“SFAS 148”).

Stock options and warrants granted to non-employeesare accounted for using the fair value method in accordance with the SFAS No. 123and EITF 96-18, *Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Service*s.

F-15

----

Thefollowing table illustrates the pro forma effect on net loss attributable tocommon stockholders (net loss) and pro forma net loss per common share as ifthe Company had applied the fair value recognition provisions of SFAS No. 123to stock-based compensation.
| ** **                                                                                                           | ** ** | **2002**   | ** **  | **2003**   | ** ** | **2004**    | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| Pro forma net loss:                                                                                                  |       |       |        |       |       |        |       |
| As reported                                                                                                          |       | $          | (7,147,305  | )          | $          | (6,185,877  | )          | $ | (6,579,416 | ) |
| Add: Non cash stock  compensation included in reported net loss attributable to common  stockholders                 |       | 76,172     |        | 126,056    |       | 153,973     |       |
| Deduct: Total employee  non cash stock compensation expense determined under fair value based method  for all awards |       | (4,996,214 | )           | (5,486,954 | )          | (3,212,044  | )          |
| Pro forma net loss                                                                                                   |       | $          | (12,067,347 | )          | $          | (11,546,775 | )          | $ | (9,637,487 | ) |
| Net loss per common  share:                                                                                          |       |       |        |       |       |        |       |
| Basic and diluted—as  reported                                                                                  |       | $          | (4.79       | )          | $          | (1.81       | )          | $ | (0.97 | ) |
| Basic and diluted—pro forma                                                                                     |       | $          | (8.08       | )          | $          | (3.37       | )          | $ | (1.42 | ) |

 

The effect of applying SFAS No. 123 on a proforma net loss as stated above is not necessarily representative of the effectson reported net loss for future years due to, among other things, the vestingperiod of the stock options and the fair value of additional options to begranted in the future years.

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing fair value model with the followingassumptions:
| ** **                       | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Dividend yield                   |       | 0        | %          | 0        | %          | 0        | %          |
| Volatility                       |       | 133      | %          | 126      | %          | 130      | %          |
| Average risk-free  interest rate |       | 4.39     | %          | 3.52     | %          | 3.87     | %          |
| Expected term                    |       | 7 years  |       | 7 years  |       | 8 years  |       |

 

*Concentration ofCredit Risk*

The Company performs ongoing credit evaluations of itscustomers’ financial condition and generally does not require collateral. TheCompany maintains reserves for credit losses, and such losses have been withinmanagement’s expectations.

Three customersindividually represented 18%, 13% and 26% of accounts receivable at December 31,2003. Three customers individually represented 25%, 21%, and 17% of accountsreceivable at December 31, 2004.

*FinancialInstruments*

The carrying value of theCompany’s financial instruments, including cash and cash equivalents, accountsreceivable, loans receivable, accounts payable, accrued expenses, deferredrevenues and notes payable approximated their fair values based on theshort-term maturities of these instruments.

*Royalties*

Royalties are due and payable by the Company upon thesale of certain courses for which the Company has acquired or otherwiselicensed the online publishing rights. In addition, the Company may beobligated to pay certain royalties related to courses which a customer may haveconverted to an online format and elected to distribute to all the Company’scustomers. Royalties accrue at a rate of 10% to 85% of the tuition feesreceived with respect to certain courses.

F-16

----

Royalties are classifiedas a cost of revenues and amounted to approximately $1,325,000, $1,530,000 and$1,198,000 during the years ended December 31, 2002, 2003 and 2004,respectively.

*Advertising Costs*

The Company expensesadvertising costs as incurred. Advertising costs amounted to approximately $0$0 and $70,000 for the years ended December 31, 2002, 2003, and 2004respectively.

*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 has been provided against the net deferred tax asset.

*Net Loss Per Share*

TheCompany follows the provisions of SFAS No. 128, *Earnings per Share* (“SFAS No. 128”) which requires theCompany to present basic and diluted earnings per share. Basic earnings pershare is based on the weighted-average shares outstanding and excludesany dilutive effects of options, warrants and convertible securities. Dilutedearnings per share increases the shares used in the basic calculation by thedilutive effect of stock options, warrants, and convertible preferred stock.For all years presented, common stock equivalents related to stock options, warrants,and convertible preferred stock have been excluded from diluted earnings pershare because their effect is anti-dilutive.

*Recent Accounting Pronouncements*

In December 2004, theFASB issued SFAS No. 123 (Revised 2004) (SFAS 123(R)), Share-Based Payment,that will require the Company to expense costs related to share-based paymenttransactions with employees. With limited exceptions, SFAS 123(R) requiresthat the fair value of share-based payments to employees be expensed over theperiod service is received. SFAS 123(R) becomes mandatorily effective forthe Company on July 1, 2005.

SFAS 123(R) allowsthe use of both closed form models (e.g., Black-Scholes Model) and open formmodels (e.g., lattice models) to measure the fair value of the share-based paymentas long as that model is capable of incorporating all of the substantivecharacteristics unique to share-based awards. In accordance with the transitionprovisions of SFAS 123(R), the expense attributable to an award will bemeasured in accordance with the Company’s measurement model at that award’sdate of grant.

The Company believes thepro forma disclosures in note 2, “Summary of Significant Accounting Policies,”on page F-15 under the sub-heading “Stock-Based Compensation” provide anappropriate short-term indicator of the level of expense that will berecognized in accordance with SFAS 123(R). However, the total expense recordedin future periods will depend on several variables, including the number ofshared-based awards that vest and the fair value of those vested awards.

In December 2004, theFASB issued SFAS No. 153 (SFAS 153), Exchanges of Nonmonetary Assets—anamendment of APB Opinion No. 29, effective for nonmonetary asset exchangesoccurring in the fiscal year beginning January 1, 2006. SFAS 153 requiresthat exchanges of productive assets be accounted for at fair value unless fairvalue cannot be reasonably determined or the transaction lacks commercialsubstance. SFAS 153 is not expected to have a material effect on the Company’sconsolidated financial Statements.

F-17

----

InDecember 2003, the SEC issued Staff Accounting Bulletin No. 104,Revenue Recognition, which updates the guidance in SAB No. 101, integratesthe related set of Frequently Asked Questions, and recognizes the role of EITF00-21. The adoption of SAB No. 104 did not have a material effect on theCompany’s consolidated financial statements.

*Risks and uncertainties*

TheCompany is subject to all of the risks inherent in a company that operates inthe intensely competitive Internet industry, providing a service that isrelatively new and constantly evolving. These risks include, but are notlimited to**,**market acceptance ofthe Company’s products and services, and reliance on third-party softwareincorporated in the Company’s products. The Company’s operating results may bematerially affected by these foregoing factors.

*Reclassifications*

Certainamounts presented in the 2003 consolidated financial statements have beenreclassified to conform with the 2004 presentation.

**3.   Property andEquipment**

Property and equipment consisted of the following:
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Equipment                     |       | $                     | 3,396,281  |   | $ | 2,453,929 |   |
| Computer software             |       | 1,304,550             |       | 1,295,173 |   |
| Leasehold improvements        |       | 154,358               |       | 105,598 |   |
| Furniture and fixtures        |       | 572,218               |       | 649,045 |   |
|                          |       | 5,427,407             |       | 4,503,745 |   |
| Less accumulated depreciation |       | (4,917,745            | )          | (3,980,083 | ) |
| Total                         |       | $                     | 509,662    |   | $ | 523,662 |   |

 

AtDecember 31, 2003 and 2004, the Company had no equipment under capitallease obligations.

**4.   Capitalized Software and CoursewareDevelopment Costs**

Capitalized software and courseware developmentcosts consisted of the following:
| ** **                               | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Capitalized software costs               |       | $                     | 4,678,902  |   | $ | 5,008,247 |   |
| Capitalized courseware development costs |       | 1,098,644             |       | 1,700,795 |   |
|                                     |       | 5,777,546             |       | 6,709,042 |   |
| Less accumulated amortization            |       | (4,124,251            | )          | (4,882,297 | ) |
| Total                                    |       | $                     | 1,653,295  |   | $ | 1,826,745 |   |

 

F-18

----

**5.   Goodwill andOther Intangible Assets**

Other intangible assets were comprised of:
| ** **                    | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Developed content             |       | $                     | 523,800    |   | $ | 523,800 |   |
| Trademarks and names          |       | 904,720               |       | 904,720 |   |
| Customer base                 |       | 304,820               |       | 304,820 |   |
|                          |       | 1,733,340             |       | 1,733,340 |   |
| Less accumulated amortization |       | (1,163,846            | )          | (1,342,838 | ) |
|                          |       | $                     | 569,494    |   | $ | 390,502 |   |

 

Amortization expense for other intangible assetsis expected to be as follows:
| 2005   |   | 133,490 |    |
|--------|--------|---------|---------|
| 2006   |   | 110,740 |    |
| 2007   |   | 66,078  |    |
| 2008   |   | 43,747  |    |
| 2009   |   | 36,447  |    |
|   |   | $       | 390,502 |   |
|        |        |         |         |  |

 

Amortization expenserelated to intangible assets subject to amortization totaled $215,855, $178,998and $178,992 at December 31, 2002 2003 and 2004, respectively.

Withthe adoption of SFAS 142, amortization of goodwill was discontinued as of January 1,2002.

**6.   Restructuring of Operations and OtherNon-Recurring Items**

During 2000, the Companyimplemented a plan to close certain office facilities related to HTR’snon-online business. The plan resulted in the closure of the Company’sfacilities located in Dallas, Texas, Rockville, Maryland and Washington, D.C.As a result, the Company recorded a restructuring charge of approximately$335,000 in 2000 included in reorganization and other non-recurring charges inthe 2000 statement of operations. The restructuring charge included expensesrelated to facilities lease cancellations and write-down of assets no longer inuse. During 2000, the Company paid no cash under the restructuring accrual.Included in accounts payable and accrued expenses at December 31, 2000 isapproximately $335,000, primarily representing future lease terminationpayments. All termination fees were paid in the second quarter of 2001. Theoperating activities of the discontinued operations were not tracked separatelyby the Company. During 2002, the Company recorded an additional expense of$192,000 to adjust its accrual related to the minimum amount due under a leasefor HTR’s Rockville, Maryland facility. In June 2003, the Company and thelandlord at its Rockville, Maryland facility agreed to a settlement regardingthe leased space that the Company vacated in December 2000. During 2003,the Company paid the landlord a total of $300,000 (plus a $24,000 securitydeposit retained by the landlord) to terminate the lease agreement.

InJune 2002, a former employee (separated in June 1998) filed suitagainst the Company in Dallas County, Texas. To avoid further litigationexpenses and the risk of an adverse ruling, in June 2003 the Company paidthe employee $99,999 in full settlement of all the claims, including theplaintiff’s attorneys’ fees.

F-19

----

**7.   Loans Receivable from Related Party**

Loansreceivable from a Company officer are unsecured and amounted to $83,745 and$49,783 as of December 31, 2003 and 2004, respectively. The Companyaccrues interest on the loans receivable at a rate of prime less 1%. Interestincome related to loans receivable amounted to $6,384, $2,992 and $2,036 duringthe years ended December 31, 2002, 2003 and 2004, respectively. Amountsrepaid on loans receivable from related parties were $23,097, $36,000 and$36,000 in 2002, 2003 and 2004, respectively.

**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 the Black-Scholesoption pricing model. The amount allocated to the warrants ($335,841 and$40,708 for the 2001 and 2002 funding, respectively), was recorded as a debtdiscount and was amortized to interest expense over the period the debentureswere outstanding. In March 2002, the Company issued 1,458,413 shares of Series F-1Preferred Stock and five-year fully vested warrants to purchase 14,584 sharesof common stock at $4.00 per share in exchange for the cancellation of a notein the original principal amount of $500,000 plus $10,445 in accrued interest.In May 2002, the Company issued of 5,878 shares of Series F-2Preferred Stock plus a warrant to purchase 5,878 shares of common stock at$4.00 per share, in exchange for the cancellation of a convertible promissorynote in the principal and accrued interest amount of $205,730. Upon shareholderapproval of the debt financing, the Company recorded an additional $91,563 ofdebt discount for the instruments’ beneficial conversion feature. Theunamortized debt discount at December 31, 2003 and 2004 was $0. Principaland accrued interest under the debentures was due and payable at December 31,2003. The debentures were convertible into shares of the Company’s common stockat the election of the holders at a conversion price of $3.50 per share.Principal and accrued interest of $225,000 and approximately $40,000 under thedebentures were repaid in March 2004.

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 Bnoteholders five-year warrants to purchase an aggregate of 383,439 sharesof common stock. The exercise price for the warrants is $1.63 per share.Additionally, the Company issued one quarter unit to the lead investor’scounsel as payment for legal services. The Company allocated the proceeds fromthe issuance of the notes to the notes and to that subset of warrants allocatedto the notes based on their relative fair values using the Black-Scholesoption pricing model. The amount allocated to the warrants ($1,462,538) wasrecorded as a debt discount to be amortized to interest expense over the periodthe notes are expected to be outstanding. The notes are convertible into sharesof the Company’s common stock at the election of the holders at a conversionprice of $1.63 per share. Total shares of common stock issued in connectionwith this private placement were 1,012,500. The fair value of the warrantsallocated to the common stock on a pro-rata basis has been accounted for ascost of capital.

The terms of the financinginclude antidilution provisions to the effect that if and whenever in the periodcommencing after the issuance date (March 23, 2004) and ending 24 monthsthereafter (March 22, 2006) (the Antidilution Period), the Company issuesor sells, or is deemed to have issued or sold, any shares of common stock, withthe exception of specific customary issuances which are excluded, for aconsideration per share less than the conversion price or exercise price ineffect immediately prior to such 

F-20

----

timefor the relevant shares, then concurrent with such dilutive issuance, theconversion price or exercise price for the notes and warrants, as the case maybe, then in effect shall be reduced to an equal amount to the new securitiesissuance price.

Upon stockholder approvalof the private placement the Company recorded an additional $2,187,087 of debtdiscount for the instrument’s beneficial conversion feature. In addition,$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, resulting in the issuance of 613,276 shares ofcommon stock. The Company recorded a total of $2,650,000 of the placement asequity and $2,650,000 as senior debt. The notes mature on April 1, 2009and 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.Principal and interest on the notes are payable in cash over the following fouryears in quarterly installments.

During 2004, an additional$512,500 of Series A and Series B senior secured convertible noteprincipal was converted into 314,420 shares of common stock, resulting in $1,512,125of aggregate principal from this financing converted as of December 31,2004. The unamortized debt discount on the notes as of December 31, 2004was $1,607,847.

Interest due for thequarters ended June 30 and September 30, 2004 amounted to $117,992and was paid through the issuance of an aggregate of 72,388 shares of commonstock valued at $1.63 per share on July 1 and October 1, 2004,respectively. Interest for the quarter ended December 31, 2004 amounted to$45,242 and is included in accrued expenses on the consolidated balance sheet.

As of December 31, 2004, future maturities oflong-term debt obligations were as follows:
| 2005   |   | $       | 267,188   |   |
|--------|--------|---------|-----------|--------|
| 2006   |   | 534,375 |      |
| 2007   |   | 534,375 |      |
| 2008   |   | 534,375 |      |
| 2009   |   | 267,187 |      |
|   |   | $       | 2,137,500 |   |

 

**9.   Commitments andContingencies**

*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, 2002, 2003 and 2004 was $521,953, $520,743and $520,710, respectively.

As of December 31, 2004, payments due undernon-cancelable operating leases were as follows:
| 2005       |   | $       | 525,027   |   |
|------------|--------|---------|-----------|--------|
| 2006       |   | 540,778 |      |
| 2007       |   | 557,001 |      |
| 2008       |   | 573,711 |      |
| 2009       |   | 590,923 |      |
| Thereafter |   | 98,968  |      |
|       |   | $       | 2,886,408 |   |

 

F-21

----

*Employment Agreements*

TheCompany has entered into employment agreements with certain members ofmanagement. These agreements specify minimum annual salaries as well asdiscretionary bonus amounts to be paid over the next year.

*Purchase Commitment*

EffectiveDecember 15, 2000 the Company entered into a three-year (subsequentlyamended to a four-year) agreement with a vendor to resell certain courseware.The agreement, as amended, requires the Company to generate sales of the vendor’scourseware sufficient to generate royalties of $650,000 over the four-yearperiod. Amounts paid under the agreement during the years ended December 31,2002, 2003 and 2004 were $144,697, $201,552 and $128,500, respectively. As of December 31,2004, the Company was required to generate sales sufficient to generateroyalties of $63,975 prior to January 30, 2005. In January 2005, theCompany and the vendor extended the reseller agreement for another year. Pursuantto this extension, the Company was allowed carry up to $50,000 of theunsatisfied portion of its commitment to this vendor into the twelve monthsending January 30, 2006, which is the period of the renewal.

*Litigation*

In June 2002, aformer employee (separated in June 1998) filed suit against the Company inDallas County, Texas. To avoid further litigation expenses and the risk of anadverse ruling, in June 2003 the Company paid the employee $99,999 in fullsettlement of all the claims, including the plaintiff’s attorneys’ fees.

In June 2003, theCompany and the landlord at its Rockville, Maryland facility agreed to asettlement regarding the leased space that we had vacated in December 2000.The Company paid the landlord a total of $300,000 (plus a $24,000 securitydeposit retained by the landlord) to terminate the lease agreement. As of December 31,2002 the Company had accrued $253,051 for this liability on its consolidatedbalance sheet.

In2002, the Virginia Department of Taxation completed an audit of the Company’ssales and use tax payments from August 1998 through October 2001. In July 2002,the Company received a draft assessment which contemplated a payment of taxes,penalties and interest by the Company of $212,719, primarily associated withthe Company’s alleged failure to assess use tax on third-party royaltiespaid by the Company to content providers for courses we delivered online. TheCompany paid the sales and use tax and interest on non-contested items, whichamounted to $18,928 out of the $212,719. The Company has formally contested theremaining items covered by the draft assessment, including the assessment ofuse tax on the royalties paid by the Company to content providers for coursesthe Company delivered online as well as the methodology used by the VirginiaDepartment of Taxation to estimate the royalties. In July 2003, theassessment was reduced by the Virginia Department of Taxation to $86,678including interest of $17,278. In October 2003, the Company appealed theassessment. In March 2004, the Company was notified that this appealremains under review. The Company does not have a firm estimate of theprobability of liability for this issue or the amount of anticipated legalcosts, but has reason to believe that the potential liability will be reducedto the point where it will not be considered material. Accordingly, the Companycannot estimate at this time the amount of liability to be incurred, if any. Noamounts have been accrued in the consolidated financial statements for thispotential liability.

F-22

----

**10.   Accrued Expenses**

Accrued expenses consisted of the following:
| ** **                        | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Accrued payroll and payroll taxes |       | $                     | 23,010     |   | $ | 37,665 |   |
| Accrued vacation                  |       | 59,230                |       | 27,952 |   |
| Other                             |       | 287,523               |       | 252,861 |   |
|                              |       | $                     | 369,763    |   | $ | 318,478 |   |

 

Accruedpayroll as of December 31, 2003 and 2004 primarily consists of earned butunpaid commissions.

**11.   Stockholders’ Equity**

*Stock Split*

OnJune 18, 2002, the Company’s Board of Directors approved a one-for-tenreverse stock split of the Company’s common stock. The reverse stock splitbecame effective as of the opening of business on July 8, 2002.Stockholders’ equity has been restated to give retroactive recognition to thestock split for all periods presented by reclassifying the excess par valueresulting from the reduced aggregate number of shares from common stock topaid-in capital. All references to common shares and per share amounts for allperiods presented have been retroactively restated to reflect the stock split.

*Conversion of PreferredStock*

InJune 2003, pursuant to approvals obtained at its annual meeting ofstockholders, together with agreements signed by holders of its preferredstock, the Company converted all of the outstanding shares of each of its eightclasses of preferred stock into a total of 3,007,453 shares of common stock.The conversions were effective on June 6, 2003 at conversion pricesranging from $2.196 to $69.82 per share. This recapitalization removed a totalof approximately $24.3 million of preferred stock liquidation preference thatwas formerly senior to the outstanding common stock and released the Companyfrom the obligation to pay future dividends on the converted shares. As anincentive to induce the conversions, the Company issued warrants to thepreferred stockholders to purchase a total of 451,445 shares of common stock at$3.85 per share. The Company valued the warrants using the Black-Scholes optionpricing model and recognized a deemed dividend of $1,042,838, which representsthe excess of the fair value of the warrants issued over the fair value of thestock issuable pursuant to the original conversion terms of the securities. Aspart of the recapitalization, the Company also issued a warrant to a preferredshareholder to purchase 166,155 shares of common stock at $2.20 per share inexchange for the cancellation of that shareholder’s warrant to purchase anequivalent number of shares of Series E preferred stock at the equivalentexercise price. The Company valued the warrants using the Black-Scholes optionpricing model and recognized a deemed dividend of $12,211 upon the cancellationof the warrants to purchase shares of Series E preferred stock.

*Series C PreferredStock*

InMarch 1998, the Company raised net proceeds of approximately $5,300,000 ina private placement of Series C Preferred Stock and warrants (the “Series CPreferred Stock”). In this transaction, the Company issued approximately626,300 shares of the Series C Preferred Stock, which were convertibleinto approximately 75,910 shares of common stock. The Company also issuedfive-year warrants, which were fully vested, to purchase approximately 62,630shares of common stock at an exercise price of $84.60 per share. The Series CPreferred stockholders were entitled to receive dividends if and when declaredby the Board of Directors. The Series C Preferred Stock had a liquidationpreference of $12.69 per share plus all declared but unpaid dividends upon saleor liquidation of the Company. The Company recorded deemed 

F-23

----

dividends of approximately $207,000 due to the Series CPreferred Stock being convertible to common stock at a discount from fair valueon the date of issuance. In 1999, 2,954 shares of Series C Preferred Stockwere converted into 358 shares of common stock. In January 2003, 11,817shares of Series C Preferred Stock were converted into 1,433 shares ofcommon stock. In June 2003, the remaining 611,522 shares of Series CPreferred Stock were converted into 74,122 shares of common stock.

*Series D PreferredStock*

InJune 1998, the Company raised approximately $5,200,000 in net proceedsthrough its private placement of Series D Preferred Stock (the “Series DPreferred Stock”). In this transaction, the Company issued 1,082,625 shares ofthe Series D Preferred Stock, which were convertible to 108,263 commonshares. The holders of Series D Preferred Stock were entitled to receive a5% annual dividend compounded and paid semi-annually. Such dividends werepayable, at the option of the Company, either in cash or in common stock. The Series DPreferred Stock had a liquidation preference of $8.25 per share plus alldeclared but unpaid dividends upon sale or liquidation of the Company.

In2000 and 2001, 2,727 and 56,834 shares of Series D Preferred Stock wereconverted into 273 and 5,683 shares of common stock, respectively. No shareswere converted during 2002. In June 2003, the remaining 1,013,809 sharesof Series D Preferred Stock were converted into 101,381 shares of commonstock.

In2001 and 2002, the Company issued 49,461 and 81,325 shares of common stock,respectively, to the Series D Preferred Stock holders as payment foraccrued dividends. The number of shares issued as payment of the dividends wasdetermined based on the fair market value of the Company’s common stock on thedate of issuance. The value of such shares amounted to $278,798 and $278,765for 2001 and 2002, respectively.

*Series E Preferred Stock*

The Company entered into aPrivate Equity Line of Credit Agreement (the “Equity Line Agreement”), asamended, with Hambrecht & Quist Guaranty Finance, LLC (“H&QGF”) inMay 1999. Under the Equity Line Agreement, the Company had the right,subject to certain conditions, to issue and sell to H&QGF, from time totime, shares of its Series E Convertible Preferred Stock (“Series EPreferred Stock”), for cash consideration of up to an aggregate of$7.0 million, subject to availability. The Company had the right to sellto H&QGF shares of its Series E Preferred Stock at a price equal to85% of the lower of (1) the closing market price of the Company’s commonstock on the date of issuance and (2) the average of the lowest intra-dayprices of the Company’s common stock over the five-day period ending on thedate of issuance. Each ten shares of Series E Preferred Stock wereconvertible into one share of common stock. The holders of Series EPreferred Stock were entitled to monthly dividends paid in Series EPreferred Stock, equal to 0.5% of the number of shares of Series EPreferred Stock held. The value of Series E Preferred Stock issued asdividends amounted to $10,954 and $3,348 for 2002 and 2003, respectively.

In connection with theEquity Line Agreement, the Company issued seven-year warrants, which were fullyvested, to purchase 100,000 shares of its Series E Preferred Stock toH&QGF at $2.50 per share (subsequently adjusted to 1,138,440 shares at$0.2196 per share pursuant to anti-dilution rights), and ten-year warrants,which were fully vested, to purchase 10,000 shares of its common stock at$40.00 per share to a third party. In March 2000, the Company grantedH&QGF fully vested warrants to purchase 43,632 shares of Series EPreferred Stock at an exercise price of $8.50 per share (subsequently adjustedto 384,960 shares at $0.2196 per share pursuant to anti-dilution rights) inexchange for an increase in capacity and extension of the equity line. Thesewarrants expire in November 2006. In October 2000, the Company grantedH&QGF fully vested, seven-year warrants to purchase 15,000 shares ofSeries E Preferred Stock at an exercise price of $1.94 per share(subsequently adjusted to 132,350 shares at $0.2196 per share pursuant toanti-dilution rights) in exchange for a further increase and extension of theequity line.

F-24

----

During 1999, the Company drew down $859,000 under theEquity Line Agreement and issued 379,437 shares of Series E PreferredStock at an average price of $2.26. During 2000, the Company drew down$4,382,000 under the Equity Line Agreement and issued 963,092 shares of Series EPreferred Stock at an average price of $4.55 per share. During 2001, theCompany drew down $213,150 under the Equity Line Agreement and issued 187,500shares of Series E Preferred Stock at an average price of $1.14 per share.During 2000 and 2001, 621,503 and 306,454 shares of Series E PreferredStock were converted into 62,150 and 30,645 common shares, respectively. Noshares of Series E Preferred Stock were converted into common stock in2002.

During 2000 and 2001, the Company recorded deemeddividends of approximately $773,000 and $38,000, respectively, due to the Series EPreferred Stock being issued at a discount from fair value on the date ofissuance. No deemed dividends were recorded in 2002 and 2003.

In February 2001, the Equity Line Agreement wasterminated. During 2001, the Company issued 60,000 shares of Series EPreferred Stock to H&QGF as consideration for the Company’s failure to keepan active registration statement effective in accordance with H&QGF’sregistration rights. In April 2001, the Company regained compliance withH&QGF’s registration rights through the filing and effectiveness of a newregistration statement.

In June 2003,the remaining 584,835 shares of Series E Preferred Stock were convertedinto 58,484 shares of common stock. Additionally, the Company issued awarrant to H&QGF to purchase 166,155 shares of common stock at $2.20 pershare in exchange for the cancellation of H&QGF’s warrant to purchase anequivalent number of shares of Series E preferred stock at the equivalentexercise price.

*Series F, F-1and F-2 Preferred Stock*

In December 2001, the Company issued 2,642,836shares of Series F Preferred Stock at a price of $0.35 per share. Underthe terms of this financing, the Company issued five-year fully vested warrantsto purchase 66,071 shares of common stock at $4.00 per share. As of December 31,2001, 285,712 shares of Series F Preferred Stock were subscribed for butnot issued until January 2002. Each share of Series F-1Preferred Stock was initially convertible into 1¤10thof a share of common stock at any time at the election of the holder. The Series Fpreferred stockholders were entitled to receive dividends if and when declaredby the Board of Directors. The Series F Preferred Stock had a liquidation preferenceof $0.35 per share plus all declared but unpaid dividends upon sale orliquidation of the Company.

The Company allocated the proceeds from the Series FPreferred Stock offering between the preferred stock and warrants on a relativefair value basis. The fair value of the warrants was estimated using the Black-Scholesoption pricing model. The proceeds allocated to the preferred stock were$700,000. The excess of the value of the common stock into which the Series FPreferred Stock was convertible on the date of issuance over the proceedsallocated to the preferred stock amounted to $225,000. This amount representsthe beneficial conversion feature discount on the Series F Preferred Stockand has been reflected as a deemed dividend in the 2001 statement ofoperations. This discount was recognized entirely in 2001 as the Series FPreferred Stock was immediately convertible.

In March 2002, the Company issued 1,458,413shares of Series F-1 Preferred Stock and five-year fully vestedwarrants to purchase 14,584 shares of common stock at $4.00 per share inexchange for the cancellation of a note in the original principal amount of$500,000 plus $10,445 in accrued interest. Each share of Series F-1Preferred Stock was initially convertible into 1¤10thof a share of common stock at any time at the election of the holder. Theexcess of the fair value of the Preferred Stock and warrants over the carryingvalue of the note amounted to $267,488 and was recognized as a loss on debtextinguishment in March 2002. The carrying value of the debt at the timeof its conversion was $324,392, excluding accrued interest of $10,445. Theextinguishment of the debt resulted in the write-off of $50,121 in deferreddebt issuance costs. The excess of the value of common stock into which the Series FPreferred Stock is 

F-25

----

convertible over theamount allocated to the Preferred Stock amounted to $44,282. Such amountrepresented a beneficial conversion feature discount and was recognized as adeemed dividend to the preferred stockholder upon stockholder approval of thetransaction in May 2002. The fair value of the preferred stock issued inthe exchange was estimated at the closing price of the Company’s common stockon the trading date prior to the exchange and the fair value of the warrantswas estimated at $48,128 based on the Black-Scholes option-pricingmodel.

In May 2002, the Company issued 242,859 shares ofSeries F Preferred Stock for $85,000 in cash at $0.35 per share andwarrants to purchase 6,071 shares of common stock at $4.00 per share. Eachshare of Series F Preferred Stock was initially convertible into 1¤10thof a share of common stock at any time at the election of the holder. Theproceeds were allocated to the Preferred Stock and the warrants based on theirrelative fair values. The excess of the value of common stock into which the Series FPreferred Stock is convertible over the proceeds allocated to the PreferredStock amounted to $57,104. Such amount represented a beneficial conversionfeature discount and was recognized as a deemed dividend to preferredstockholders upon stockholder approval of the offering in May 2002.

In May 2002, the Company issued 17,859 shares of Series F-2Preferred Stock for approximately $625,000 in cash at $35.00 per share (each ofwhich Series F-2 Preferred Share was initially convertible into 10shares of common stock) and warrants to purchase a total of 160,365 shares ofcommon stock at $4.00 per share. The proceeds were allocated to the PreferredStock and the warrants based on their relative fair values. The excess of thevalue of common stock into which the Series F-2 Preferred Stock isconvertible over the proceeds allocated to the Preferred Stock amounted to$579,746. Such amount represented a beneficial conversion feature discount andwas recognized as a deemed dividend to preferred stockholders upon stockholderapproval of the offering in May 2002.

In May 2002, the Company issued 5,878 shares of Series F-2Preferred Stock plus a warrant to purchase 5,878 shares of common stock at$4.00 per share, in exchange for the cancellation of a convertible promissorynote in the principal and accrued interest amount of $205,730, each of which Series F-2Preferred Share was initially convertible into 10 shares of common stock. Theexcess of the fair value of the Preferred Stock and warrants over the netcarrying value of the debt was $170,677 and was recognized as a loss on debtextinguishment. The carrying value of the debt at the time of its conversionwas $143,944, excluding accrued interest of $5,730. The extinguishment of thedebt resulted in the write-off of $16,038 in deferred debt issuance costs. Theexcess of the value of common stock into which the Series F PreferredStock is convertible over the amount allocated to the Preferred Stock amountedto $24,267. Such amount represented a beneficial conversion feature discountand was recognized as a deemed dividend to the preferred stockholder uponstockholder approval of the transaction in May 2002. The fair value of thepreferred stock issued in the exchange was estimated at the closing price ofthe Company’s common stock on the trading date prior to the exchange and thefair value of the warrants was estimated at $26,451 based on the Black-Scholes option-pricing model.

In May 2002, the Company issued 3,841 shares of Series F-2Preferred Stock in exchange for the cancellation of $126,970 of accountspayable, each of which Series F-2 Preferred Share was initiallyconvertible into 10 shares of common stock. The excess of the fair value of thePreferred Stock over the carrying value of the accounts payable amounting to$65,081 was recognized as a loss on the exchange. The excess of the value ofcommon stock into which the Series F Preferred Stock is convertible overthe amount allocated to the Preferred Stock amounted to $57,627. Such amountrepresented a beneficial conversion feature discount and was recognized as adeemed dividend to the preferred stockholder upon stockholder approval of thetransaction in May 2002.

In June 2002, the Company issued 114,305 sharesof Series F Preferred Stock for $40,007 in cash at $0.35 per share andwarrants to purchase 2,858 shares of common stock at $4.00 per share. Eachshare of Series F Preferred Stock was initially convertible into 1¤10thof a share of common stock at any time at the 

F-26

----

election of the holder.The proceeds were allocated to the Preferred Stock and the warrants based ontheir relative fair values. The excess of the value of common stock into whichthe Series F Preferred Stock is convertible over the proceeds allocated tothe Preferred Stock amounted to $17,685. Such amount represented a beneficialconversion feature discount and was recognized as a deemed dividend topreferred stockholders upon stockholder approval of the offering in May 2002.

In June 2003, the4,485,991 shares of Series F, F-1 and F-2 Preferred Stockoutstanding were converted into 1,150,144 shares of common stock.

*Series GPreferred Stock*

In September 2002, the Company issued 46,400shares of Series G Preferred Stock at a purchase price of $21.96 per share(10 times the trailing five-day average closing price of its common stock) toaccredited investors. Under the terms of the financing agreement, the Companyalso issued five-year fully vested warrants to purchase 116,000 shares of commonstock at $2.42 per share. Each share of Series G Preferred Stock wasinitially convertible into 10 shares of common stock at any time at theelection of the holder. The excess of the value of common stock into which the Series GPreferred Stock is convertible over the proceeds allocated to the PreferredStock amounted to $185,883. Such amount represented a beneficial conversionfeature discount and was immediately recognized as a deemed dividend topreferred stockholders. The fair value of the preferred stock was estimated atthe closing price of the Company’s common stock on the trading date prior tothe issuance date and the fair value of the warrants was estimated at $227,360based on the Black-Scholes option-pricing model. The issuance ofthe Series G Preferred Stock triggered an antidilution adjustment in theconversion price of the Series F, F-1 and F-2 Preferred Stockfrom $3.50 to $2.196. As result, the number of common shares potentiallyissuable upon conversion of the Series F, F-1 and F-2 PreferredStock was increased from 721,620 to 1,150,124. the Company recorded a deemeddividend of $1,499,762 in connection with this adjustment.

In November 2002, the Company issued 2,800 and120 shares of Series G Preferred Stock at a purchase price of $24.90 pershare (10 times the trailing five-day average closing price of its commonstock) to accredited investors and a placement agent, respectively. Under theterms of this financing, the Company also issued five-year fully vestedwarrants to purchase 7,000 and 300 shares of common stock at $2.74 per share tothe same accredited investors and placement agent, respectively. Each share of Series GPreferred Stock was initially convertible into 10 shares of common stock at anytime at the election of the holder. The excess of the value of common stockinto which the Series G Preferred Stock is convertible over the proceedsallocated to the Preferred Stock amounted to $12,283. Such amount represented abeneficial conversion feature discount and was immediately recognized as adeemed dividend to preferred stockholders. The fair value of the preferredstock was estimated at the closing price of the Company’s common stock on thetrading date prior to the issuance date and the fair value of the warrants wasestimated at $14,910 based on the Black-Scholes option-pricingmodel. In February 2003,the Company issued 10,125 and 226shares of Series G Preferred Stock at a purchase price of $39.50 per shareto accredited investors and a placement agent, respectively. Under the termsof this financing, the Company also issued five-yearfully vested warrants to purchase 25,313 and 564 shares of common stock at$4.35 per share to the same accredited investors and placement agent,respectively. Each share of Series GPreferred Stock was initially convertible into 10 shares of common stock at anytime at the election of the holder. The excess of the value of commonstock into which the Series G Preferred Stock was convertible over theproceeds allocated to the Preferred Stock amounted to $48,995. Such amountrepresented a beneficial conversion feature discount and was immediatelyrecognized as a deemed dividend to preferred stockholders. The fair value ofthe preferred stock was estimated at the closing price of the Company’s commonstock on the trading date prior to the issuance date and the fair value of thewarrants was estimated at $82,267 using the Black-Scholes option pricing model.

F-27

----

InMarch 2003, the Company issued18,370 shares of Series G Preferred Stock at a purchase price of $27.22per share to accredited investors. Under the terms of this financing,the Company also issued five-year fullyvested warrants to purchase 45,925 shares of common stock at $2.99 per share tothe same accredited investors. Each share of Series G Preferred Stock was initially convertible into 10 sharesof common stock at any time at the election of the holder. The excess ofthe value of common stock into which the Series G Preferred Stock wasconvertible over the proceeds allocated to the Preferred Stock amounted to$198,312. Such amount represented a beneficial conversion feature discount andwas immediately recognized as a deemed dividend to preferred stockholders. Thefair value of the preferred stock was estimated at the closing price of theCompany’s common stock on the trading date prior to the issuance date and thefair value of the warrants was estimated at $129,967 using the Black-Scholesoption pricing model. The issuance of the Series G Preferred Stock inMarch 2003 triggered an antidilution adjustment in the conversion price ofthe Series G Preferred Stock issued in February 2003 from $3.95 to$2.72. As a result, the number of common shares potentially issuable uponconversion of the Series G Preferred Stock issued in February 2003increased from 103,527 to 150,229. The Company recorded a deemed dividend of$184,481 in connection with this adjustment.

In June 2003, the78,041 shares of Series G Preferred Stock outstanding were converted into873,022 shares of common stock.

*Series HPreferred Stock*

In May 2003, the Company issued 7,503 shares of Series H Preferred Stock at a purchase priceof $240.00 per share to accredited investors. Under the terms of thisfinancing, the Company also issued five-yearfully vested warrants to purchase 187,575 shares of common stock at $5.00 pershare to the same accredited investors. Each share of Series H Preferred Stock was initiallyconvertible into 100 shares of common stock at any time at the election of theholder. The excess of the value of common stock into which the Series HPreferred Stock was convertible over the proceeds allocated to the PreferredStock amounted to $776,862. Such amount represented a beneficial conversionfeature discount and was immediately recognized as a deemed dividend topreferred stockholders. The fair value of the preferred stock was estimated atthe closing price of the Company’s common stock on the trading date prior tothe issuance date and the fair value of the warrants was estimated at $455,807using the Black-Scholes option pricing model. The issuance of the Series HPreferred Stock in May 2003 triggered an antidilution adjustment in theconversion price of the Series G Preferred Stock issued in November 2002and in February and March 2003 from $2.49, $2.72 and $2.72,respectively, to $2.40. As a result, the number of common shares potentiallyissuable upon conversion of the Series G Preferred Stock issued in thoseperiods increased from 363,114 to 409,020. The Company recorded a deemeddividend of $124,676 in connection with this adjustment.

In June 2003, the7,503 shares of Series H Preferred Stock outstanding were converted into750,300 shares of common stock.

*Common Stock*

During 2002, the Company issued 10,794 shares of itscommon stock, at an average price of $3.15 (equal to the fair market value ofthe stock on date of each transaction) per share, to certain of its directorsin lieu of cash compensation for their services. The Company recorded $33,972of compensation expense in connection with these issuances.

In June 2003, pursuant to approvals obtained atits annual meeting of stockholders, together with agreements signed by holdersof its preferred stock, the Company converted all of the outstanding shares ofeach of its eight classes of preferred stock into a total of 3,007,453 sharesof common stock.

F-28

----

On September 30, 2003, the Company raised$825,330 through the private placement of 318,660 units, at a purchase price of$2.59 per unit. On October 9, 2003, the Company raised $200,000 throughthe private placement of 77,220 units, at a purchase price of $2.59 per unit.Each unit consisted of one share of common stock and a three-year warrant topurchase one share of common stock with an exercise price of $2.59 per share.Aggregate proceeds from these private placements, net of $120,000 in financingcosts, amounted to $905,330. In connection with these financings, the Companypaid a placement agent a fee equivalent to 7% of the amount raised, paid inunits. Under the terms of the financing, because the Company did not raise anadditional $2,000,000 in equity financing by November 15, 2003, on thatdate the unit holders became entitled to receive additional shares of commonstock as if the purchase price per share of common stock had equaled $2.00 whenthe units were purchased, and the exercise price of the warrants decreased to$2.00 per share. As this was a placement of common stock, the fair value of thewarrants issued was accounted for as cost of capital.

During 2003, the Company issued 23,618 shares of itscommon stock, at an average price of $2.18 (equal to the fair market value ofthe stock on the date of each transaction) per share, to certain of its directorsin lieu of cash compensation for their services. The Company recorded $51,487of compensation expense in connection with these issuances.

During 2003, the Company issued 12,041 shares ofits common stock at an average price of $2.49 (equal to the fair market valueof the stock of the date of each transaction) to a financial advisor as aretainer fee. The Company recorded an expense related to the stock issuance of$30,000.

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. TheCompany issued an additional $250,000 of Series B senior secured notes inexchange for cancellation of existing short-term indebtedness in that amount.The Company 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 details ofthe March 2004 private placement.

During 2004, the Company issued an additional 314,420and 72,388 shares of common stock upon the conversion of $512,500 of Series Aand Series B senior secured convertible note principal and $117,992 ofinterest thereon, 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 exercisesamounted to $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, theCompany issued 55,085 shares of its common stock at an average price of $1.71(equal to the fair market value of the stock of the date of each transaction)to two financial advisors as retainer fees. The Company recorded an expenserelated to these stock issuances of $94,000.

F-29

----

*Stock Option Plans*

The Company adopted a stock option plan (the “OriginalPlan”) which permitted the Company to grant options to purchase up to 28,892shares of Common Stock to employees, board members and others who contributematerially to the success of the Company. In November 1996, the Company’sBoard of Directors decided not to grant any further options under the OriginalPlan.

During 1996, the Company’s Board of Directors approveda new stock plan (the “1996 Plan”), for the grant of stock awards to employees,directors and consultants. Stock options under the Original Plan and 1996 Planare generally granted at prices which the Company’s Board of Directors believesapproximates the fair market value of its common stock at the date of grant.Individual grants generally become exercisable ratably over a period of four tofive years from the date of grant. The contractual terms of the options rangefrom three to ten years from the date of grant.

Commonstock option activity was as follows for the periods indicated:
| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| ** **                                | ** ** | **Shares**                                  | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| Outstanding at  the beginning of the Year |       | 325,637                                     |       |   | $ | 18.95 |   |   | 299,865 |   |   | $ | 15.03 |   |   | 529,243 |   |   | $ | 7.50 |   |   |
| Granted                                   |       | 111,222                                     |       |   | 3.71 |   |   | 307,469 |   |   | 2.50 |   |   | 1,129,544 |   |   | 1.94 |   |   |
| Exercised                                 |       | (25,576                                     | )          |   | 3.36 |   |   | (35,659 | ) |   | 2.29 |   |   | (76,837 | ) |   | 2.26 |   |   |
| Canceled or  expired                      |       | (111,418                                    | )          |   | 17.87 |   |   | (42,432 | ) |   | 28.83 |   |   | (167,903 | ) |   | 2.38 |   |   |
| Outstanding at  the end of the Year       |       | 299,865                                     |       |   | 15.03 |   |   | 529,243 |   |   | 7.50 |   |   | 1,414,047 |   |   | 3.95 |   |   |
| Options exercisable at  year-end          |       | 198,829                                     |       |   | $ | 13.06 |   |   | 240,442 |   |   | $ | 11.99 |   |   | 259,756 |   |   | $ | 11.92 |   |   |

 

As of December 31, 2004, 116,783 shares wereavailable for issuance under the 1996 Plan.

Thefollowing table summarizes information about fixed-price stock optionsoutstanding at December 31, 2004:
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                             | ** ** |
|---------------------------------------------|------------|------------------------------|------------|----------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding at  December 31,  2004** | ** ** | **Average  Remaining  Contractual  Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  Exercisable at  December 31,  2004** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Less than $1.50                             |       |                         | 184,000    |                                                     |       |   | 9.2 |   |   |   | $ | 1.33 |   |   |   | 34,874 |   |   |   | $ | 1.40 |   |   |
| $  1.50  - $  3.00      |       |                         | 998,782    |                                                     |       |   | 9.3 |   |   |   | 2.03 |   |   |   | 69,355 |   |   |   | 2.54 |   |   |
| $  3.01  - $  5.00      |       |                         | 155,637    |                                                     |       |   | 7.8 |   |   |   | 3.80 |   |   |   | 85,078 |   |   |   | 3.81 |   |   |
| $  5.01  - $  7.50      |       |                         | 5,000      |                                                     |       |   | 6.7 |   |   |   | 6.00 |   |   |   | 4,062 |   |   |   | 6.00 |   |   |
| $  7.51  - $10.00                 |       |                         | 16,577     |                                                     |       |   | 2.0 |   |   |   | 9.39 |   |   |   | 16,077 |   |   |   | 9.41 |   |   |
| $10.01 -  $20.00                            |       |                         | 18,487     |                                                     |       |   | 5.8 |   |   |   | 13.08 |   |   |   | 17,032 |   |   |   | 13.04 |   |   |
| $20.01 -  $180.00                           |       |                         | 35,564     |                                                     |       |   | 4.4 |   |   |   | 63.97 |   |   |   | 32,278 |   |   |   | 64.57 |   |   |
|                                        |       |                         | 1,414,047  |                                                     |       |   | 8.9 |   |   |   | $ | 3.94 |   |   |   | 259,756 |   |   |   | $ | 11.92 |   |   |
|                                             |            |                              |            |                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average fairvalues of the options granted in 2002 with a stock price equal to the exerciseprice was $3.71. The weighted average fair values of the options granted in2003 with a stock price equal to the exercise price was $2.50. The weightedaverage fair values of the options granted in 2004 with a stock price equal tothe exercise price was $1.94.

F-30

----

*Warrants*

TheCompany has also granted warrants to purchase common stock to variousinvestors, employees and outside vendors. Warrant activity was as follows forthe periods indicated (in shares of common stock):
| ** **                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| Outstanding at  the beginning of the year |       | 635,388                                     |       | 1,108,911 |   | 2,375,116 |   |
| Granted                                   |       | 551,492                                     |       | 1,924,159 |   | 3,751,560 |   |
| Exercised                                 |       | —                                      |       | — |   | (1,111,942 | ) |
| Canceled or  expired                      |       | (77,969                                     | )          | (657,954 | ) | (2,053,324 | ) |
| Outstanding at the end  of the year       |       | 1,108,911                                   |       | 2,375,116 |   | 2,961,410 |   |

 

Exercise prices on theoutstanding warrants range from $1.63 to $70.00 per share. The weighted averagegrant date fair value of warrants issued in 2004 was $2.01. 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 sevenyears. During 2002 the number of shares and exercise prices of certain warrantswere adjusted to satisfy certain anti-dilution rights previously granted.

*Reserve forIssuance*

As of December 31,2004, the Company had reserved 4,375,457 shares of common stock for issuanceupon the exercise of outstanding options and warrants.

**12.   Retirement Plans**

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 2002, 2003 and 2004,there were no discretionary Company contributions made to the plan.

**13.   Income Taxes**

Incometax expense for the years ended December 31, 2002, 2003 and 2004 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** | ** ** |
|------------------------------------------------|------------|----------------------|------------|
| ** **                                     | ** ** | **2002**             | ** ** | **2003** | ** ** | **2004** | ** ** |
| Tax benefit at  federal statutory rate         |       | $                    | (1,489,000 | ) | $ | (1,108,000 | ) | $ | (2,303,000 | ) |
| State income  taxes, net of federal tax effect |       | (212,000             | )          | (158,000 | ) | (329,000 | ) |
| Increase in  valuation allowance               |       | 1,571,000            |       | 1,240,000 |   | 1,844,000 |   |
| Other                                          |       | 130,000              |       | 26,000 |   | 788,000 |   |
| Income tax expense                             |       | $                    | —     |   | $ | — |   | $ | — |   |

 

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 it is more likely than not that sufficient taxableincome will not be generated during the carryforward period available under thetax law 

F-31

----

to utilize the deferred tax assets. The valuationallowance for deferred taxes increased $1,571,000, $1,240,000 and $1,844,000 inthe years ended December 31, 2002, 2003 and 2004. Significant componentsof the Company’s net deferred tax assets were as follows:
| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2003**              | ** ** | **2004** | ** ** |
| Net operating  loss carryforwards  |       | $                     | 24,023,000 |   | $ | 26,279,000 |   |
| Accrued payroll                    |       | 25,000                |       | 35,000 |   |
| Other accruals                     |       | 73,000                |       | 53,000 |   |
| Other assets and  liabilities, net |       | 1,789,000             |       | 1,387,000 |   |
| Total deferred  tax assets         |       | 25,910,000            |       | 25,754,000 |   |
| Valuation  allowance               |       | (25,910,000           | )          | (27,754,000 | ) |
| Net deferred tax assets            |       | $                     | —     |   | $ | — |   |

 

As of December 31,2003 and 2004, the Company had net operating loss carryforwards for federalincome tax purposes of approximately $60,051,000 and $65,000,000, respectively,which will expire at various dates through 2024. The Company may have hadchanges in ownership which may impose limitations on its ability to utilize netoperating loss carryforwards under Section 382 of the Internal RevenueCode.

**14.   Net Loss Per Share**

Thefollowing table sets forth the computation of basic and diluted net loss pershare:
| ** **                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                             | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** |
| Numerator:                                                                             |       |                                        |       |   |   |   |   |
| Net loss                                                                               |       | $                                           | (4,378,911 | ) | $ | (3,259,023 | ) | $ | (6,579,416 | ) |
| Less: Dividends  accruing to preferred stockholders                                    |       | (2,768,394                                  | )          | (2,926,854 | ) | — |   |
| Net loss  available to common stockholders                                             |       | $                                           | (7,147,305 | ) | $ | (6,185,877 | ) | $ | (6,579,416 | ) |
| Denominator:                                                                           |       |                                        |       |   |   |   |   |
| Denominator for  basic earnings per share—weighted-average shares                 |       | 1,493,643                                   |       | 3,423,056 |   | 6,792,321 |   |
| Denominator for diluted earnings per share—adjusted weighted-average  shares |       | 1,493,643                                   |       | 3,423,056 |   | 6,792,321 |   |
| Basic and diluted  loss per share:                                                     |       |                                        |       |   |   |   |   |
| Net loss per share  available to common stockholders                                   |       | $                                           | (4.79      | ) | $ | (1.81 | ) | $ | (0.97 | ) |

 

F-32

----

Thefollowing equity instruments (with underlying common share numbers show in thetable) were not included in the diluted net loss per share calculation becausetheir effect would have been anti-dilutive:
| ** **                    | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|
| ** **                    | ** ** | **2002**                                   | ** ** | **2003** | ** ** | **2004** | ** ** |
| Convertible notes  payable:   |       | 64,285                                     |       | 64,285 |   | 1,311,354 |   |
| Convertible preferred  stock: |       |                                       |       |   |   |   |   |
| Series C                 |       | 75,554                                     |       | — |   | — |   |
| Series D                 |       | 101,380                                    |       | — |   | — |   |
| Series E                 |       | 57,490                                     |       | — |   | — |   |
| Series F                 |       | 478,142                                    |       | — |   | — |   |
| Series F-1               |       | 232,443                                    |       | — |   | — |   |
| Series F-2               |       | 439,540                                    |       | — |   | — |   |
| Series G                 |       | 493,200                                    |       | — |   | — |   |
| Stock options                 |       | 299,865                                    |       | 529,243 |   | 1,414,047 |   |
| Warrants                      |       | 1,108,911                                  |       | 2,375,116 |   | 2,961,410 |   |

 

**15.   Subsequent Events**

On March 30, 2005,the Company completed a private placement of its common stock. Under the termsof this private placement, the Company raised $995,950 in gross proceedsthrough the issuance of 611,012 shares of common stock at a purchase price of$1.63 per share to 12 accredited investors. Under the terms of this financing,the Company also issued five-year warrants to purchase 763,765 shares of commonstock with an exercise price of $1.63 per share to the same accreditedinvestors. In connection with this financing, the Company paid a placementagent a fee equivalent to 5% of the amount raised, paid in common stock. Asthis was a placement of common stock, the fair value of the warrants issued wasaccounted for as cost of capital.

**16.   QuarterlySales and Earnings Data—Unaudited**

Thefollowing table presents the quarterly results for VCampus Corporation and itssubsidiaries for the years ended December 31, 2003and 2004
| ** **                                    | ** ** | **1st Quarter** | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|-----------------------------------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|----------------------|------------|
| **2004**                                      |       |                 |       |                 |       |                 |       |                 |       |
| Revenue                                       |       | $                    | 1,494,052  |                 | $          | 1,464,944            |       | $                    | 917,635    |   | $ | 987,228 |   |
| Loss from  operations                         |       | (762,493             | )          | (885,930             | )          | (1,321,648           | )          | (1,211,266           | )          |
| Net loss  attributable to common stockholders |       | (789,205             | )          | (2,297,861           | )          | (1,768,487           | )          | (1,723,863           | )          |
| Net loss per  share, basic and diluted        |       | $                    | (0.15      | )                    | $          | (0.34                | )          | $                    | (0.24      | ) | $ | (0.22 | ) |
| **2003**                                      |       |                 |       |                 |       |                 |       |                 |       |
| Revenue                                       |       | $                    | 1,644,666  | *                    | $          | 1,640,894            | *          | $                    | 1,405,699  |   | $ | 1,374,776 |   |
| Loss from  operations                         |       | (1,009,527           | )          | (926,791             | )          | (684,849             | )          | (732,350             | )          |
| Net loss  attributable to common stockholders |       | (1,616,549           | )          | (2,583,443           | )          | (718,174             | )          | (1,267,711           | )          |
| Net loss per share,  basic and diluted        |       | $                    | (1.03      | )                    | $          | (1.09                | )          | $                    | (0.16      | ) | $ | (0.25 | ) |

----

*                    Certainrevenues and corresponding expenses included in the quarterly results have beenreclassified from the presentation in prior periods. While thisreclassification causes revenues and expenses reported in the consolidatedfinancial statements to be lower than previously reported, it has no impact onpreviously reported assets, liabilities or net loss.

F-33

----

**SCHEDULEII—VALUATION AND 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,  2002 |       |       | $          | 99                                             |       |          |       | $              | 12         |                                         |       |   | $ | (80 | )(1) |   |   | $ | 31 |   |   |
| Year ended  December 31, 2003 |       |       | 31         |                                           |       |          | 9          |           |       |                                         | (35        | )(1) |   |   | 5 |   |   |
| Year ended  December 31, 2004 |       |       | 5          |                                           |       |          | —     |           |       |                                         | —     |   |   |   | 5 |   |   |
|                                    |            |            |            |                                                |            |               |            |                |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Uncollectible amountswritten off. Net of recoveries.

F-34

----